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No crisis in Australia's housing market; NZ prices seen stable to lower: Nikko

Friday 11th January 2019

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House prices in Australia, particularly in Sydney and Melbourne, are falling sharply and may have further to fall but this is by no means a crisis, according to Chris Rands, a portfolio manager with Nikko Asset Management in Sydney.

Even if there was a crisis in Australia, his colleague, Fergus McDonald, Nikko’s head of fixed interest in New Zealand, says it would be wrong to expect similar price falls in our housing markets.

Sydney house prices are approaching a 10 percent drop from their 2017 peak while prices in Melbourne are 4 percent lower.

Property data company CoreLogic is forecasting a further 3.3 percent decline in Sydney house prices and an up to 6 percent fall in Melbourne prices this year, with the worst declines in the inner city areas.

“While the performance of house prices has been poor, we don’t believe this is reflecting housing stress. Rather it is due to tightening lending standards which are constricting credit supply,” Rands says.

All the indicators he’s looking at suggest credit conditions will tighten further, reflecting measures introduced by the Australian Prudential Regulation Authority aimed at reducing lending to investors and the scandals emanating from Australia’s royal commission into financial services.

In particular, the banks have been accused of failing to accurately estimate borrowers’ living costs and their ability to repay loans.

Rands says that typically in a housing market crisis it’s the ability of households to continue servicing their debt that comes under pressure due to factors such as rising unemployment or significant increases in mortgage interest rates, neither of which look likely any time soon.

“It’s hard to see why it’s going to turn into a 40 percent fall rather than a 5-to-10 percent one. It’s really just credit availability at the moment,” he says.

As far as rising interest rates are concerned, if the tighter credit conditions start to affect wider economic conditions, “that will get the Reserve Bank of Australia thinking about what they need to do about it.”

The RBA is well aware of that risk and will likely act before household pain gets too great.

“Generally what happens is the central bank cuts interest rates,” Rands says.

The Reserve Bank of Australia’s cash rate has been fixed at a historically low 1.5 percent since August 2016, giving the Australian central bank much less firepower than it had when the global financial crisis hit in 2008. Its cash rate in July 2008 was 7.25 percent.

“The way of thinking about that at the moment is that there’s a high hurdle for them (the RBA) to start doing anything” but it will use its remaining firepower if it has to.

As for unemployment in Australia, it’s currently at 5 percent. “While an increase in unemployment would hurt, the current business environment shows that the employment situation in Australia looks strong,” Rands says.

For example, National Australia Bank – which owns Bank of New Zealand – has a business conditions index that’s just a little off its all-time high “which often leads the direction of unemployment by approximately six months.”

While it’s true that Australia’s household debt is high at about 120 percent of GDP and only surpassed in the developed world by Switzerland, the current cost of servicing that debt is at a record low, meaning “it is unlikely that they are struggling to repay what they owe in the current interest rate environment,” Rands says.

As well, RBA statistics show that the majority of mortgage borrowers, about 60 percent, have loan-to-valuation ratios of less than 10 percent and only a small percentage have LVRs above 90 percent.

“This means the moderate declines we’ve seen in the housing market will not create a situation of negative equity for a meaningful share of borrowers,” he says.

On top of all that, many Australians are well ahead of their scheduled repayments. Most Australian home loans are at floating interest rates and when interest rates fall, borrowers often maintain their previous level of payments. RBA statistics show the average borrower is nearly 36 months ahead of their required repayments.

McDonald says he expects New Zealand house prices will be stable to lower in the short term but the long-term outlook is still favourable because of rising incomes.

“The laws of supply and demand will ultimately apply to property markets,” he says.

“The Christchurch property market is a good example of how a large supply of residential property stimulated by the earthquake rebuild resulted in a stable level of prices.”

The Real Estate Institute of New Zealand’s house price index rose just 0.8 percent in the 12 months ended November and 2.3 percent a year in the five years ended November.

By contrast, house prices nationally rose 3.5 percent in the latest year and 8.7 percent a year over the last five years.

“The same is expected to occur in Auckland and other areas of the country as supply ramps up with new building activity. The negative sentiment that has gripped the housing market in Sydney and Melbourne is misplaced here,” McDonald says.

His view aligns with that of ASB Bank economist Mark Smith, who said last month that local house prices do tend to broadly track Australian house prices, particularly in Auckland, but that New Zealand's shortage of houses, lower mortgage rates and still elevated net migration will counter any impact.


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