The likelihood of a “huge” decline in the Australian housing market is relatively small, but concerned investors should be watching unemployment and interest rates, Nikko AM has said.
In an August insight, the asset management company said that house prices and housing demand will “remain robust” in the short to medium term, but added that changes to interest rates and unemployment were potential pressure points.
“As long as both unemployment and interest rates remain low, it’s hard to envisage huge declines in the Australian market,” said Chris Rands, portfolio manager fixed income at Nikko AM. "In this environment, it is more likely that prices move sideways, allowing wages and income to catch up.
“For investors that are worried about house price declines, it will be important to monitor both unemployment and interest rates as key metrics for borrowers’ ability to pay.”
He explained: “There could be two main threats to the housing market: rising interest rates causing borrowers to be unable to afford repayments, or rising unemployment which makes households incapable of making repayments.”
According to Nikko AM, rising interest rates would be the “most obvious reason” for households falling behind on mortgage repayments, adding that high levels of debt in the economy could lead to a deterioration in interest coverage ratios should rates rise.
“When looking at Australian house prices from a historical perspective, rising interest rates have usually been associated with lower house prices and falling interest rates with rising prices.
“Should the Reserve Bank of Australia [RBA] move to a more hawkish bias and start lifting cash rates higher than the market expects, then this should raise some concern for investors exposed to housing. However, at the moment, this looks like a relatively low probability outcome.”
The second pressure point, rising unemployment was similarly seen to be of relatively low risk.
“The strength in the business conditions does not suggest that a large fall in unemployment is just around the corner. Rather, it shows the opposite—that we should continue to see a stable unemployment rate, which would be supportive for housing.”
Mr Rands noted that, historically, rising unemployment has been associated with weak house prices, and that an RBA official rate cut in order to free up household income was a typical response.
However, he warned that should unemployment rise rapidly, the RBA has “limited scope” to cut interest rates as they are sitting at a record low of 1.5 per cent.
The RBA last moved its official cash rate in August 2016, when it ticked down by 0.25 per cent to the current 1.5 per cent.