In the ten years since our Market Comment began, it would be hard to find a single year without someone in the media mentioning a forthcoming ‘crash’ of the Sydney housing market. Even if times are good, the doomsayers will often forecast a dire ending.

And if times are bad, too often there’s a focus on the negatives and warnings of how much worse it could become. However, during those ten years the market has resolutely made its way upward – sometimes faster than other times but, in the long-term, always ending up ahead.

Current market indicators show that Sydney’s house price growth has virtually stopped, falling to a 15-month low as a combination of lending restrictions, increased building supply and first-home buyer concessions take effect.

Sydney leads what is an Australia-wide property price pullback, down 2.1 per cent for the December 2017 quarter and finishing the year 2.2 per cent below the market’s peak in August last year. Scarcely a sparkling performance, but not an unexpected one according to CoreLogic’s Tim Lawless.

"We're likely to see lower to negative growth rates across previously strong markets, more cautious buyers, and ongoing regulator vigilance of credit standards and investor activity," he said. "There's going to be a negative growth rate, probably most similar to the 2000 to 2003 [time period] when prices fell by about seven per cent."

While a seven per cent fall equates to a sizeable sum for Sydney’s average million-dollar plus properties, it still represents a small fraction of the 75 per cent growth in prices over the past five years. And it may not even happen.

One of the most consistently objective, analytical property market watchers during this time has been the ABC’s Michael Janda whose comments have been quoted many times in this column. It was therefore a bit of a surprise to see his by-line in an article captioned: “Australian housing crash is a possibility that should worry us all” on 18 January this year.

The article, however, proved to be an interesting discussion of just how difficult forecasting the future can be, and of how the worst possible ending can never be ruled out, just as we must also say there’s always a chance for a splendid, rewarding outcome. It’s all about the multitude of variables that affect every economy, and nobody can say with any certainty precisely how those variables will impact something as significant as housing prices twelve months down the track.

Mr Janda references Steve Keen whom we’ve mentioned before in these pages. Dr Keen is noted for his consistently negative position on housing prices, forecasting falls of ten, twenty or an even greater percent when asked his thoughts on the year ahead. He’s also famous for his walkup Mt Kosciusko after losing a bet on house prices with economist Rory Robertson. But is there anybody who can say exactly what’s going to happen next?

In June 1942 Japanese submarines breached a wartime defence boom erected across Sydney Harbour, surfacing to shell such iconic Sydney suburbs as Bondi, Rose Bay and Woollahra. Naturally, this had a somewhat negative effect on Eastern Suburbs property prices.

However, according to contemporary reports, by October 1942 auction prices for eastern suburbs flats and houses had recovered and once again compared favourably to Neutral Bay or Strathfield. Whatever panic selling had taken place was quickly over and, despite the continuation of the Second World War on Australia’s doorstep, property prices returned to their contemporary normal.

So, what could happen in today’s economy that might help realise Dr Keen’s perennially gloomy forecasting? Another attack by Japanese submarines is unlikely, but Michael Janda does list some possible causes of a serious Sydney property price correction: rising interest rates, rising unemployment or a falling population. He notes that Ireland, Spain and the US all experienced property price crashes during the GFC; it’s also worth noting that it didn’t happen here.

There are factors in play right now that will no doubt ensure a continued cooling of the Sydney property market, among them: a flood of new apartment buildings coming onto the market, a possible interest rate rise later this year, a tightening of bank loan restrictions, additional costs imposed on overseas buyers, and a pullback of investors from the market. The end of a five-year boom is apparent, but it’s happening in a very orderly fashion.

We’re entering the slow lane for sure. But a crash – no!

Future slowing

A new Fairfax Media Scope economic survey conducted among a panel of 26 of Australia’s leading economists paints an overall unexciting picture for Australia’s economy in the near future. The panel forecasts economic growth of just 2.7 per cent, a growth in living standards of 1.8 per cent, Sydney housing prices to slip by 0.9 per cent, and negligible wages growth. The panel also sees further falls in housing investment as well as in Sydney housing prices.

JP Morgan economist Henry St John told the Sydney Morning Herald there is a "close relationship" between lending to property investors and house prices: "The final housing finance report for 2017 was unambiguously weak, corroborating some of the price adjustment seen in the Sydney and Melbourne property markets through December and January," he said.

Figures from ABS show that the number of loans to people buying a home to live in fell by 2.3 per cent in the month of December, while the value of approvals to people intending to buy their property for an investment fell by 2.6 per cent in the month.

Steven Anthony of Industry Super Australia even says there is a 30 per cent chance of a recession within the next two years: “This current housing boom is easily the greatest in the history of our major capital cities, and history shows that the deepest recessions tend to follow real estate busts,” he said.

“The key risk to the domestic economy in 2018 and 2019 is depressed spending on the back of a property slump in eastern Australia combined with record household debt and rising borrowing costs.”

However, most of the panel indicated a ‘steady as she goes’ situation wherein modest economic growth happens alongside a mild fall in housing prices, due primarily to little or no wages growth.

When it comes to the chance of a recession in the next couple of years, University of Tasmania’s Saul Eslake - quoted frequently in this column as a proven forecaster of economic developments in Australia, had this to say: “Recessions are the result either of a policy mistake, or an external shock.

“There is no compelling reason to think that policy-makers have made, or are about to make, a mistake of the sort that could precipitate a recession. My estimate of a one-in-six chance of a recession reflects my assessment of the probability of an external shock, most likely emanating from policy mistakes in the United States."

Interest rates stay low

Interest rates have remained at their record low 1.5 per cent after the RBA’s February board meeting decided the present level was “continuing to support the Australian economy.”

In other words, things are cruising alright at this time and nothing’s screaming out for an immediate rate hike or cut. But Credit Suisse disagrees, saying the RBA’s forecasts for the economy are ‘too optimistic’.

The Bank thinks the economy would benefit from additional stimulation delivered by a combination of lower rates and tax cuts, saying that the rate of household saving is too low.
IFM Investors chief economist Alex Joiner agrees, saying: “It’s evident from the Reserve Bank’s own forecasts that they’ve been too optimistic on household consumption for too long, and have consistently had to revise their forecasts lower,”

So, is a rate cut at all likely to happen? NAB chief economist Alan Oster doesn’t think so. He told Domain: “The chance of getting more rate cuts is virtually zero,” he said, adding that another rate cut would “just fire up the housing market again”.

Australian economists are in general agreement that the next interest rate move will be upwards with an average rate forecast of 1.7 per cent, and most expect at least one hike late in 2018. It’s likely that Credit Suisse will be overruled by RBA Governor Philip Lowe who clearly feels an upwards move would be in the right direction, but not just yet.

A flipping good year

Something new has been added to the real estate literature this year. CoreLogic has just released its first ‘Property Flipping Report’ – a document that conducts a national analysis of properties that were bought and re-sold within a short time for a profit in 2017.

That’s what ‘flipping’ is all about. CoreLogic’s research measures ‘flips’ within one year of purchase and those within two years of purchase. This first report also tracks national trends over the past 20 years and its findings will be of interest to all property investors or those who would like to invest in property but just haven’t yet.

Nationally, 2017 was a good year for flipping. Almost nine in ten flipped properties made a profit. To break it down a bit, for properties re-sold within one year of purchase 89.1 per cent were profitable; for properties re-sold within one to two years of purchase 89.9 per cent made a profit.

The highest rate of flipping was in Sydney where 6.8 per cent of property sales over 2017 were flips between one and two years of ownership. 94.3 per cent of these were profitable. Only 5.7 per cent of flips made a loss. Regional NSW didn’t perform badly either, recording 94.5 per cent of flips as profitable, and just 5.5 per cent were unprofitable.

Interestingly, Westpac’s latest Home Ownership Report found that Australian women are considerably more active than men in planning some sort of real estate transaction over the next five years, and it’s not just buying a home (although women outpace men in this area by 28 per cent to 20 per cent).

16 per cent of women plan to buy an investment property, while only 13 per cent of men have this intention, and when it comes to planning the sale of a property women outpace the men by 17 per cent to 14 per cent. And to really show who values home ownership, 43 per cent of female first home buyers said they strongly believed that ‘owning your own
home is a reflection of your success in life’, compared with just 22 per cent of men.

Westpac’s head of women’s markets Felicity Duffy said she expected to see a spike in home loan applications from women over the next five years: “They’re taking matters into their own hands and increasingly investing in property as a potential way to secure their financial futures.”

Foreign buyers retreat

The share of foreign buyers in Australian housing markets continued to fall in the fourth quarter of 2017, dropping to a six-year low of 8.4 per cent in new property markets and a five-year low of 5.5 per cent in the established housing market.

This isn’t surprising as recent policy changes in NSW mean that foreign investors are charged 8 per cent of the purchase price in stamp duty, double the previous level. The Chinese government has also continued to tighten its rules on offshore investing, successfully dampening demand.

According to research conducted by Credit Suisse, Chinese buyers accounted for as much 87 per cent of foreign property investment in NSW between January and June 2017. Foreign buyers, the majority of whom are Chinese, are expected to account for around 18 per cent of residential sales in NSW in the three months to March 2018.

A recent article in the Australian Financial Review highlighted problems for foreign investors that have also affected major developers. The article said: "Government taxes and credit restrictions have started to hit foreign buyer demand for residential property so hard in Australia that major developers are either pulling out of the apartment market altogether or, like Meriton's Harry Triguboff, are left grappling with Chinese investors who can't settle on pre-sold apartments."

In an interview, Mr Triguboff agreed that many Chinese investors have put down deposits on units, but he insists their inability to settle isn’t leading to a correction in the market. "So now we have to resell them – there is another problem. And everyone thought that the Australian buyer would come in when the prices started coming down – they haven't – I knew they wouldn't – it wouldn't make any sense if they did," he said.

And the reason Australian buyers haven’t rushed in to fill the vacuum? According to Harry Triguboff: "The problem with Australians is they are very slow," he told the AFR. "They ask their lawyer, they ask their financial adviser, they ask their family, they ask everybody. The Chinese don't ask anybody, they come off the plane, buy their unit and go."

If that’s the case, it’s just a matter of time before Aussies step up to purchase those units that Chinese investors no longer want. However, it would be most unlikely that Australian buyers would simply accept the original prices as they ones they’d have to pay. Expect to see some aggressive discounting and ‘special offers’ in the coming months.

Canada’s foreign buyers hit

A Reuters analysis of data compiled by Statistics Canada (equivalent to our ABS) found that foreign buyers have driven up the price of property in that country’s two largest housing markets, Vancouver and Toronto.

Not surprisingly, public debate about foreign investment in Canada has surged, with locals saying price increases of 60 per cent in Vancouver and 40 per cent in Toronto over the past three years have kept them out of the market.

With echoes of recent developments in Sydney property, Reuters’ number-crunching found that in Toronto the average value of a detached home built in 2016-2017 and owned by a non-resident is C$1.7m - 48.7 per cent higher than C$1.1m for residents. In Vancouver the difference was less, but still a solid 40.6 per cent. (The Australian dollar buys about 98 Canadian cents.)

Jane Londerville, a real estate professor at the University of Guelph in Southern Ontario, said that the data shows that foreign buyers tend to focus on the most affluent neighbourhoods: “If the goal is to get a couple million dollars out of their country and put it in a very safe, calm economy, you might as well buy a C$2m house,” she said.

In response, in 2016 Vancouver imposed a 15 per cent ‘foreign buyers’ tax, followed by a similar impost in Toronto in 2017.  This has resulted in a slowdown of purchases by foreign buyers in both markets, although local analysts say the cooling may be only temporary.

Negative gearing debate

Australia’s federal politicians have already started gearing up for the next election and one subject – negative gearing, is sure to be on the table for vigorous consideration. Liberal governments generally support negative gearing, arguing that it helps to increase the supply of housing and increased supply will (eventually) result in a reduction in the costs of housing.

The other side of politics says that negative gearing unfairly favours the wealthy over those without sufficient capital to invest in property and castigates taxation policies that discount taxes on capital gains made from property investments.

A recent Melbourne University research project by researchers Yunho Cho, Shuyun May Li and Lawrence Uren concluded that eliminating negative gearing entirely would lead to an overall welfare gain of 1.5 per cent of GDP, which would make three quarters of the population better off.

According to the project’s findings, renters and owner-occupiers would be the biggest beneficiaries. Biggest losers would be landlords, especially those who are young, high earners. Another interesting conclusion was that thirty per cent of rental properties would be freed up and bought by Australians who would have otherwise have rented.

Perhaps even less certain is the finding that renters would benefit because, although rents would climb by 2.4 per cent, the government would be in a position to compensate them with the extra $2 billion it would make in increased tax revenue.

A bit more veracity can be attributed to advice given to treasurer Scott Morrison by Australian treasury officials in early 2016 that said the ALP’s policies to restrict capital gains: “…could introduce some downward pressure on property prices in the short term, particularly if the commencement of the policy coincides with a weaker housing market. In the long term, increases in taxation on rental property could have a relatively modest downward impact on property prices."

And, as for the impact on property prices if negative gearing is abolished, Treasury said: “'Overall, price changes are likely to be small.”

In 2016 then NSW planning minister Rob Stokes presented the moral case against tax write-offs like negative gearing: “We should not be content to live in a society where it’s easy for one person to reduce their taxable contribution to schools, hospitals and other critical government services – through generous federal tax exemptions and the ownership of multiple properties – while a generation of working Australians find it increasingly difficult to buy one property to call home.”

However, respected economist Saul Eslake said that politicians will never scrap negative gearing for one simple reason, and it all comes down to votes: “On average, about 100,000 people successfully become home buyers in every given year. They would obviously like the government to do things to make housing cheaper, more affordable for them,” he told ABC’s 7.30.

“There are over two million people who own at least one investment property, and the last thing they want a government to do is make housing cheaper and more affordable for people who don’t currently own housing.

“Even the least intelligent of our politicians can do that maths: 100,000 people who want cheaper housing versus two million people who want housing to get more expensive.”

The battle will rage to the next federal election, due sometime in 2019, but property owners needn’t be concerned over much about the outcome of this particular debate. The Grattan Institute, an independent think-tank, estimated that halving the capital gains discount, and phasing out negative gearing after a decade, would only reduce house prices by a maximum of two per cent.

Sources:

‘Housing investor loans slumped by 10 per cent in 2017,’ Clancy Yeates, Sydney Morning Herald, 9 February 2018
‘9 in 10 Australian Properties Are "Flipped" For A Profit,’ CORELOGIC, 29 January 2018
‘A Bill market - meet the forecaster who owned 2017,’ Peter Martin, Sydney Morning Herald, 3 February 2018
‘Australian housing crash is a possibility that should worry us all,’ Michael Janda, ABC News online, 18 January 2018
‘When Sydney’s beachside property came with a view of a barbed wire fence,’ Marea Donnelly, History writer, The Daily Telegraph, 17 June 2016
‘Axing negative gearing would boost economy and home ownership, RBA conference paper finds,’ Peter Martin, Sydney Morning Herald, 13 January 2018
‘Government negative gearing claims contradicted by official advice, FOI reveals,’ Dan Conifer and Michael McKinnon, ABC News online, 8 January 2018
‘Why we shouldn't be too scared of dramatic house price drop predictions,’ Michael Pascoe,
Sydney Morning Herald, 15 January 2018
‘Dismal, but no disaster. How the BusinessDay economic panel sees 2018,’ Peter Martin, Sydney Morning Herald, 3 February 2018
‘The jig’s up for Coalition’s negative gearing lies – and apologists in the media,’ Rob Burgess, The New Daily, 9 January 2018
‘NSW and Victoria’s property decline sees other states shine,’ Chris Kohler, Sydney Morning Herald, 2 February 2018
‘Foreign buyers are dropping out of the Australian property race,’ Chris Kohler, Domain, 11 January 2018  
 ‘Why rate and tax cuts should be on table in 2018 – Credit Suisse,’ Chris Kohler, Domain, 15 January 2018
‘Sydney property prices tipped to fall 10 per cent in 2018,’ Jennifer Duke & James Robertson, Sydney Morning Herald, 3 January 2018
‘Girl power driving property market: report finds more women than men buying homes,’
Elizabeth Tilley and Samantha Landy, The Courier-Mail, 3 February 2018
‘Only way is up: Brace for a rate rise this year, most economists say,’ Eryk Bagshaw, Brisbane Times, 2 February 2018
‘Sydney, Melbourne house prices have one-in-five chance of correction: JP Morgan,’ Michael Janda, ABC News online, 27 January 2018
‘Simple reason negative gearing will never be scrapped,’ AAP release on News.com.au, 17 January 2018
‘House prices fall in Sydney’s inner west, lower north shore and northern beaches,’ TawarRazaghi, Domain, 1 February 2018