Australian property bubble hasn’t yet burst, but can house prices keep rising amid the pandemic?
After years of dire predictions that Australia’s property bubble could burst, national house prices continue to withstand the otherwise devastating impact of the coronavirus pandemic, and once again the doomsayers have been proven wrong.
Data released this week from CoreLogic shows the national average rose 0.4 per cent in October, following five months of national declines during the COVID-19 pandemic.
Every state across Australia (except for Melbourne which suffered the impact of a second COVID lockdown) experienced gains.
But how long will the good run last?
It’s a question I asked AMP Capital chief economist Shane Oliver, who in late March at the onset of the pandemic in Australia, had warned that house prices could plummet by 20 per cent in a worst-case scenario.
In response to my question, Dr Oliver jokes that when people get their Australian citizenship, it should come with a written warranty saying, ‘Congratulations, you are now guaranteed to live in a country where house prices will continue to rise’.
He says over the years regulators and government have always stepped in and introduced measures that stopped the bubble bursting.
These range from interest rate cuts, tax incentives for property investors and other measures aimed at propping up construction.
“It’s [created] a super cycle of debt,” Dr Oliver says.
During the early 1990s recession, the level of household debt in Australia was around 40 per cent of income, he says, whereas now it is close to 200 per cent — one of the highest levels in the world.
“Each time there’s a downturn people get worried about debt and pay some of it back, but before things go too far [into the positive], the Reserve Bank cuts rates and people start borrowing again — we go back to a new level of debt and it starts the cycle again.”
So, does Dr Oliver still think house prices will dive 20 per cent this year?
“No, I had to accept the reality — for now we’re not going to see significant price falls, if anything they may go up a bit,” he says.
Limits to fuelling the property bubble
But Dr Oliver and other economists also warn that in the current environment there are limits to how fiercely regulators and governments can fuel house prices.
Interest rates are near zero, and tax incentives aimed at housing are already generous (with calls to wind them back as part of a wider tax reform package).
The Government also has to consider the political consequences of continuing to throw stimulus at construction over other sectors that are in pain.
In short, the pandemic has created several reasons to maintain a level of cynicism about the future of house prices.
Firstly, economists warn that the combination of record-low mortgage rates combined with an easing in lending standards —including the removal of responsible lending obligations — will drive household debt levels even higher.
Secondly, mortgage loan repayment holidays are coming to an end and major banks’ profits have been slashed as they set aside provisions to deal with an expected rise in mortgage defaults.
APRA data on the major banks’ home loan deferral scheme showed that at its peak use in May, 11 per cent of all home loans were being deferred.
That figure fell back to about 9 per cent by the end of September, with some customers restarting repayments, but others (mainly investors) considering selling to avoid trouble down the track.
Finally, and most importantly perhaps, is the real possibility that house prices (and especially apartment prices which are already tracking down) will fall next year, in the face of substantially lower immigration and higher unemployment.
As the Reserve Bank of Australia (RBA) continues to warn us — this increases the risk of financial instability.
The central bank has been modelling what would happen in worst-case scenarios of 40 per cent house prices falls — something it says is an “extreme but plausible” scenario.
Regulators and governments also worried about lower population projections and how that could feed into housing demand.
Slowest population growth in more than a century
After the Federal Budget, the Australian Government’s Centre for Population released a report noting that the impacts of COVID-19 will lead to Australia’s slowest population growth in more than a century.
Population growth is expected to fall to 0.2 per cent in 2020-21 and 0.4 per cent in 2021-22.
The age at which women have children has been increasing while the total number of children per family has been falling.
As a result, the total fertility rate is projected to decline from 1.69 babies per woman in 2019-20, to 1.61 in 2020-21, and 1.58 in 2021-22.
The fall in population growth is also due to the sharp reduction in net overseas migration, which is expected to be negative for the first time in 75 years.
This is based on far fewer arrivals while international borders remain closed and departures of temporary residents and a small number of Australian citizens.
The most important measure of Australia’s migration is net overseas migration — the number of people arriving in Australia minus those leaving.
The report says net overseas migration is projected to be an outflow for the next two years, at -72,000 in 2020-21 and -22,000 in 2021-22, down from an increase of 154,000 in 2019-20.
The shape of migration is also set to change.
Migrants have historically settled in central areas of Sydney and Melbourne.
There’s evidence showing that the pandemic is causing people to drift towards the outer suburbs and regional areas.
Digital Finance Analytics (DFA) principal Martin North says there is a massive oversupply of units — more than 670,000 as people decide to sell — and that includes many local and overseas investors.
Meanwhile, he says there is a net undersupply of houses, around 86,000 and those in areas close to CBD on large plots are in high demand. This, he says, partially explains the latest rise in house prices.
Mr North also adds that interstate moves from NSW and Victoria suggest more support for price rises in smaller states.
Mortgage stress and delinquencies expected to rise
But Mr North warns lower population growth does pose a threat to house prices over the next few years.
He says selling pressure will come from mortgage stress plus investors seeking to exit.
The latest data from DFA, based on its rolling household surveys, reveals that to the end of October, the percentage of households in mortgage stress has reached a new record of 40.6 per cent, which equates to 1.57 million households.
“Bank pressure to sell will increase next year,” Mr North says.
“Delinquencies are rising and will rise further, with investment properties most at risk.”
Although mortgage repayment deferrals may have insulated the number of loss-making sales in the investor segment, investors are being encouraged to sell before mortgage repayment deferrals wind down in March next year.
In its October house price report, CoreLogic noted that since June, there had been instances of lenders signalling that distressed borrowers, particularly investors, should look to sell before the end of repayment deferrals.
“This could see an increase in loss-making sales over the following two quarters, particularly in more high-risk, investor-concentrated markets,” the CoreLogic report said.
CoreLogic’s data also shows the incidence of homes resold at a loss has been higher across capital cities than the regional markets since December 2019, and widened over the June quarter.
In the June quarter, the value of the combined capital cities market fell 1.1 per cent, while regional Australian dwelling values increased 0.3 per cent.
Over the June quarter, the median profit on resales was $229,873 for houses, and $142,000 for units. The median loss among unprofitable resales was -$50,000 for houses and -$46,000 for units.
“A sharper decline in [home sale] profitability may be expected in markets with historically high exposure to overseas migration,” the report said.
Oversupply of housing amid lower population growth
Dr Oliver is of course not the only economist who has incorrectly forecast house prices will dive.
Australian economist Steve Keen is known for being a bit of a housing doomsayer. He’s been predicting imminent massive house price falls since the early 2000s.
By 2010, after years of painting a gloomy picture that did not eventuate, Dr Keen, a University of Western Sydney associate professor at the time, had to retract.
He lost a bet to then Macquarie Group interest rate strategist Rory Robertson that house prices would fall 40 per cent. The punishment: Dr Keen was forced to walk more than 200 kilometres from Canberra to the top of Mt Kosciuszko.
Despite that, Dr Keen still forecasts his prediction could come true by 2025, and today he believes there’s an even greater likelihood the property bubble could burst.
But these days it comes with a caveat: Dr Keen says Australian governments prioritise the property price level over everything else, and thereby keep fuelling the bubble.
Dr Oliver says the big risk, as we move into the new year, is the impact of migration on housing supply and demand.
He says over the past few years there have been about 180,000 to 200,000 new dwellings adding to housing supply, and that’s now dropped to about 150,000 annually.
At the same time, demand for dwellings, due to lower migration, has plummeted to about 80,000.
“So there’s potential oversupply, and that’s what ultimately could unwind the property market,” Dr Oliver says.