Falling Sydney & Melbourne home prices – is this the crash?
April 11, 2018
(AMP Capital) 9 April 2018
Property prices in Sydney and Melbourne likely have more downside, but a crash is unlikely in the absence of much higher mortgage rates, much higher supply and a long continuation of recent high construction activity.
Other cities will perform better.
Property investors should remain wary of Sydney and Melbourne and focus on laggard or higher yielding markets.
Australian capital city home prices fell 0.2% in March, their fifth monthly fall in a row. This has brought annual growth down to 0.8% from 11.4% in May last year. Most of the recent weakness relates to Sydney and to a less extent Melbourne.
With prices falling in Sydney and Melbourne some see this as the start of a crash. There is good reason to be concerned:
Real capital city house prices are 27% above their long-term trend (see the next chart) and are at the high end of OECD countries in terms of the ratio of prices to income and rents.
While crash calls and stories of mortgage stress are common, they have been repeated endlessly over the last 15 years. But, a crash (say a 20% national average price fall) remains unlikely:
First, the real driver of high home prices and their persistence has been that, thanks to tight development controls and lagging infrastructure, the supply of dwellings has not kept pace with population driven demand. Over the last decade annual population growth has averaged about 150,000 above what it was over the decade to the mid-2000s, which would require roughly an extra 50,000 new homes per year. But it’s only recently that supply has caught up with the pick-up in population growth. And population growth remains very strong.
A further tightening in lending standards as banks get tougher on borrowers’ income and living expense levels along with rising supply and more realistic capital growth expectations by home buyers will see Sydney and Melbourne property prices fall another 5% or so this year with further falls likely next year.
A slowdown in the housing cycle can affect the broader economy via slowing dwelling construction, negative wealth effects on consumer spending and via the banks if mortgage defaults rise. However, as things currently stand the drag from housing construction is likely to be minimal – building approvals don’t point to a collapse in new construction (see the next chart) and it looks like alterations and additions will rise, negative wealth effects will weigh on consumers but not dramatically if we are right, and in the absence of a property price crash the impact on the banks will be manageable. Finally, other sectors of the economy are taking over from housing, eg business investment and state capital works, as being growth drivers.
There are several implications for investors:
Firstly, over the very long term residential property adjusted for costs has had a similar return to Australian shares (see next chart). Its low correlation with shares, lower volatility but lower liquidity makes it a good portfolio diversifier. So, there is clearly a role for property in investors’ portfolios.