Australian house prices – unlikely to fall… especially after 4 October, 2008 RBA Rate Drop

A few analysts have for some time been predicting that Australian house prices will drop. Not only do I hope these predictions will be proved wrong, I also think they will be. These analysts are of course wholly correct in pointing out that Australian house prices are high (relative to incomes), both by historical and international standards, and that Australians have accumulated a lot of debt (again relative to incomes) in the process of pushing house prices to where they are. And house prices have already fallen significantly in some other countries – notably the US and Britain - where both house prices and household debt have previously risen by similar proportions as they have in Australia.

Despite these undeniable similarities, there are nonetheless some important differences between the Australian and American housing and mortgage markets.

Australia does not have a physical excess supply of housing. America does, because unlike us, it actually built more new dwellings than it required to meet growth in underlying demand. In Australia, the reverse has happened: we haven’t built enough dwellings to meet underlying demand, which has been pushed up by rising levels of immigration. As a result, we actually have a significant backlog of unmet underlying demand for housing (as also indicated by the upward pressure on rents in recent years).

BIS Shrapnel's Robert Mellor said yesterday Australian house prices were unlikely to collapse or suffer a sustained decline as in the US and UK.

"I think the fears of a collapsing housing market have been totally overdone," he said.

"There are a lot of things happening out there that are going to support the market."

Mr Mellor said there was a major difference between overseas' housing markets and Australia's. "We don't have an oversupply of housing - we have a significant under supply," he said.

"In Brisbane we've seen a strong rental growth for going on three years."

He said the current situation in Brisbane was similar to the price peak of 2003-04, before the 2007 surge.

Other factors mitigating against a collapse and which were yet to bite, included the recent interest rate cut, with the likelihood of more cuts to follow, the doubling of the first home buyers' grant for existing properties and the tripling of it for new constructions and, in Queensland, the stamp duty exemption for first home buyers of properties less than $500,000.

Those factors, coupled with the easing of prices, meant that affordability was improving.

"These are all factors that, in Brisbane, will continue to support the market," he said

Reflecting this, the IMF’s World Economic Outlook specifically acknowledges that ‘if some country-specific factors are taken into account, the results [of a cross-country study of the extent to which house prices could be explained by ‘fundamentals’ by IMF researchers] do not produce evidence of a significant overvaluation of [Australian] house prices’(IMF 2008, World Economic Outlook (Washington DC, October), p. 17, note 4).

Why there is unlikely to be a large across-the-board fall in Australian house prices as there has been in the United States…

Australia does not have a huge supply of existing dwellings for sale at any price hanging over the market because of the huge increase in foreclosures that has been the primary source of downward pressure on American house prices. Mortgagees in possession will sell at any price because they don't want to keep the house, they want to get at least some of their money back as soon as possible. That is now happening on an unprecedented scale in America. But it isn't happening, and in my view is unlikely to happen, in Australia.

One reason for that is that there has been far less imprudent lending here than in America. "Non-conforming" loans (the closest thing we have to sub-prime) represent around 1% of all mortgages outstanding in Australia, as against around 15% in the US; while “low-doc” and “no-doc” loans account for around another 7% in Australia compared with about 15-20% of American mortgages being "Alt-A" which is their equivalent of “low-doc” or “no-doc”.

More generally, the Reserve Bank of Australia was one of the very few central banks which did not make the mistake (which the US Federal Reserve under Alan Greenspan in particular did make) of keeping interest rates too low for too long in the first half of the current decade, after the risk of recession and deflation in the aftermath of the bursting of the "tech bubble" had subsided. That's why proportionately far fewer Australians than Americans were enticed into taking out mortgages that they couldn't hope to be able to service when interest rates returned to more "normal" levels.

Secondly, mortgage lending in America is typically "non-recourse": that is, in the event of default, the lender can take possession of, and sell, the property against which the mortgage is secured, but cannot make any claims against any other assets or income which the defaulting borrower may have.

That means that when an American borrower finds him or herself in a position where he or she can't (or even doesn't want to) keep up the repayments on a mortgage which may be worth more than the home, it can be quite rational for him or her to "walk away". Yes, he or she will have a bad credit rating, and may never be able to get a mortgage again: but many of the borrowers were in this position to begin with - that's why they got "sub-prime" mortgages in the first place.

By contrast, in Australia the generally applicable legal position is that lenders can go after a defaulting borrower's other assets and income, if any, in order to make up any shortfall remaining when a foreclosure sale results in proceeds which are less than the outstanding debt. That, together with the generally greater social stigma which the Australian culture attaches to default, provides a powerful incentive to Australian home buyers to avoid default if possible.

And that is one reason why default rates on Australian mortgages have remained vastly lower than on American ones - even though the interest rates which Australian borrowers have been paying have generally been somewhat higher than those paid by American (or British) homebuyers.

Because there are proportionately far fewer dwellings in foreclosure, and thus “on the market” for whatever price someone is willing to pay for them, in Australia than in the US, there has been far less downward pressure on house prices here than in the US. And provided (and this is an important proviso), unemployment in Australia does not spike sharply higher (as it did in the early 90s) this is likely to remain the case - especially now that interest rates are falling, and falling a lot. If mortgage defaults rose only a little while interest rates were high and rising, provided unemployment remains low, why should mortgage defaults start rising when interest rates are falling?

Here's the simple but critical point: house prices will only fall significantly if lots of owners have to sell them for whatever price that they can get.

It is increasingly true that vendors are finding that they can't get the prices they would like. Sometimes they find that if they really do want to sell, they may have to settle for less than they had hoped. But the more common reaction, among the vast majority vendors who are not selling because they have to, is not to sell, and to remain in the property for longer.

Together with appropriate reductions in interest rates, it would help ensuring that Australian home-buyers were able to continue servicing their mortgages, reduce the risk of rising mortgage delinquencies and defaults, and minimize the risk of sharp and destabilizing falls in house prices.

Source: Saul Eslake, ANZ Chief Economist and BIS Shrapnel's Robert Mellor