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House price doomsayers: Could housing prices really fall by 20%?

Will house prices fall by 20% or more, as many pundits are predicting? Those predictions go against the historical record and against economic reasoning. It is more likely that house prices will suffer single digit percentage falls, and then remain flat (in real terms) for an extended period of a decade or more.

The graph below shows real (inflation adjusted) house prices in Australia from the beginning of 1970 until the end of 2021. There is an obvious pattern in the graph of house prices zooming up and then staying flat for a long period of time. That pattern is not just an accident of the data; it occurs for a particular economic reason, and the same pattern occurs in other countries. House prices in Canada, for instance, follow a strikingly-similar pattern.

How shares and houses differ in response to demand

Why do house prices evolve in an up-and-flat pattern rather than up-and-down like shares?

The difference between the housing market and the sharemarket is in how they respond to a fall in demand.

In the share market the supply of shares available for sale (the float) is essentially fixed and unchanging with the level of share prices. When the demand for shares falls, then to get back to the equilibrium of demand = supply all the change has to come from prices adjusting. Prices have to fall until some investors switch from thinking shares are over-valued to thinking that they are under-valued. There is no reduction in supply to help get back to equilibrium. All the adjustment is in prices.

The residential property market is different. When the demand for houses falls, then prices start to fall. As prices fall, the supply of houses available for sale declines because some sellers pull back from the market. Many homeowners are reluctant to sell into a falling market, or even to accept a price below the high water mark that their property had previously reached.

For instance, homeowners who were thinking of selling their home in Malvern and moving to the Sunshine Coast now delay that plan. Likewise, the empty nesters who were thinking of downsizing from their home in Randwick withdraw until prices improve.

Because supply falls as prices fall the market gets back to an equilibrium of demand = supply without all the adjustment having to be in prices. On the flip side, when demand rises after a period of flat prices, then supply expands. It then takes a substantial increase in demand to soak up the extra houses for sale before prices start increasing.

Have you noticed how much attention is paid to the volume of sales in the market and the number of houses available for sale? Realtors know the importance of the supply data. Moreover, they know that entry and exit of sellers is a response to price changes rather than the cause of housing price changes.

What to expect

Australian house prices rose sharply from late 2020 onwards in response to the sharp fall in interest rates engineered by the RBA in response to the Covid crisis. What we should expect now is that house prices fall by single digit percentage amounts, or perhaps a bit more, but not by 20-25%. There is no precedent for those kinds of falls in Australian housing prices in normal circumstances.

Real housing prices suffered very large falls during the Great Depression of the 1930s and during WWII and its immediate aftermath. But we are not talking about depressions or world wars here.

The largest fall in real house prices since 1970 was the 12.7% decline between mid-2017 and mid-2019. A 20% fall in nominal house prices (no adjustment for inflation) over the next year would be a 27% fall in real house prices if inflation runs at 7%. 27% is more than twice the largest fall we have seen in real house prices (12.7%) since 1970. It could happen, but it is very unlikely.

However, investors should not expect real house prices to rise either for a decade or more. There might even be a slow decline in real house prices, as happened from 1974-1987. There is something to work through here and that will take a long time.

Inflation expectations

The doomsayer pundits also seem to have a misunderstanding of the role of interest rate expectations in setting house prices. Homeowners are for the most part thinking about how high, or how low, interest rates will go in the long term, not the very short term. Homeowners are not easily convinced that interest rate changes are permanent.

In 2019, the Reserve Bank of Australia (RBA) cut the cash rate from 1.50% to 0.75% by 1 October 2019, or three months before the first Covid fatality in Wuhan in January 2020. But the property market did not respond quickly. Even after the cash rate was cut to 0.10% in mid-2020 in response to the Covid crisis, the market still took its time to be convinced that the rate cuts were long term.

The same will happen in this cycle. Housing market participants will look at rising mortgage rates and think they are not obviously permanent. Rising inflation might be pushing rates up now, but inflation will fall away and then rates will fall with it.

The point is that house prices won’t respond rapidly downward due to rising mortgage rates until households think those rates are higher for the long term. We can see in bond prices that the bond market thinks inflation and interest rates will fall away quickly over the next 12 months. Long bond rates have fallen significantly in recent months. The money market is expecting the cash rate to rise to about 3% and then be lowered again in 2023.

The doomsayers of 20-25% property price falls are focusing too heavily on short-term interest rates.

Other misunderstandings

There are other misunderstandings leading to these bearish predictions.

One is an exaggerated view of the mortgage stress that will arise if the cash rate goes to 3% of more. The danger of forced sales of properties adding to supply is being seriously overstated. Another misunderstanding is just how constrained the supply of new housing is in Australia. 

There is no doubt that house prices in Australia have reached highly-elevated levels. The total value of the housing stock is 480% of GDP in Australia versus 180% of GDP in the US. Moreover, average house prices are more than 6 times average household disposable income, up from a multiple of 2.5 times in 1990.

Nonetheless, homebuyers and investors should be sceptical about predictions that house prices will fall by 20-25% in the next 12-24 months. There are sound economic reasons to expect that house prices will suffer much more modest falls, and also to expect that real house prices will stay flat for a decade or more. Investors need to position themselves for a long period of low growth in house prices.

 

Dr Sam Wylie is Director of Windlestone Education, and a Principal Fellow at Melbourne Business School. This article is for general information only and does not consider the circumstances of any individual. Dr Wylie runs a 10-week online investment course via live Zoom, Finance Education for Investors, and the next course starts on 3 October. For enrolments, see his website.

 

16 Comments
Bill Kaye
August 21, 2022

I would be interested to see the data for ACT over the past 50 years. Annecdotedly, the mean/median price never seems to fall by any more than a couple of percentage points at best, just flatlines until Sydney starts to move again. I would expected the same response this time.

Daniel Traylen
August 21, 2022

"As a percentage of GDP, all residential
land in Australia is now worth more than
all Japanese land was in 1989 - and that
was one of the great bubbles of all time,
followed by one of the great crashes of
all time."

Glenn
August 20, 2022

Time will tell whether Modern Monetary Theory was a failed experiment. I believe it will be leaving us with deflating asset bubbles and rising long term inflationary expectations.

Inflation cycles are long and Australia's long term inflationary expectations changed after the 1991 recession. Back then if anyone suggested that our banks housing indicator rate would fall below 10% they were laughed at.
Our CPI over the past 70 years shows long periods of high inflation, disinflation, and low inflation - the key word been long!

Australia's globalisation strategy has left our economy vulnerable to supply side shocks and with no clear affordable energy policy it will be difficult to rebuild closed industries or expand those remaining.

Australia's Government debt to GDP is rapidly increasing and at some point in the future we face a limited multiplier effect to our government expenditure.

Most Central banks are continuing to run stimulative policies including the RBA at a time when they need to reign in inflation. The lessons learned from the depression period or the 1970's have long been forgotten as apparently we are too smart to repeat those mistakes again - Ha look at Glass-Steagall repealed in 1999 and within 10 years a housing debt disaster.

The Glass-Steagall Act was repealed in 1999 amid a concern that its limitations on banks were unhealthy and that allowing banks to diversify would reduce risk.
Whereas when the act was first introduced in the US in 1933 it separated commercial banking from investment banking as many believed the mixing of retail and investment banking
was a key reason for the stock market crash of 1929 and the subsequent depression.
.
Good luck to anyone who believes they can accurately predict housing prices, when companies can't accurately predict earnings beyond 9 months, forecasting is difficult but with the storm clouds out there and an inability to find a valuation parameter for housing that makes sense the risk seems to be asymmetrical to me.

Ps Australia's demographics and world population growth is also not supportive with the growth rate peaking in 1968 at 2.1% and today 1% and falling to .1% by the end of this century

Former Treasury policy maker
August 22, 2022

Glenn, MMT was not actually tried, so it's hardly been a potential failed experiment.

Oh, they increased government spending and funded it through central bank bond purchases. But MMT also required that you pay attention to what that did to the money supply. For that was the issue - QE after the GFC had not actually printed much, if any, money because it just got recycled back to Fed reserves. MMT was all about improving the chances that QE would actually fund real economic activity, which would show up when money supply growth emerged.

That happened during 2020 and should have been the signal that enough was enough. But money supply growth still hardly rates a mention in most commentaries. The latest Australian data, for M3 and Broad Money, show growth has re-accelerated over the last year from around 8% to 10%.

That's created the dilemna we now have on the inflation front. Inflation won't come down while that's happening.

Gareth
August 20, 2022

Housing in 2019 was valued $7T in aggregate.
Ripped to $10T in face of crashing interest rates and regional move shock.
Return to trend is housing back to about $8T.
That is where the nominal 20% crash will reveal itself. In aggregate.

Jason
August 19, 2022

Looking at some lenders borrowing power calculators I noted that many lenders were busy at the time of covid structuring their PAndI loans as slow starts. By making payments at the beginning of the loan mostly interest then it amplified borrowing power. The trouble is with a doubling of interest rate you end up with almost a doubling of payments. Sneaky.

In addition, other house costs which often aren't adequately captured in borrowing power calculations are going up fast, eg that $10k a year body corporate on a fancy apartment might now be $12k . After a few years of suffering distressed borrowers might sell up.

I'm not sure that reserve banks will drop interest rates once inflation drops. They may need to keep them high to stop inflation reemergimg. Reserve banks want to keep rates high to insure against the next financial crisis.

In the end of you are highly employable or got family reserves to bail you out all is well.

Orsova
August 17, 2022

"In the share market the supply of shares available for sale (the float) is essentially fixed and unchanging with the level of share prices."

This is incorrect. You're conflating the free float with the volume present on the ask side of the order book. These are two seperate things. The former is (in the short term, static, as you point out) whereas the latter is very dynamic.

SMSF Trustee
August 18, 2022

Orsova, Technically correct, but I think you miss the author's main point. All shares are potentially ready for sale at any time. Even long term holders can offer their shares at very short notice. But most houses are owner-occupied and will be put on the market once in a decade on average. The decision to sell your home isn't a quick one, or even one based mostly on price considerations. Also, when you sell shares you don't have to buy more to replace them. But with most houses, you do, as you move to a new neighbourhood or upsize or downsize. This does create a different dynamic for houses vs shares. How relevant it will be in an interest-rate driven cycle, where the houses that are sold/bought are exchanged at lower prices than last year's trades stock, is a different matter of course.

Orsova
August 18, 2022

Yes. It's a pedantic point on my part. But it's a pedantic point that the author reasons outwards from.

It wasn't my intention to imply that residential real estate and equities are the same.

My only other point would be to note that supply in real estate markets is, to a greater or lesser extent, a function of policy choice, and we might all be surprised by how that develops in the medium term.

Paul
August 17, 2022

I think the real impact on housing prices will be what is the "normal" long term OCR. Buyers are looking at their individual monthly payments and capacity to pay (driven by the OCR), whilst motivated by FOMO. For all sorts of reason's I'd like to think that a 0.25% OCR is not what we consider normal, least of which is the lack of dry powder to address any future economic problems Australia faces.

I hope that the rate doesn't drop when inflation falls away, and that the RBA ensures the economy gets used to what they perceive as a "normal" rate.

David Wilson
August 17, 2022

Give it another 6-9 months and that is when we are likely to see some serious falls in prices. Basically, it will take that long before the penny drops for many vendors that the extraordinarily high prices of the last 2 years are gone for a very long time.
Rather than owner occupiers, it is those investors those who have leveraged up with multiple properties on all time low interest rates who are likely to struggle to make interest payments and then become forced sellers in a declining market. It is hard to have sympathy for these people as they have have pretty much had things go their way for a very long time (via favourable taxation treatment; low interest rates; and willingness of banks to lend them massive amounts to invest).

Rob
August 17, 2022

I would take a slightly different view.

-20% could happen as it becomes a self fulfilling prophecy with all the noise, comments like the ANZ, loan eligibility dropping as rates rise BUT, I suspect it will be short lived as it was in the early stages of Covid - there were bargains around in the first half of 2020 that gave way to a boom as "work from home" became the norm and offices were vacated.

As always, there will be those over exposed to debt but, at least to some extent, rental increases for investors will alleviate that problem. Bottom line - certainly some panicked Vendors and cautious Buyers, but you only need a hint that future rates rises will not be as bad as currently thought and the mood will brighten.

Aussie HIFIRE
August 17, 2022

A couple of points. Firstly that although some people who might otherwise sell won’t due to anchoring on a higher price, there are likely going to be some people who simply cannot afford to pay the mortgage and would be forced sellers. It’s very difficult for a lot of borrowers to come up with another $500-$1,000 a month, and in particular for those who have only just bought and don’t have a lot of equity or fat in their budget to trim. Perhaps there is enough pent up demand out there from buyers that this won’t be a problem, but it’s difficult to know. Secondly the claim that borrowers focus on the long term rather than the short term when it comes to mortgage rates seems at odds with the various stories we are seeing in the media from borrowers who believed the RBA head when he said that interest rates would stay low until 2024. And were borrowers to focus on the long term they would notice that mortgage rates were actually higher than they were now up until the early 2010s, in which case that long term rate would present quite the problem for borrowers in the present. I have no idea what sort of fall we will see in the market, but a fall back to pre-pandemic levels (which would be roughly the 20% figure from the headline) does not seem at all out of the question.

Col
September 18, 2022

I agree with you. In recession, some of the banks revalued a lot of properties and forced some properties to be sold up.

Jerome Lander
August 17, 2022

Oh Sam, if the RBA pushes rates up quickly to 3% by the end of 2022 it won't take long until you are likely proven wrong. Of course they may not do so in which case your prediction of no or flat return from property for a long time will be a base case for now. Borrowers are highly interest rate sensitive and simply pay what they can afford to and what the banks are prepared to lend them and this is largely determined by the variable rate (and not more sophisticated and less reliable forward expectations). A rapid rise in interest rates from ridiculously low levels while the economy slows greatly and housing is more expensive than ever will indeed be enough to see a large decrease in property prices (and that won't be a bad thing for a lopsided Australian economy). Other factors could also see a large decrease in prices including a loss of confidence if the global economy completely disintegrates or we do get escalating global conflict, neither of which should be ruled out. The main uncertainty, however, is whether the RBA can be relied upon to push interest rates to 3% - and not whether property prices will reset in response to this. Yes, there will be fewer transactions but these transactions will occur at lower levels.

Fergus
August 16, 2022

Sam writes: "What we should expect now is that house prices fall by single digit percentage amounts, or perhaps a bit more, but not by 20-25%. There is no precedent for those kinds of falls in Australian housing prices in normal circumstances."

But also surely there is no precedent for such rises in prices experienced in 2021 (not in his chart that misses 2021):

"Housing values end the year 22.1% higher" source: https://www.corelogic.com.au/news-research/news/archive/housing-values-end-the-year-22.1-higher-with-the-pace-of-gains-continuing-to-soften-as-multi-speed-conditions-emerge

Never say never.....no one expected a PANDEMIC that closed the pubs and locked us indoors, no one expected another WAR in EUROPE ....no one saw INFLATION hanging around and increasing (not merely transitionary)...and no one knows how stressed out home owners will react with higher rates...lower real wages...and higher inflation (and the risk of recession)...again not saying that property prices will fall -20% +, but not impossible. NEVER SAY NEVER.

 

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