Housing Prices and Financial Stability: The recession we do not need to have

Rising house prices in Australia are commonly associated with good economic times for all, especially home owners. The apparent housing price ‘bubble’ risks in Australia in 2014 have been taken far too lightly and the current chorus of nervousness from the RBA, Treasury, the Murray Financial Inquiry and APRA bear heavy consideration. First, the RBA seems to be relatively comfortable with current housing price levels. The key issue in the next 12 months with modest business investment levels, increasing unemployment and increasing demand for dwellings is a lack of supply (in the form of sales listings) for preferred dwelling types/localities. Million dollar plus properties with high amenity and quality locations continue to see demand outstrip supply. This is reflected in reductions in dwelling sales periods. At the same time in several inner city areas rents are dropping and vacancy rates are increasing (e.g. Melbourne) as the geographically specific markets absorb supply of ‘vanilla’ apartment product. The recent upturn in international student numbers and more recent growth in service sector jobs should put a floor in the vanilla inner city markets of Melbourne and Sydney, but this could be at yields of 2% to 3% i.e. at CPI. Great for renters but it goes to the core of financial nervousness. What happens to loan serviceability for investors (38% of purchasers) when variable home loan rates re-establish at around 7% and the ongoing supply prevents capital growth?

Further as middle and inner ring housing prices continue to increase (prices have not increased substantially in many fringe areas) will purchasers have sufficient equity to cover say a 20-30% price reduction as occurred in 1989 - 91? More importantly what is the impact on the banking sector?

From a demand/market assessment perspective it is clear that there is strong underlying demand focused in hot spot areas. With high population growth rates, population driven employment, niche markets like overseas students and the initial return of financial services sector jobs (not legal services yet) there is little cause for alarm in 2014. The question is the impact on the coming cyclical downturn.

Prior to 2020 the key issue is highlighted by APRA and Christopher Joye (AFR). Since 2008 the current risk weighting given to home loans by major banks is 50%, i.e. a real equity level of 5% and 20 times leverage Tier 1 capital. This has reduced progressively so that in 2014 the real equity requirement is now 1.5% and real leverage is 67 times, i.e. according to Joye real bank leverage overall has increased post GFC from 20.7 times to 21.1 times. The real concern is not just housing prices, but the impact on financial stability.

The RBA recent research paper (Is the price of housing too high?) signals that from a dwelling finance perspective the banking sector has hit an amber light, but not a red light yet.

Graph The banks have sharply increased equity requirements for new loans with 20% deposits becoming the new norm. RBA research papers highlight the likely price impact and demand reduction at higher interest rates but indicate that with interest rate flexibility there is no current housing investment risk to financial stability. The current key issue in Australia is the connection between increasing interest rates and any impact on increasing the value of the Australian dollar with its subsequent impacts on the export sector. This may not be the case after the spring auction phase if housing prices increase too sharply. A delicate balance and enthralling game of wait and see is likely.

International conditions are improving albeit with many risk factors (wars, political instability, Eurozone, China). Recent analysis by the RBA drew a much stronger connection between the Australian economy and the US economy in terms of the real value added export supply chain through the end destination for resources (e.g. iron ore in fridges/cars). There is cause for cautious optimism given the improving economic performance of the US.

On balance with the likely continuing strength in property prices between, APRA, the RBA, the Murray Inquiry into the Financial Sector and Treasury, some action may be required. Accordingly rather than suffer the sword of Damocles, the property, building and construction industries could develop policy responses which do not decimate the property sector and avoid a recession we do not need to have.

About MacroPlan: MacroPlan’s experienced and qualified economists align their understanding of macro-economic forces with micro-economic variables such as geographic and industrial characteristics, demographics, labour market shifts, resource demand and commercial realities.  Contact Brian Haratsis, Executive Chairman today to discuss your property research requirements.

Brian Haratsis MacroPlan’s Executive Chairman is an economist and future strategist who has more than 30 years’ experience in providing detailed advice to governments and major corporate clients throughout Australia.
E: haratsis@macroplan.com.au P: 03 9600 0500