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Close to the bottom

John McGrath
Tuesday, December 18, 2018

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It’s been a year of volatility in Sydney and Melbourne but despite the scary headlines, this downward market cycle was entirely expected and very welcome following a protracted period of high price growth that probably went about a year too long.  

Latest figures from CoreLogic show Sydney house prices are down -9.2% in the 12 months to November 30 and Melbourne prices are down -7.6%. I think both cities have fallen further than this, as statistics tend to lag behind actual market activity.

I think Sydney is down 10-15% already and Melbourne is down about 10%. Both cities are getting close to the bottom of their cycles. It might get a bit worse before it gets better but I think we are through the worst part of the correction.

I think Sydney will soften another 2-3%, then there will be mini rebound, followed by two to three years of stabilisation, then another uptick.

As discussed in our latest annual McGrath Report 2019, affordability and declining investor activity are key drivers of this market fall, as is usual at the end of booms. But it is the engineered changes to lending that have arguably had the biggest impact below $5 million.

Greater scrutiny of borrowers’ personal expenses and debt-to-income ratios were implemented virtually overnight and affected almost every buyer this year. Suddenly, people couldn’t borrow as much as they thought, or get finance approved in time to bid at auction.

The impact on market momentum was quick and dramatic in comparison to normal cooling forces, such as affordability and rising interest rates, which have a much more gradual effect.

Tighter credit is a key reason for clearance rates dipping quite low in a comparatively short timeframe. So, you need to put screaming headlines like ‘biggest monthly fall for 14 years’ into perspective. The pace of this change is about lending – not market fundamentals. 

The economy is strong, unemployment is low, we have high population growth, an undersupply of housing and an extraordinary concentration of people living in our eight capitals (just under 70% of the entire Australian population), which puts a solid floor under major city home values.

APRA is insisting on tighter lending standards to shore up our financial system following high investor activity during the boom. The Royal Commission has added further pressure to the banks, who are curbing new credit so they can build an image as responsible lenders.

Credit is tough right now but it’s achieving a higher purpose in strengthening our financial system and it won’t be this way forever.

Lending standards have probably been too loose for a while; and in response to the Royal Commission, the banks have now set standards arguably too tight for the moment. Somewhere in the middle is probably where we will end up for the long term.

In a speech last month, RBA Governor Philip Lowe highlighted the need for reasonable availability of credit to keep the economy healthy. 

“Banks need to take risk and manage that risk well. If they become afraid to lend simply because of the consequences of making a loan that goes bad, our economy will suffer. So a balance needs to be struck here.”

The impact of tighter credit is still filtering through and it’s going to take time for the market to adapt. Prices have fallen a bit more and a bit faster in Sydney and Melbourne than we’d usually expect in a correction because buyer competition has dropped away very quickly.

CoreLogic figures show the worst peak-to-trough losses in our big markets since 1980 were -11.6% in Sydney in the correction of 1988–1991 and -9.4% in Melbourne during 2008–2009. 

I think we’re already beyond those numbers but it’s no reason to panic. Cyclical price corrections must occur to ensure the long-term stability of our property markets and the broader national economy.

If you bought at the top, remind yourself that property is a long-term proposition and you simply need to wait this out. The fundamentals of Australian real estate will continue to underpin property prices through the volatility of this shift period.

Meantime, the RBA is keeping the official cash rate at historical lows. Savvy owners should use this quieter time to pay down debt; and recent borrowers should start preparing now for the inevitable switch from interest only to principal and interest over the next few years.

This is my final column for 2018. I’ll be back in January with my outlook for 2019. Until then, I wish you and your family a great Christmas and a relaxing holiday season.

Published: Tuesday, December 18, 2018


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