House prices to drop but ‘crash landing’ unlikely

AMP Capital chief economist Dr Shane Oliver claimed that house prices in the two biggest capital cities, Sydney and Melbourne, would see top-to-bottom declines of 15 per cent by 2020 — meaning a further 10 per cent fall in prices can be expected in the next two years — while average prices nationwide are predicted to drop by around 5 per cent over the same period.

“There is more to go yet,” Mr Oliver said in a note to AMP clients, after data released by CoreLogic showed that national house prices dropped by 3.7 per cent in the year to September 2018, the weakest since 2012.

“Ongoing home price falls in Sydney and Melbourne will depress consumer spending as the wealth effect goes in reverse, and so home owners will be less inclined to allow their savings rate to decline.”

He warned of risks such as possible changes to negative gearing and capital gains tax concessions if the Labor Party wins the next federal election, as well as further out-of-cycle interest rate increases and stricter lending standards, especially around income and expense verification and debt-to-income limits — all of which could impact house prices.

While the risk of a “crash landing” (where average house prices fall by at least 20 per cent) remains unlikely in the absence of much higher interest rates or unemployment, Mr Oliver said that it is still a “significant risk” because it is not yet clear what will eventuate from the financial services royal commission.

“It’s a significant risk given the difficulty in gauging how severe the tightening in bank lending standards in the face of the royal commission will get and how investors will respond as their capital growth expectations collapse at a time when net rental yields are around 1–2 per cent,” the AMP chief economist said.

Mr Oliver said that it is likely that the Reserve Bank of Australia (RBA) would continue to leave cash rates on hold until late 2020 at least. (The cash rate has remained at a record low of 1.5 per cent for 26 months.)

“Home price weakness is at levels where the RBA started cutting rates in 2008 and 2011, so we still can’t rule out the next move in rates being a cut rather than a hike,” the AMP chief economist said.

Federal Treasurer Josh Frydenberg said that the downturn in house prices is “healthy for the economy”.

“What we have seen is the prices come back to a more sustainable level,” the Treasurer told media in Sydney on Tuesday (2 October).

“This is healthy for the economy. This is what the Reserve Bank had wanted. This is what APRA, the prudential regulator, had intended when it tightened investor loans.”

Mr Frydenberg said that the government would need to “be very careful” when implementing the recommendations of the Hayne royal commission to ensure “competition is maintained and Australians get access to credit in a way that doesn’t harm the economy”.

The Treasurer also slammed the Labor Party’s plan to ditch negative gearing, saying that it would be “smashing people’s house prices” and “driving up rents”.

“They need to now explain to the Australian people why, with housing prices coming back to a more sustainable level, they want to take this destructive policy to the next election and why they want to see people’s wealth and equity in their own home fall,” Mr Frydenberg said.

UBS recently reiterated its belief that Australia is at risk of experiencing a “credit crunch” in the next couple of years, but it is waiting on a number of “signposts” to make a more calculated judgement. These include the Hayne royal commission’s final report, major bank policies around living expenses, details from the Australian Prudential Regulation Authority on debt-to-income caps, the federal election, changes in property prices and sentiments from the RBA.

“We believe the royal commission creates an inflection point and credit conditions are tightening materially. Whether Australia can orchestrate an orderly housing slowdown remains to be seen, and we think the risks of a credit crunch are rising given the significant leverage in the Australian household sector,” the investment bank said in its September banking sector update.

[Related: Rate pressures mounting despite cash rate stability]