Market comment: Prices down, construction down, even interest rates may finally come down

Fri, 12 Apr 2019

Market comment: Prices down, construction down, even interest rates may finally come downSo, just how bad is the Sydney housing price fall? So far, it’s a good example of the old adages: “What goes up must come down”, and “The bigger they are, the harder they fall”. We enjoyed the ride up, but the ride down isn’t much fun.

It’s notable that Sydney has had the biggest yearly slump of all Australian capital cities. According to The Guardian’s Greg Jericho, residential prices fell an overall 7.8 per cent in 2018 which was the biggest 12 months fall of all capital cities in the past 15 years. Other analysts quote higher rates of decline. Sydney also led the country in price falls in established dwellings: houses down 8.4 per cent and apartments down 6.4 per cent.

In 2019 our city isn’t faring much better. There are more properties on the market and fewer buyers. According to Domain senior research analyst Dr Nicola Powell, the number of units on the market across Sydney is up more than 20 per cent year on year, while houses are up almost 13 per cent.

BIS Oxford Economics says the current price fall in Sydney – 3.7 per cent so far this year, is about twice as fast as historical averages. The research firm’s senior manager, Angie Zigomanis explains: "Investors were a key driver of price growth through their upturns, and the fall in investor demand is now underpinning the decline in prices.

"The weakness in prices and likely concerns about further falls will continue to play on purchaser sentiment through 2019, with further price falls in Sydney and Melbourne expected."

Factoring inflation into the price falls, Mr Zigomanis says that in real terms, Sydney house prices have declined 16 per cent since the last peak in June 2017, which is about three-quarters of the average real decline in prices during previous downturns of 21 per cent. However, he also notes that the longest downturn recorded was 23 quarters during the first half of the 1980s, which resulted in a total real house price decline of nearly 34 per cent, so for those of us with long memories we’re still not record-beaters. Not yet.

Shane Oliver, chief economist and head of investment strategy and economics at AMP Capital, told’s Frank Chung that the past 18 months of steep declines in the New South Wales capital shouldn’t be called a ‘property crash’: “To put it into perspective, prices are really just back at 2015 levels and on track to go back to 2014 levels. We had many years of very strong gains. We’re giving back some of that.”

Dr Oliver says a “crash” was what we saw at the time of the Global Financial Crisis, although he still expects the fall in Sydney prices to continue into 2020 and hit a total of 20 per cent from the market’s peak by the time recovery begins: “Hopefully all of this takes us back to what’s a more affordable market rather than a speculative one. My judgment is that it will be a more measured market, the recovery stage.”

A slightly more optimistic outlook comes from the analysts at Moody’s Analytics who say house prices in Sydney will bottom out in the September quarter of this year, before beginning a moderate recovery in 2020. They foresee a 9.3 per cent fall in house prices and 5.9 per cent slide in unit prices over 2019, before a 3.6 and 4.2 per cent rebound respectively in 2020.

Regardless, global investment bank RBC Capital Markets has done its own calculations and says that sales of houses and apartments in NSW were 40 per cent lower in January than a year earlier. It also says that so far in 2019 sales have fallen by about 26 per cent. This would indicate that the Sydney property market is even weaker than indicated by the 10 per cent fall over the past year calculated by research firm CoreLogic.

What’s selling?

Falling prices, of course, always bring out those bargain-hunters with access to sufficient capital to take advantage of an opportunity. The summer just past saw sales of more than 120 properties a day; between December and February around 11,000 homes were sold in greater Sydney, so the market was anything but dormant.

Domain’s analysis of sales data from that period show that three-bedroom houses were the most common property traded with 2850 sales during that 90-day period. The Agency’s director of sales Thomas McGlynn explains why: “It appeals to nearly every single type of demographic in the marketplace - investors, families, to single professionals and couples after more room … so there’s consistent turnover of that type of property.”

The figures from Domain also showed that four-bedroom houses and two-bedroom apartments were next in demand, with about 2700 and 1750 deals made respectively. Interestingly, other unit sales were far less common, and five-bedroom houses were more in demand than all the other apartment types. As investors withdraw from the market and house prices come down, apartment sales are becoming less common and buyers are opting for a more traditional dwelling.

“There is a tailwind in terms of the demographics, especially the baby boomers who have more capital, as they make that transition to apartments for lifestyle reasons,” David Chin, founder of investment advisory firm Basis Point, told’s Frank Chung.

“The larger two- and three-bedroom apartments still have a market. In Europe and (places like) Paris, it is quite common for apartments to be very large, three bedrooms, almost like homes. It sets the higher density living in three- four-, five-storey buildings, not high rises. It works and I think that will be more common in Australia,” he said.

REA Group chief economist Nerida Conisbee said concerns about apartment quality, amenity and overdevelopment have led to a number of states implementing minimum size requirements in the past few years to clamp down on so-called “dog boxes”.

Ms Conisbee said the changing environment meant developers were now having to set their sights on the three owner-occupier groups — first homebuyers, downsizers and upsizers: “Downsizers are a key market, what they’re looking for is often quite bespoke apartments. They want greater choice in the layout, bigger apartments, they’re a bit more fussy about the type of fit-out,” she said.

Some other statistics show a shifting landscape for Sydney property. Of all the properties sold last summer, about 40 per cent of units and 23 per cent of houses were priced at or below $650,000 which is the cut-off point for the first-home buyer stamp duty exemption. There were more houses sold at the lower end of the market, which is around $750,000, than at the $1 million mark.

So, with investors pulling out, and by so doing putting a number of cheaper properties on the market, it’s first-home buyers that are driving the demand for lower-priced properties. Expensive apartments have diminished appeal for those first-home buyers or for owner-occupiers who sell their houses and want to downsize.

In which areas are investors likely to offload their properties? An online property research platform, Sell or Hold, has used what it calls a ‘sophisticated algorithm’ to identify areas likely to have negative growth out to 2020. The firm’s head of research, Jeremy Sheppard, says their modelling is based on those old industry staples of supply and demand.

“If demand exceeds supply obviously prices go up, the other way round they die. What we’re looking for is markets that have the lowest demand to supply ratio, markets which over the next three years are unlikely to keep up with inflation and some might go backwards,” he said.

According to their analysis, 13.2 per cent of NSW markets are likely to record negative growth over the next three years. It’s a subscription service, so to read their predictions about a given area will cost something, but chief economist Nerida Conisbee said the firm’s modelling was “interesting.”

“It’s definitely justified if you’re in Sydney,” she told’s Frank Chung. “The market has taken a pretty sharp turn and prices have fallen quite a bit already. The negativity in the media is not really helping at the moment.”

Mothballed projects?

For anybody living within 10km of the Sydney CBD and anywhere near a transport facility, there’s a good probability they’ve seen their suburb grow at least one large block of apartments, and in some cases a whole forest of towers up to 40 storeys high. Apartment construction has been a massive driver of construction and therefore employment over the past five years.

But property price falls and the consequent drop in demand for apartments has meant an accompanying drop in construction; many existing projects under construction are at the risk of being ‘mothballed’ until the market picks up again, and there’s now a serious risk of oversupply in some parts of Sydney.

Scott Gray-Spencer, local head of capital markets at the global real estate firm CBRE, told ABC's The Business: "Areas of oversupply will see a bit more chaos in the next six to twelve months."

The reason’s simple. The usual pattern is that developers purchase a building site, then spend the next 12 months or so on planning and marketing their project. Once around 80 per cent of the development has been pre-sold, finance will be obtained, and construction can begin.

At this stage the developer has the buyers’ deposits but still has to get the balance of their contract price to complete the deal. If, by the time construction is complete and the balance is due, the valuation of the new apartment is less than the original price, the banks will not be willing to finance the full amount of the difference. They may finance a lesser amount and the buyer will have to put up the new, higher amount of the difference; the buyer may also decide to forfeit the deposit and not risk paying full price for a devalued asset.

“At the moment we're seeing a lack of sales in the marketplace," Luke Mackintosh, partner with EY Real Estate Advisory Services told ABC News. "There's a lack of foreign buyers, a lack of investors and not much confidence in the marketplace for first home buyers, and hence [previous] sales rates of 24 to 30 a month are lucky to be one or two a month on a project."

He’s also telling his clients that this is a good time to snap up development sites on the cheap because in two years' time they'll be rewarded by demographics: "We have 50 per cent of the population that are under 35; 35 per cent of millennials still live with their parents. The oldest of the millennials are turning 35 this year. They are the buyers' market. They are the market that developers will be selling into."

RBA’s response

The RBA is concerned that the downturn in property markets across Australia will affect the country’s financial stability. The Bank's assistant governor Michelle Bullock said the increase in apartment construction since the start of the decade could potentially be "sowing the seeds of a decline" now that prices are falling in both Sydney and Melbourne.

Her concerns are accurate, if a bit late: “[This increase in construction] ultimately sows the seeds of a decline in prices which, if large enough, results in development becoming unattractive, new supply falling and the cycle starting again.

"Our main concern with this from a financial stability perspective is the potential for this large influx of supply to exacerbate declines in housing prices and so adversely impact households' and developers' financial positions."

Well, yes. The greatly increased supply of housing is indeed putting pressure on prices and as a result they’re falling. To quote Ms Bullock: "The apartment market is quite soft in Sydney; apartment prices have declined since their peak, rental vacancies have risen, and rents are falling."

One key reason property prices have fallen is that borrowers are finding it harder to borrow the money they need, and loans that used to require a deposit of ten per cent now need twenty per cent deposit or even more. The RBA’s talks with the banks found that, on average, the maximum loan size offered to new borrowers had fallen about 20 per cent since 2015 and only 10 per cent of people borrowed the maximum they were offered.

The RBA’s own economists, Trent Saunders and Peter Tulip, have said that the recent tightening of credit limits - which banks have introduced themselves in reaction to direction from banking regulators and the RBA - "seems to be important in the decline in house prices in 2018".

And once again, at its April meeting, the RBA kept its cash rate at 1.5 per cent, just where it’s been for 32 months. However, Westpac’s Bill Evans said the RBA Governor’s monthly statement contained a “significant” change in language when Governor Lowe said: “The Board will continue to monitor developments and set monetary policy to support sustainable growth in the economy and achieve the inflation target over time”.

Mr Evans said this statement was a “very clear intention to signal that policy is much more ‘live’ than has been the case since the Governor was appointed”. He also said Westpac expected a downgrading of the Bank’s growth forecasts in its May statement.

The International Monetary Fund (IMF) says the Reserve Bank was right to shift from a tightening bias to a more neutral stance given weaker-than-anticipated GDP figures for the fourth quarter and "signals of weakness" elsewhere across the economy. Dr Thomas Helbling, the IMF’s lead analyst for Australia, told the Australian Financial Review: “"I think the question is: will it need to change the monetary policy stance, and I think they are looking at that."

What happens if the Bank’s projected growth rate of three per cent for 2019 falters? Westpac’s analysts hold the view that “that the RBA is on track to adopt an easing bias in May and [will] cut the overnight cash rate in August and November.”

Political possibilities

It’s usual for the property market to experience a brief pause before a federal election. Even if the outcome isn’t expected to impact the buying and selling of real estate, people seem to want to know who’s won before they get back to being concerned about such things as house prices and property auctions. But this year’s a bit different.

There’s no certainty of a particular party winning or losing the May 18 election, although if a majority of Canberra watchers are correct the Coalition’s time is about up and May will see a change of government. But there was little in the Budget papers announced 2 April that would reassure Sydneysiders their housing market would recover soon.

“Uncertainty about the outlook for the housing market, in particular the extent to which housing prices fall, poses a downside risk to the forecasts for both dwelling investment and consumption,” the budget papers read, indicating that the government expects buyers will hold off purchasing a home until they’re sure the market’s hit bottom.

This time around, one of the two major parties contesting the 2019 federal election has a set of policies that will most certainly affect the Sydney property market and have financial implications for investors, developers, builders and almost everybody else in the industry if it’s elected.

First, it must be noted that changes to our governmental policies on housing are overdue. Even after the recent price falls, the cost of housing in Sydney is at unaffordable levels for many who live here. This isn’t helped by having rents so high that they make it hard for many families to save a deposit for a home.

The Conversation’s Duncan Maclennan and Hal Pawson did their homework to analyse the twin problems of falling home ownership rates for young adults and long-term declines in home ownership affordability. They found that: “In Sydney in 2017, moderate-earning and low-earning tenants paid, on average, more than $6,000 a year in rent over and above 30 per cent of their incomes. And that still didn’t spare them the growing costs and lost productivity of commutes commonly exceeding 90 minutes.”

They concluded that this situation reduced economic productivity by blocking people’s opportunities and capabilities. They saw an emerging perception that growth dividends had been directed into raising the prices of land and housing through investor speculation. The few attempts by governments to redress this – with subsidies and tax concessions, have proven counterproductive because they have ultimately driven up demand and therefore prices.

Politicians of both major parties have, over the years, recognised voter dissatisfaction with the increasing difficulty of obtaining suitable housing at reasonable cost. They have responded with a range of measures that may have been well-intended but, to put it simply, haven’t fixed the problem and may well have made it worse.

This year’s federal election will give voters the chance to vote for Labor’s proposed changes to the present system of negative gearing and capital gains taxation. Under their plans, negative gearing will be restricted to new properties only, and the present capital gains tax discount of 50 per cent will be reduced to 25 per cent. These changes will be ‘grandfathered’ and will only apply to properties acquired after January 1, 2020.

Domain’s Trent Wiltshire summarised his expectations of the outcomes if Labor’s policies become law: “Prices are likely to be pushed lower in the short run, rents wouldn’t change much, and housing construction would decrease in the short run due to prices falling, but might rise a bit in the long run.”

These are significant changes, intended to better equalise the positions of first-home buyers with investors and, by reducing demand, should cause property prices to stabilise or even fall. We read on the Labor party’s website: “This policy will see a boost in new housing and will provide young families with the chance to find a home and will take pressure off inner-city housing markets that are predominantly made up of existing dwellings.”

Mr Wiltshire quantifies the hit to property prices if Labor’s housing policies are implemented: “The total impact on property prices of Labor’s policies is in the range of prices falling 3 to 7 per cent lower than they would otherwise. Importantly, these price falls have mostly been “priced in”, meaning much of it has already occurred as investors predicted that Labor’s policies were likely to become law.”

As we would expect from politics, there’s another and quite opposite side to the argument. The Property Council says it is still "strongly opposed" to the proposal and its possible impact on the housing market and broader economy, particularly around new housing construction.

A Cadence Economics report commissioned by Master Builders Australia, has forecast a decline in new home building of between 10,000 and 40,000 dwellings and a loss of 7500 to 32,000 full-time construction jobs if Labor’s changes are enacted. Another report from SQM Research says the changes will cause property prices to fall nationally by between five per cent and 12 per cent by 2022.

Not surprisingly, Federal Trade Minister Simon Birmingham says the start date of Labor's policy would be a dark day for home owners: "Labor's policy announcement today is [that] January 1, should a Labor government be elected, can be marked in the diary as the time in which Australian home owners will see the values of their properties diminish and renters will see the price of rent increase," he said.

Chief economist and head of investment strategy and economics at AMP Capital, Shane Oliver, thinks the timing of any changes is of prime importance. He agrees there will be downward pressure on property prices because of Labor's proposed changes, but he is concerned that, with property prices already falling, this could be the wrong time to make changes to tax breaks for property investors: "The risk is that it just adds to the perfect storm that's around property prices at the moment - that it adds to the uncertainty and pushes prices down even further.

“We all want more affordable housing. Even I think it's unfair that young people have to pay so much for housing, but we don't want that increase in affordability to happen so quickly that it damages the economy," said Dr Oliver.


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