Australian housing slowdown Q&A – What impact will higher interest rates have? How far will prices fall?

April 12th 2022

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Key Points

  • Australian home prices are likely to fall by 10% to 15% into 2024 primarily as a result of poor affordability and rising interest rates.
  • The negative wealth effect from falling home prices should help limit how much the RBA raises rates.
  • A change in Government is unlikely to significantly affect the outlook for home prices, but medium-term price gains are likely to be more constrained as the tailwind from ever-lower interest rates comes to an end.

 

Introduction

House prices always incite a lot of interest in Australia. Until recently it was all about surging prices and ever-worsening affordability as prices boomed. But the focus is shifting to the emerging slowdown in the face of rising interest rates. This note provides a Q&A on the main issues.

 

What is the current state of the property market?

Last year saw national average home prices rise 22%, their fastest 12-month increase since 1989, with gains propelled by record-low mortgage rates, home buyer incentives, coronavirus driving a switch in spending to “goods” like housing, recovery from the lockdowns, a lack of supply and a fear of missing out.

 

aus housing qna 1
Source: CoreLogic, AMP Capital

 

However, the monthly capital city and national price growth peaked in March last year at 2.8% and has trended down to just 0.3% for capital cities in March this year. The slowing trend since March last year has been led by Sydney and Melbourne, with prices now falling in both cities. But price gains remain very strong in Brisbane and Adelaide with property demand in Brisbane benefitting from strong interstate migration, and these cities seeing less of an affordability constraint and very low listings. Perth is accelerating, helped by its reopening to other states. And regional price growth remains very strong.

 

What is the outlook for home prices?

National average property prices are likely to peak around mid-year and then enter a cyclical downswing. After 22% growth in national average home prices last year, average home price growth this year is expected to be around 1% and we expect a 5-10% decline in average prices in 2023. From top to bottom the fall in prices into 2024 is likely to be around 10 to 15%, which would take average prices back to the levels of March/April last year.

This is likely to mask a continuing wide divergence. Sydney & Melbourne look like they have already peaked & are likely to see falls at the high end of the range. But Brisbane, Adelaide, Perth & Darwin and regional areas are less constrained by poor affordability and are likely to see shallower falls.

 

Have home prices fallen before?

A common property myth is that home prices only ever go up and never fall. But a simple look at history tells us this is not so.

 

What are the key drivers of the current downswing?

The slowdown in property price growth already underway and the likely fall in prices ahead reflects a combination of:

 

The major driver is the rise in interest rates. While the property slowdown appears to be starting earlier relative to the timing of RBA rate hikes this cycle, this reflects the bigger role ultra-low fixed rate mortgage lending played this time around in driving the boom. Normally fixed-rate lending was around 15% of new home lending, but over the last 18 months or so it was around 40% as borrowers took advantage of sub 2% fixed mortgage rates. But now fixed rates are up sharply which is taking the edge of new buyer demand well ahead of RBA hikes.

 

Will Australian home prices crash?

House price crash calls have been a dime a dozen over the last two decades, only to see the boom roll on after periodic dips. So, the experience since the early 2000s warns against getting too bearish. Some would see a 15% fall in prices as a crash, but I take it to mean prices falling 25% or so. Our assessment is that while a crash is possible, it is unlikely unless we see very aggressive rate hikes – say taking the cash rate to 4 or 5% – or much higher unemployment, driving a sharp rise in defaults and forced property sales. Several factors argue against a crash:

 

aus housing qna 2
Source: REIA, Domain (for last observation), AMP

 

However, the risk of a crash cannot be ignored given the high level of household debt and that it’s been more than 11 years since the last rate hike in Australia, meaning many current borrowers have never seen a tightening cycle.

 

What will be the impact on the economy?

The housing downturn will affect the economy via negative wealth effects on consumer spending (ie, wealth goes down, we feel poorer, we spend less) and a slowing in housing construction. The former was a significant drag on the economy in the 2017-19 period when a 10% fall in average home prices contributed to a significant slowing in consumer spending.

 

What will it mean for interest rates?

In a way the negative wealth effect of falling home prices means that the slowing housing cycle will do some of the RBA’s work for it, which means there is a good chance that it will pause tightening next year (at around 1.5% for the cash rate) – which in turn should limit the fall in house prices to 10 to 15%.

 

Are we near the end of the 25 year home price boom?

The past 100 years have seen 3 major long-term booms in Australian home prices – in the late 1920s, the post WW2 period and the late 1990s. These are highlighted with green arrows in the next chart that shows real house prices back to 1926. The boom over the last 25 years has largely been driven by the shift from high-interest rates to low-interest rates and a surge in population relative to housing supply.

 

aus housing qna 3
Source: ABS, AMP

 

At present the unfolding property downswing looks like just another cyclical downswing. But the 25-year bull market is likely to come under pressure in the years ahead.

 

What to do to permanently improve affordability?

My shopping list on this front includes:

Neither side of politics is offering a serious effort on this front.

 

Would a change of Government impact the outlook?

It’s doubtful. Unlike in 2019 when the ALP’s policy was to limit negative gearing and raise capital gains tax, which modelling indicated could reduce property prices by 2% to 9%, this time around the policy differences with respect to property between the ALP and the Coalition are minor. Out of interest, using CoreLogic data since 1980 capital city property prices have risen 6.6%pa under Coalition governments and 5.2%pa under Labor. But the dominant influence has been the economic cycle and interest rates, as policies with respect to housing have not been particularly different (excepting the brief removal then return of negative gearing in 1985 and 1987).

 

If you have any questions about this please get in touch with us.

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About the Author

Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital’s diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

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