This Housing Downturn is Over

The housing cycle has turned. Regulators have been spooked by a slowing economy and are about to turn on the gas burners. Demand for housing is set to increase quickly over coming months.

Here are the big reasons why:

1. Interest rate cuts to drive affordability and demand for housing:

• This will be the biggest driver of demand increases. An 0.25% cut is now a near certainty, with an 0.50% cut in interest rates likely.
  • This will drive OO mortgage rates near 3.25% and INV mortgage rates around 3.75%. Affordability will be significantly improved as a result.
  • RBA research appears to indicate a 1% cut in the interest rate leads to a 28% change in house prices

• Rate cuts work by increasing nominal asset prices rise. For example:
  • Sydney house prices rose 15-20% from mid 2016 to mid 2017. This was immediately following an 0.50% cut to the interest rate (May & August 16 rate cuts) and in a similarlending climate. The 40-60% appreciation in Sydney house prices from 2012 followed a rate cutting cycle from a 4.50% cash rate to 2.00% cash rate (from late 2011-2015). In reverse, the 2010 slowdown in Sydney housing followed a large 1.75% increase to the cash rate.

2. Borrowing power improvements coming:

• The proposed assessment rate change by APRA allows banks to lend more money. Combined with rate increases, borrowers will have an increased borrowing power of between 5-20%.
  • Overall lending verification is stricter but borrowing power will near the strongest its ever been for large segments of the market.

• Combining the first two points – history suggests every time Australian regulators allow for more money in housing, Australian’s take it on, and house prices inevitably rise.

3. No changes to taxation imminent:

• No changes to negative gearing or capital gains tax will help improve housing sentiment. It’s difficult to measure what impact this has had, but the removal of the prospect of this should improve sentiment.

4. Price base is 10-20% lower:

• The current price level is already attracting more interest.
  • Without the above interventions, the market was naturally correcting and finding a stabilisation point around this mark.

5. Interest only loans no longer a structural issue:

• The stock of interest only loans is around 25%. This adjustment has seen 15%+ of ALL mortgages in Australia convert to Principle & Interest repayments.
  • This macroeconomic adjustment is now over, with the stock of IO loans similar to new IO loans being written. It is quite likely IO loans will become more popular again as pricing spreads tighten.
  • Previously I noted Australia had a debt problem. This has now been resolved. Nonetheless, the changes to interest rates & assessment rates may be fuelling the next big debt problem.

6. Fiscal policy support:

• Permanent income tax cuts will begin to hit the economy in Q3/Q4 this year providing support to demand. Net disposable incomes will rise as a result, further helping affordability.

The above six factors are all demand side factors and will drive confidence/sentiment. What is happening to supply will dictate whether the above leads to material price increases.

Downward pressure on supply: Existing property ‘new’ listing are very low at the moment:

• At the moment stock levels are dry for the limited buyers in the market. As more buyers enter the market, stock levels will continue to be an issue. This will drive up prices, particularly of existing dwellings.
• This is because new listings are down over 20% through the course of the year

Upward pressure on supply: OTP & New property settlements:

• Unlike the 2012-2015 boom, Sydney and Melbourne don’t appear to have a significant supply shortage. Current levels of supply entering the market are likely to meet or exceed ‘structural’ levels of demand (i.e. new entrants, etc).

Upward pressure on supply: Is there a large ‘ghost’ supply?

• There is likely to be a lot of sellers who are also waiting in the wings for some improvement to the market before selling. Developers look to be doing the same, holding off on marketing and selling projects until the market improves.
• It’s quite possible there’ll be a big supply side response to meet the increase in demand and prices won’t run away as a result.

Prediction: The above will play out in 2019/2020 and will lead to a 5-10% increase in house prices nationally. Supply will eventually respond to stabilise prices. This appears to be an outlier prediction that goes beyond those suggesting that the above conditions will mean house prices no longer fall. Noting the 2019-2020 impacts, pumping money into the housing market usually leads to debt fuelled binges and may create the longer term seeds of Australia’s next debt problem.

 

Love your work! The logic follows so I hope you are right.

Also, Brisbane first this time please. Sydney and Melbourne you guys had your fun 2011-2017, while we watched from the sidelines. You need to wait your turn this time around!

 

Don't be so impatient, let the down market play out, give the regionals their day in the sunshine before expecting the cities to bounce back.

 

Brisbane is becoming like the youngest child who fails to do well despite whole family emotionally invested in their success and the more everyone tries, the more they disappoint

May be we should leave Brisbane on its own and massively cut down on expectations!

 

The First Home Loan Deposit Scheme- game changer for entry level properties.

 

Oh ......so we're all OK then? Back to...............

 

Good points...but I can't see Sydney and some parts of Melbourne moving up...there is some further reductions albeit more slowly. This is due to vals and affordability. Less so in Melbourne..as Outer suburbs in some areas are looking like good value again.

The real issue is Sydney...paying 750-850k plus for a new House and Land in NW and SW is too much.

 

I know a lot of people seem to expect rate cuts to help, but the Fed started cutting rates in late 2007, when house prices had fallen only about 10%. e.g. Fed cuts rates again - Oct. 31, 2007 and Economy faces risks, not recession: Bernanke - Reuters

There was a real "it's all going to be fine now" and "we fixed it" feeling. It didn't last long. House prices kept falling because markets were very oversupplied, and because unemployment began to rise. Not saying things are going to go the same way here, but they did in Ireland a year later (rate cuts did nothing to stop the downturn). Rate cuts didn't help there, or at least not for years. I just think it's a wee bit early to start declaring this is over.

 

Redom the core logic chart is a good one but do you have an updated version?

 

I am happy to see the the downturn is potentially over but quite disappointed by how we are making it happen by loosening credit, surely this can't be good in the long run

 

I’ll nominate this as The “going the early crow” post of the year

 

In just 3.5 years? Completely resolved? That's impressive

I love the enthusiasm, and the bold call.... but that data underpinning your position is underpinned by "actuals " and Henderson Poverty Index living expenses.

Now, we all accept that when "actuals" are in play, rate cuts = price rises - we absolutely know this to be true. Every rate cut equates to a pay rise for anyone with debt. That’s the cold hard reality of actuals . But we also now know that the removal of actuals and the introduction of HEMs seriously impacts prices through the reduction in borrowing capacity - lots for investors, less or owner occupiers, but it absolutely impacts everyone. Gone is the free ride . What’s left is a DTI of 7ish and no real solution to get most people beyond that other than debt reduction or wage increases. The artificial pay rises gifted to lots of borrowers via actuals are gone - leaving real wages as the only way to deliver extra income and they are non existent.

It’s this detail that today’s “told you so’s “ are continuously failing to grasp . More fool them ...

We have had this debate already previously. More than once. Those tables you have used are tainted, even though they run well into 2017, which you will argue was AFTER APG223 . But as debated previously, WBC, CBA and NAB were still using actuals or actuals + 20% well into mid 2017, in spite of APG223 , and they were not fully onboard with HEM's by then either . In fact, the living expenses crackdown didnt really come until late 2017/ early 2018 Forensic levels of scrutiny of living expenses wasnt happening until about 18 months ago is the point. So the data on those tables for 2015 and 2016, which implies rate cuts continued to drive post APRA borrowing capacity is massively misleading because it is influenced by 3 major lenders who were doing 60-70% of the total market volume at the time, and who were still using PRE APRA lending ie "actuals" or "actuals +20% " and who were still using PRE APRA living expenses ..... They were all even still allowing PRE APRA IO extensions without reassessment, right the way throughout 2016.

When you look at the date AFTER they fell into line from mid 2017, the worm changes. By then, actuals , actuals + 20 , old living expenses and IO renewals without reassessment were all a distant memory and playing no role in borrowing capacity or prices.

What Im saying is that the new floating assessment rate , even in conjunction with rate cuts, will not produce the same capacity increases that rate cuts produced previously, because "actuals" "actuals + 20" and HEMs are now in play where they werent previously.

And dont forget the HIT your servicing takes with a rate cut, as your NG goes DOWN.

I get that everyone's excited that something that isn't bad news for borrowing capacity is about to happen... I get the optimism. But please everyone, hold your heads.

 

I'm still concerned about the supply of new apartments still to wash through in Sydney. Big drag on prices and rents of existing dwellings.

 

Yes, and we didn't have this problem during the last rate cut.

 

I think so, at least an IO repayment issue which is the issue noted as the problem.

The pace of this has certainly surprised though, 15-20% of all mortgages moving in repayment inside 24 months is a bit crazy. I can't really see how having a stock of IO debt at around 25% and new IO lending around the same as an issue anymore.

In saying that...we may be creating another problem!

And yes agree, this is definitely requires both rate cuts and assessment rate changes noted to come to bear.

Agree, it's actually a little bit concerning (this particular move). Playing out a scenario: Australia goes through another mining investment boom (external factors drive it), inflation rises substantially, interest rates rise to around 4.5% cash rate, and then you have a situation where most loans that have been approved from mid 2019 to this period as 'under water'. I.e. borrowers can't meet repayments at this interest rate level.

If it's not very carefully managed, a bigger problem may actually brew from trading off growth vs financial stability.

Great charts - agree on this. Big reason why any growth is likely to be more limited this time around from strong monetary stimulus.

 

I appreciate in our worlds and this forum, 'actuals' was amazing to allow borrowers to recycle their borrowing power, i.e. repeat investors. But I think it may be easy to overstate its importance in a macro context (very difficult to measure though). Actuals that impacted borrowing calculators were only in place when rates were around high 4's, early 5's too (not very useful when rates were 6).

Also 60-75% of the market doesn't have OFI debt and don't benefit at all. That same market now has interest rates approaching 100-200 bps lower than what they were paying then and a borrowing power environment that may actually exceed their borrowing power than (for larger Sydney to Melbourne loan sizes, depending on size of assessment rate cut).

A 3.25% OO rate + a 6-6.75% assessment rate is IMO, a very large stimulus to monetary conditions that underpin housing. It benefits the mass market, and in particular larger loans. It will almost certainly improve demand conditions. I think the quantum is unknown and whether it will be enough to outstrip supply.

What do you think will happen to prices nationally @euro73 from this type of monetary stimulus over the next financial year?

 

Hello Redom although i like your thoughts and the outcome proposed; i do think that back to boom is questionable. in realty melbourne hasn't corrected much in the mid to lower segment and people have lost faith in the system already. to top it up the immigration changes and discouragement of new arrivals in major cities can drive up vacancy rates and put a reverse pressure on rents; which are important for price growth to attract investors.

not only that but AUD falling to 60s and cost of living going up in parallel opposite can also put pressure on households going further.

Boom is great but depends on what we trade off in return!

 

I think those with no OFI will see a modest increase in capacity. They gave up 15-20% of their theoretical max capacity through the 7.25% assessment rate and HEMs. This may give them back half of that, or perhaps more if there were significant RBA cash rate reductions... ie 100 bpts . But if we only get 25 or 50bpts we are going to be looking at maybe a 10% improvement to some borrowers purchasing power, and almost no improvement to many INV borrowers. I just dont see how this is so stimulatory that it results in a sustained increase, unless the RBA goes to almost 0.

Really, only SYD and MEL have prices well about the current DTI cap of 7 x income. Other markets are at or below those levels so their prices are already mathematically supported and could actually rise , but they arent. Why? no wage growth for years. ... if those markets can already grow, and arent... will this make them grow? I dont know... I just wonder whether it will without accompanying wage growth

And where SYD and MEL are concerned I still look at medians in excess of 9 or 10 x income and even if this changed policy results in DTI ratios expanding from their current caps of 7 x income to 8 or 9 x income, that really only puts a mathematical floor under prices rather than allowing medians to take off higher - and thats if everyone borrows the maximum possible, which you've argued previously is not common.

There's still no wage inflation. The tax cuts that are coming are tiny, and the rest are years away. Add in 25 or 50 bpts and it all helps, but it doesnt double anyones borrowing power .... so I dont think this changes things too much besides the potential for a short term sugar hit . Maybe the first home thing Morrison is launching will bring forward some FHB's and give the sugar hit some legs for a while... but once they are all done, we are back to

low rates. nowhere to go but up.
low wage growth
higher debt
no more tricks in the bag

For me- it's still a decade to concentrate on paying down debt

I think this could help arrest the decline . Put a floor under things . Maybe provide a short sugar hit after that . That’s about all it can do , really .

These are all good things - I’m just questioning why all the “I told you so’s “ are pretending it’s more than that ...


I hope you are right and I hope I'm wrong. I own a lot of property It would be lovely if it jumped 10-20% . On a portfolio my size thats 7 figures . But I don't think this can create price growth like rate cuts and actuals used to. Some, yes. Boom times- doubtful. So I'll continue to pay down debt ...and the lower rates that are supposedly coming will mean I make some extra inroads into that . Thats how people should be using the lower rate environment- pay down debt. dont overextend.

 

Great insights as usual @Redom

I want to play the devil's advocate a bit (and you've touched on it in your initial post)

Borrowing power improves materially for O.O..not so much for investors

The graphic below illustrates this quite nicely. The threshold appears to be around 4.75%. If you are paying over 4.75% (investors with large portfolios on IO terms), borrowing capacity actually diminishes

Cameron Kusher on Twitter

So the impact is a bit more segmented:
1. Areas and stock tailored towards owner-occs are likely to be supported by this change
2. Areas and stock targeted by investors are less unlikely to see material uplift.

Chances of rate cut
It was only about a year ago that the expert consensus was almost universally that rates would go up over the medium term. The same experts are now claiming rate cuts (multiple) are almost a certainty. So excuse me for being a skeptic.

Whilst weak economic data, falling house prices etc all support rate cuts, one case for holding rates is Australia's cash rate relative to U.S. Over the last thirty-odd years Australia's cash rate has seldom been lower than the U.S. It is right now, and further cuts would only widen the gap. Are we trying to tank the AUD?

Gap between US and Australian cash rate widest ever as monetary policies diverge

 

Not this little Black Duck