The Australian housing market: the question is not if but when it will crash

Since its settlement by Europeans, Australia has always drawn most of its wealth from its land, be it the natural resources of its subsoil or the real estate of its big cities. But this may be changing with the end of the mining boom five years ago and the resulting probable end of the real estate boom.

Real estate prices have continued to surge in Sydney and Melbourne during the last year with increases of respectively 16% and 15.3% year-on-year while they have increased by only 4.5% in Brisbane and have been dropping by 0.9% in Adelaide and 6% in Perth where the end of the mining boom has had the most impact. Many signs are showing this might be the peak.

Prices have kept surging because of lack of supply

Of course, prices are primarily driven by the forces of supply and demand. As there is not enough supply in the most sought after areas of Sydney and Melbourne for the demand, prices have kept going up to reach “irrational” levels. As it took an average of 3 years of salary to buy a home in Sydney in 1970, it takes now 11 years. So, as Australian homeowners have grown wealthier, Australian younger generations have become much poorer and can now hardly afford buying their home. Even more worryingly, Australia has the world’s second highest ratio of mortgage debt to GDP at 99% and banks devote on average 60% of their lending to home loans. This does not leave much to the other sectors of the economy.

However, on the long-term, prices always revert to their mean

In 2015, the IMF already considered that Australia’s houses are overestimated by an average of 10%. And the economy literature teaches us prices always revert to their mean on the long run.

The question is what will trigger the mean reversion and when it will happen. Property market doomsayers have cried wolf so often during the last twenty years when they have ended up being wrong that they are not listened to and real estate professionals keep believing in an always booming market, at least in Sydney and Melbourne.

Signs are showing a downturn is near

However several signs show that a market downturn might be around the corner for the Australian housing market, including in Sydney and Melbourne. Typically prices surge before a downturn as they did over the last year in Sydney and Melbourne. Most importantly, supply is catching up with demand as it has become a priority for both state and federal governments. And last but not least, regulators such as APRA and ASIC have called for tougher requirements for home loans, especially for investors, and banks are now asking for higher deposits for investors and even owner occupiers in the most expensive areas.

The IMF in its latest Article IV in January 2017 warned of two major macro-financial vulnerabilities for Australia: a hard landing in China and housing vulnerabilities, and the former could result in the latter.

Using superannuation savings would be a bad idea

The federal government is looking at solutions to make housing more affordable for new home buyers but the idea of using superannuation savings to pay for a home deposit is a very bad idea that would only fuel prices up and leave younger Australians with lower or no savings for their retirement.

A better idea would be to exempt first home buyers of stamp duty for all homes and not only newly constructed as it is now in most states.

Negative gearing is a big part of the problem

A part of the solution would be to abolish or substantially reduce the advantages of negative gearing for property investments in Australia which is one of the most favourable system for investors in the world, as this is what prompts investors to speculate in the property market. Of course this measure would trigger a slump in real estate prices but this is unavoidable and it is better to have an orderly de-escalation now than a sudden crash later.

A vulnerability also for Australian banks

Australian banks should also look at the part of mortgages in their balance sheet. Having 60% or even 70% of their portfolio for some in this one domestic asset class is not healthy and not a good diversification of risks. Ironically, as the concentration on their domestic market saved them from the GFC, it might be a very different story when a new recession will hit from home or from China which is heavily invested in the Australian property market. This time it would be better for them to be more exposed to foreign markets where the property market downturn has already happened or to other markets which are not overpriced.

https://www.imf.org/external/pubs/ft/scr/2015/cr15275.pdf

https://www.imf.org/~/media/Files/Publications/CR/.../cr1742.ashx

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