You often don’t know you’re in a bubble until it has actually popped. This is what ASIC chairman, Greg Medcraft, was warning three years ago. Shortly after Federal Treasury secretary, John Fraser, was somewhat less circumspect saying that Sydney was ‘unequivocally’ in a housing bubble with the same applying to Melbourne and other parts of Australia.
Home prices in Sydney at that time were rising very strongly reaching growth rates of nearly 20 per cent per annum, while in Melbourne price growth was not that far off.
Only now in mid-2018, across most capital cities, are home prices falling. But they are not collapsing.
In the major markets of Sydney and Melbourne, where most of the attention is naturally focused, home prices now are 4.8 per cent and 2.0 per cent lower than their respective peaks. In Sydney that peak occurred back in August 2017, while in Melbourne it occurred in November 2017 – a very modest retreat relative to the pace of the ascent.
So what happened in the intervening time between the multiple warnings of a bubble in 2015 and what appears to be an orderly correction in property prices now in mid-2018?
The critical events were government and regulatory interventions, focused on cooling the investor side of the housing market. In the first instance, APRA imposed a 10 per cent ‘speed limit’ on banks’ growth in lending to investors. In a second round of intervention APRA then instructed banks to restrict their issuing of interest-only loans to 30 per cent of all new residential mortgages. These federal regulatory measures coincided with the federal government, as well as various state governments, imposing additional stamp duty charges on foreign investors into the housing market. Coincidentally this happened as foreign governments (namely the Chinese government) started clamping down on capital outflows from the country.
The questions now are, how much more is there to go and will the pace of the declines accelerate and what will be the impact on new home building?
Falling house prices is something that happens routinely, usually following a period of rapid price rises. The fall in prices tends to last twelve to eighteen months and results in a 5 per cent to 10 per cent reduction in average prices. Moreover the size of the fall in prices tends to be modest relative to the immediately preceding expansion.
For the fall in house prices to go beyond these historical norms would require a fundamental imbalance between the supply of and demand for housing.
The evidence for such an imbalance is slim. While the run-up in home prices was unleashed by record low interest rates, it was underscored by record population growth that the industry was still catching up to in terms of providing the additional roofs over the additional heads. Population growth has since slowed and so too has the annual level of new home building.
The record volume of new homes built over the past five years is also one of the major causes of the fall in house prices and rental prices. It is simple, increase supply and prices will slow.
While a bubble isn’t popping before our eyes, there are risks that prices fall to the extent that wider economic conditions and specific variables are affected – that new home building falls by more than necessary, household consumption weakens and GDP gets dragged to a slower pace of growth.
These risks include: further regulation and additional stamp duty charges on foreigners on investing into housing, a prolonged slowdown in population growth, or an external shock to the global economy leading to a significant downturn in demand for Australia’s major exports (namely resources, tourism and education).
While these risks are present, the current strengths in the domestic economy represent cause for confidence that the decline in home prices will transpire as historically consistent and relatively orderly. That is, the low (and falling) value of the Aussie dollar and relatedly strong performance of key exports of resources, tourism and education will all serve to add momentum to GDP growth. These factors will support population growth (despite the recent changes to migration and citizenship rules) and ultimately stability in house prices.
co-author: Tim Reardon, Principal Economist.