Ross Stitt casts an eye over the Australian housing market amid the suggestion the downturn is accelerating

By Ross Stitt*

“The housing market downturn is accelerating, and widening.”

Those are the ominous words in the latest report on Australian house prices released by CoreLogic. Nationally, prices were down 3.4% in the quarter to 31 August; 1.6% in the month of August alone.

The picture is even more dire in Sydney, the bellwether for national prices, where the quarterly decline was 5.9%; 2.3% just in August.

If the decline keeps accelerating, things could get very messy in the Emerald City. Modelling from the investment bank Barrenjoey suggests that if the Reserve Bank of Australia (RBA) continues to raise interest rates in accordance with market expectations, Sydney house prices could fall a remarkable 25% to 30% by next year. And they are not alone in these bleak forecasts.

While declines of this magnitude would only return prices to where they were at the start of the pandemic, that would be cold comfort to the thousands of recent purchasers who would be left with negative equity in their homes and escalating interest payments.  

One interesting aspect of the Sydney price falls is that they are much more pronounced among higher value properties. Houses in the lowest value quartile dropped 2.8% in the August quarter versus a chilling 7.5% in the highest quartile. That translates to thousands of dollars a day for three months for vast sways of Sydney real estate.

This disproportionate decline in higher value residential property is consistent with comments made in a speech on Monday by Jonathan Kearns, Head of Domestic Markets with the RBA. He said that “housing prices in the most expensive areas are the most sensitive to interest rate changes” and the most cyclical.

There’s not much good news here for most first home buyers who tend to be shopping in the lower value quartiles. And any benefit that they are gaining from lower prices are being more than offset by rising mortgage rates. House prices are falling but housing affordability is not improving.

For years, would-be purchasers have prayed for a major downturn in house prices, particularly in Sydney. Their prayers are finally being answered but the concurrent major upturn in mortgage rates leaves them no closer to fulfilling the Australian dream of home ownership.  

According to Barrenjoey Chief Economist Jo Masters, speaking at the AFR Property Summit, mortgage repayments in Sydney now exceed more than 60% of household disposable income. And it will only get worse as the RBA continues to raise interest rates.

CoreLogic has examined how the changing conditions are effecting different buyers. The conclusion is that “demand for housing finance across owner occupiers that are not first homebuyers … appears to be fairly resilient in the rising interest environment”.   

The rest of the market i.e. first home buyers and investors, are “more sensitive to interest rates”.

There’s also great variability on the supply side. The position for existing homeowners depends on when they bought, their level of mortgage financing, and its interest rate terms. The RBA’s Kearns is reasonably sanguine on the grounds that “around 35 per cent of housing credit is fixed-rate debt” and “a large share of variable rate borrowers have been making excess mortgage payments into offset and redraw accounts”.

Some investors will be forced to sell. No doubt many already have, given the ugly combination of rising interest costs and falling prices. The one saving grace for investors is that rents are rising rapidly in some capital cities. According to SQM Research, rents in Sydney rose 3.1% in the last month alone. 

Another factor impacting on supply is development and construction. Figures from the Australian Bureau of Statistics show that the number of residential dwelling approvals fell 17.2% in July. That was driven by a 43.5% slump for units. This is the result of uncertainty about future economic conditions, the difficulty of accessing funding, the upward trajectory of interest rates, and prohibitive construction costs.    

Of course, the problem now is that not enough houses are being built, particularly as migrants and foreign students are returning in numbers. Last month, the Labor government increased the permanent migrant intake by 35,000 in the 2022-23 period. The objective is to ease a chronic skills shortage, but it will also put pressure on housing in Sydney and Melbourne. That will mean upward pressure on rents.     

SQM Research data show that last month the residential vacancy rate nationwide fell to a 16-year low of just 0.9%. In Sydney and Melbourne, it was 1.3% and 1.4% respectively. There’s little capacity to deal with natural population growth, let alone higher immigration. The situation could become acute in 18-24 months when the recent drop off in construction approvals flows through to fewer new developments being completed.  

In the meantime, the key factor is interest rates. The RBA has raised the cash rate five months in a row from 0.1% to 2.35%. In his September statement, RBA Governor Philip Lowe said that the RBA “expects to increase interest rates further over the months ahead” and is committed to doing “what is necessary” to get inflation back within its 2% to 3% target range.

Where will it end? The RBA is widely expected to raise the cash rate by 0.5% to 2.85% at its next meeting in October. Beyond that, opinions differ. Westpac is predicting the RBA will eventually go to 3.6%. ANZ says 3.35%. Either outcome would have a severe impact on the borrowing capacity of would-be buyers and the budgets of existing floating rate mortgagors.

And on house prices.    

The Commonwealth Bank takes a very different view. It predicts rises of 0.25% in October and November to a peak of 2.85% followed by rate cuts in 2023.

Time will tell who’s right.

The RBA’s job of taming inflation would be a lot easier if the federal government exercised a little fiscal restraint. But with large budget deficits as far as the eye can see and voters screaming for ‘cost of living’ assistance, the RBA Governor won’t be holding his breath.

Interest rates, inflation, immigration, consumer confidence, government spending, and international events will all play a role in determining what happens next in Australia’s housing market. The only certainty is uncertainty.

*Ross Stitt is a freelance writer with a PhD in political science. He is a New Zealander based in Sydney. His articles are part of our 'Understanding Australia' series.