Sydney has had a decline of 9.50% in property prices since they peaked in July last year, and Melbourne is not far behind with a drop of 5.80%. Technically anything more than 5% is considered a crash, so are Australian house prices really crashing and should we be worried in New Zealand?
I was in Australia for a securitization conference last week. It brought together global investors, banks, lenders, regulators and rating agencies all in one place. The reason they come together is that lenders in Australia issue about $30 billion of residential backed mortgage securities to investors each year.
It is always a great conference, and yes, I was the most under-dressed person there! Anyway, my takeaway from the conference is that Australian house prices will decline 15%-20% from peak to trough.
What surprised me is that nobody seems too fussed. The decline, which in my world is quite scary, was widely reported as an orderly unwind. When one of the big rating agencies was asked for a figure that would ‘concern’ them, they came back with more than a 30% decline.
So yes, Australian house prices are declining and there’s more to come. But lenders and investors are pragmatically viewing this in the context of house prices that have doubled over the past decade. Overall there is plenty of equity in property to not create systemic risk for lenders.
Regardless, some individual borrowers will hurt. Anyone forced to sell (like a matrimonial or business failure) could lose all of the equity and still find themselves owing money. Developers, builders, and over-extended real estate agents could all find themselves in trouble and Porsche dealerships will have an influx of leased Cayenne’s. At an individual level the consequences could be cataclysmic. At a portfolio level, housing is remarkably resilient.
I’m writing another post on housing and credit risk. For the purposes of this post, you just need to understand that there are two key risks for lenders. Firstly, the probability that a borrower defaults, and second, the loss given default. The probability someone defaults relates to their employment. Loss-given-default basically relates to the sale value (less costs) of the property used as security.
Actual losses are a multiple of both. So as long as the probability of default stays low, then the loss given default doesn’t matter nearly as much. That’s why nobody is too worried about falling prices. Australia is at full-employment and consumer and business confidence is steady, loan delinquency is at near historic lows, and interest rates are very low and will stay low.
The caveat is that falling house prices don’t take the wider economy into a consumer led recession. So far, consumer confidence is holding up, helped by full employment and job growth.
To understand housing risk, Ireland is a useful example as it had one of the biggest housing market failures in modern history. During the GFC, Irish default rates increased to 11 percent (primarily due to unemployment) and property prices fell a staggering 50 percent. For rating agencies that’s their worst-case scenario. And yet, as bad as the Irish economy was, the losses from residential housing peaked at five percent.
Rating agencies typically attribute a AAA rating to 93 percent of a residential mortgage fund. That’s a better credit rating than most countries and all of our banks. Reinforcing that, no investor in Australian prime mortgage funds has ever lost money.
Conversely, with shares you can lose your investment (or a big chunk of it) in a matter of days. Talk to investors in Pumpkin Patch, CBL Insurance, Wynyard, or Fletcher Challenge.
So, global investors aren’t overly concerned about an orderly unwind of house prices in Australia.
Firstly, it is playing out here already but not in the headline numbers. I’ve said for months now that I think parts of the housing market are very illiquid and some homeowners are selling at a 10% lower price than the unofficial peak about two years ago.
Entry-level house prices are holding-up underpinned by population growth, a lack of building activity, and high construction costs. Look at first homebuyers who now make up 24% of new purchases, according to CoreLogic. Entry-level houses are still selling and that turnover is keeping the median price up.
Meanwhile the market for anything above the median seems a lot more fickle. It is not homogenous and plays out differently in micro-markets depending on the demographics of those markets.
The composition of Auckland housing stock is still very different to Sydney. House price indexes are a reflection of whatever is turning over. In Auckland that is still typically houses whereas in Sydney it’s apartments. In Sydney there is an over-supply of apartments at a time that foreign investors (who have been big buyers of Australian apartments) are stepping back. In other words you could call it the great unwind of the Australian apartment boom.
Yes our houses are over-valued, and yes price softness exists, but quite simply we have not been building apartments anywhere near the same speed as our cousins over the ditch. Our Reserve Bank also tightened earlier and we’ve been in a tight credit market for a little over two years. With strong terms of trade, full employment, low interest rates, a slight relaxing of the LVR rules and strong terms of trade, there’s nothing on the horizon that would suggest that house price indexes drop.
Below the surface, there will be opportunities and risks. For many homeowners the market will be illiquid and that can throw up nasty surprises. If you have no intention or need to sell, then just get on with life and ride it out. You’ll be fine!
For our take on what's expected for our housing market in 2019, have a read of this blog post.