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 Australia’s
Achilles heel
Shane
Oliver,
Head
of Investment Strategy
&
Chief Economist
Key
points
• How
house prices behave over the year ahead is likely to be a key
determinant of how well Australia weathers the global financial
crisis and recession now embracing the rest of the
world.
•
Falling interest rates, increased home owner grants and a housing
undersupply are positives for house prices. However, these are
offset by poor affordability, overvaluation, low rental yields
& rising unemployment.
• On
balance, we see average house prices falling another 10% to 15%
over the year ahead
Introduction
In
several ways, Australia is better placed than many other countries
to withstand the global recession now underway. We have plenty of
scope for fiscal and monetary stimulus, our financial system is
still operating comparatively well, and while growth in our trading
partners is slowing, it will be higher than in the US, Europe and
Japan. However, there is one area where Australia is
particularly vulnerable and this is the intersection of high
household debt levels and high house prices. If house prices
slide too much, we risk entering a debt-deflation spiral where
sliding house prices trigger further falls in spending, which in
turn trigger further increases in unemployment, further falls in
house prices and so on. So far this year, the Australian housing
market has started to slow with house prices off by two to four per
cent from their recent high.
US and
UK house prices on the slide
The
last decade has seen a massive surge in house prices in many
countries. The surge in Australian house prices relative to income
levels has gone hand in hand with a substantial rise in household
debt, as evident in the chart below.
The
boom in Australian house prices has gone hand in hand with surging
household debt
Source:
Thomson Financial, AMP Capital Investors
This
has been the same in other countries, except that the rise in
household debt has been much faster in Australia. We have therefore
gone from the bottom of the pack, in terms of comparable countries,
to the top. Refer to the chart below.
Australian
household debt has surged to near the top of the
pack
Source:
OECD, ABS, Thomson Financial, AMP Capital Investors
Similarly,
the gains in Australian house prices have been greater than in many
other countries. Refer to the chart below.
Australiahad a
bigger house price bubble than the US and UK
Source:
Case-Shiller, Nationwide, ABS, AMP Capital Investors
From
their highs, US house prices are off 20% and UK house prices have
fallen approximately 12% and are still falling. The slump in house
prices is weighing heavily on consumer spending in both countries,
as it leads to a loss of wealth and has halted the phenomenon of
mortgage equity withdrawal.
The
case for optimism on house prices
Despite
all this, many would argue that there are good reasons for optimism
regarding Australian house prices. Firstly, while America’s housing
boom ended because of an oversupply of housing, Australia has a
huge shortage. This is reflected in approximately 1% vacancy rates
for rental properties, and 10% per annum rental growth.
Secondly,
whereas the US housing boom saw a huge reduction in lending
standards with more marginal borrowers obtaining finance, in
Australia the surge in borrowing was focused on existing home
owners trading up who tend to be older with higher
incomes.
Thirdly,
the slump in US house prices may have been accentuated by
non-recourse mortgages which result in a strong incentive for home
owners to hand over the keys once the house value falls below the
value of the loan. This is not the case in Australia where full
recourse mortgages provide a powerful incentive to keep servicing
the loan.
Reasons
for caution on house prices
There
are however several reasons to expect further weakness in house
prices going forward.
Firstly,
despite the turn in the cycle to falling mortgage rates, most
housing related indicators remain very weak. Housing finance is
continuing to fall, new home sales are decreasing and weekly
auction clearance rates are running 20 to 30 percentage points
below year ago levels even two months after the first rate
cut.
Secondly,
past periods of house price strength have commenced when housing
affordability is good, whereas affordability today is poor
despite falls in mortgage rates. This is because house prices
remain so high.
Interest
rates and house prices need to fall a long way to improve housing
affordability
Source:
Commonwealth Bank/HIA. REIA, AMP Capital Investors
Thirdly,
despite recent softness, Australian housing remains highly
overvalued, by an average 23%.
• In
real terms (i.e. after inflation), Australian house prices remain
well above their long-term trend (by 23%). Over the last 80 years,
the trend rate of growth in real house prices has been 3.1% per
annum. This is consistent with long-term real gross domestic
product (GDP) growth around the same level. However since the
mid-1990s, house price gains have been well above trend growth.
Refer to the chart below.
Australian
house prices remain well above trend
Source:
ABS, AMP Capital Investors
•
Average Australian house prices remain very high relative to
average weekly wages and need to fall about 22% to return to more
normal levels. The ratio of house prices to median household income
in Australia is more than double what it is in the US.
•
Despite strong growth in rents, rental yields remain very low.
Gross rental yields of 3.6% for houses and 5% for units are well
below the 6.5% plus net rental yields available on directly held
commercial property, the 10% distribution yields on listed property
trusts and a grossed up dividend yield of over 7% available on
Australian shares. House prices would need to fall about 25% to
bring the ratio of house prices to rents (adjusted for inflation)
back to its long-term average.
Finally,
at a time when housing affordability is poor, household debt
levels are high and house prices are overvalued, rising
unemployment poses a significant threat to house
prices.
Into
2010 we see the unemployment rate rising to 6.5% or higher. This is
likely to result in an increase in mortgage delinquencies and
greater caution on the part of prospective new home buyers who are
likely to be less certain about their future employment. The chart
below shows the relationship between real house prices in Australia
(house prices adjusted for inflation) and the unemployment rate. As
indicated, the rise in unemployment associated with the early
1980’s and early 1990’s recessions contributed to significant falls
in real house price. While this was masked by much higher inflation
at the time, real house prices fell 12% in the early 1980s and by
20% in the early 1990s.
A
likely rise in unemployment points to falling house
prices
Source:
Thomson Financial, REIA, AMP Capital Investors
This
time around, we don’t have the same high level of inflation to mask
falling house prices in real terms. More importantly, while the
quality of Australian mortgagees may be higher than in the US, the
level of indebtedness underpinning the housing market is much
greater than prior to the last two recessions, and house prices
were not as overvalued. This would suggest that house prices may
now be much more sensitive to rising unemployment than in the early
1980s and early 1990s.
Concluding
comments
Earlier
this year, the housing market was threatened by rising interest
rates. Now it is the economic downturn and rising unemployment.
Coming at a time when affordability is poor, housing is overvalued
and debt levels are very high, our assessment is that house prices
are likely to fall further over the year ahead. Barring a very deep
recession or depression, 40% falls in house prices are unlikely.
But with the economy on track for a mild recession, and if not then
a very serious slowdown, house prices are likely to fall 10% to15%
over the next year or so. This in turn will put further downwards
pressure on consumer spending and drive further sharp interest rate
cuts.
Dr
Shane Oliver
Head
of Investment Strategy and Chief Economist
AMP
Capital Investors
Important
note:While
every care has been taken in the preparation of this document, AMP
Capital Investors Limited (ABN 59 001 777 591) (AFSL 232497) makes
no representation or warranty as to the accuracy or completeness of
any statement in it including, without limitation, any forecasts.
Past performance is not a reliable indicator of future performance.
This document has been prepared for the purpose of providing
general information, without taking account of any particular
investor’s objectives, financial situation or needs. An investor
should, before making any investment decisions, consider the
appropriateness of the information in this document, and seek
professional advice, having regard to the investor’s objectives,
financial situation and needs. This document is solely for the use
of the party to whom it is provided and may not be reproduced
without permission from AMP Capital.
19
Nov 2008
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