Are we in for a sustained decline in prices?

Summary: The ingredients for a major property crash are not present, but there are still risks.

Key take-out: A 40 per cent drop is media overkill, but expect some more price softening.

A recent alarmist piece in the media about how house prices could drop by 40 per cent was not surprisingly met with much scepticism by people in the property industry.

Sure, we could see declines this big, but the trigger would have to be pretty dramatic to get to that point. While such a decline is unlikely, we are certainly not in ideal buying conditions at the moment. It is tough to get finance, mortgage rates are creeping up, and prices declining in Sydney and Melbourne are impacting sentiment. What then is the likely outlook for house prices in Australia?

Before we look at what could be the trigger for better conditions, first I need to reiterate that not all of Australia is seeing declining prices. Hobart and Canberra continue to see strong growth, while Brisbane seems to be improving. Even Perth seems to be at the end of four years of tough conditions. Outside of Sydney and Melbourne, the changes in the market have either delayed recovery or muted growth.

What could turn the market around?

End of the Financial Services Royal Commission
A bright spotlight on banks and other lenders is leading to very conservative behaviour by banks. Everyone is finding it hard to get finance, but investors are feeling particularly challenged. The end of the Royal Commission will be a positive to lending. The final report and recommendations will be released at the start of 2019 and, at this time, banks will have greater certainty around what they can and cannot do. While it is possible that the recommendations will be far more restrictive than expected, the likelihood of this is low. The aim of the Commission wasn't to make the banking sector unviable or to crash the property market. What is certain is that lending conditions after the Commission will be more restrictive than they were prior.

Positive economic and jobs growth, particularly wage rises
Do you remember the aftermath of the Global Financial Crisis? Property in Sydney and Melbourne declined at this time, primarily because of job losses. Right now, we are moving into very different economic conditions. Businesses are confident and employment growth is strong. Eventually that will lead to more confident consumers and wages growth. While prices are declining, this will certainly cushion the fall.

Greater political stability
No market likes uncertainty and instability, and in politics we have certainly had a lot of that. While the outlook for this in the US and UK seems never ending, in Australia it is likely that things will settle down fairly soon, either because the Coalition becomes more stable, or we have a new government sometime next year. A new government, however, will have its own problems for property.

The return of foreign buyers
Foreign Investment Review Board approvals have shown a big drop in purchases from offshore buyers, and media in Asia now focuses on Australia being overpriced and with large price falls expected. While this is impacting buyers, our internet traffic shows that property seekers from Asia, particularly China, are still very interested in Australian property. The number continues to rise. While foreign buyers are unlikely to start becoming more active in a hurry, particularly given their difficulties in getting finance as well as the additional taxes on foreign buyers, it is possible in the next two years they will return. This will, however, primarily impact the new home space.

What could lead to conditions worsening even further?

Trump's trade war
As he promised, US President Donald Trump has started a trade war and China is his major target. Australia's economic growth is reliant on China's economic growth for a number of reasons. It buys a lot of our resources, it sends a lot of students here, and it provides us with low-cost goods. Right now, Chinese economic growth is solid off the back of better global growth conditions, however a trade war will impact this. If China's economic growth takes a dive, Australia's economic growth will also grind to a halt. Of all uncertainties in the market, this is one that could have the greatest impact on jobs and ultimately house prices.

Rapid rise in interest rates
A rise in interest rates is bad news for mortgage holders in that their loans increase, but for many it is also good news. Interest rates will start increasing once wages start to rise. On one hand, you will pay more on your mortgage, but on the other, you will be getting paid more. While most people could easily stand a couple of rate rises, it will be more challenging if they start to rise rapidly. At this stage, this isn't really a risk.

Changes to negative gearing and capital gains tax concessions
A month ago it seemed unlikely we would see a change of government, however it is now more likely. A policy change outlined by the ALP is for the current negative gearing tax incentives to only apply to new housing. For existing properties already negatively geared, there will be no changes. This could have a big impact on pricing, particularly in Melbourne and Sydney. Whether the policy is changed, however, remains to be seen. It was announced at a time at which prices were increasing dramatically and investors were particularly active. Investors have now pulled back and prices are declining.

Conclusion

While Australian housing prices declining by 40 per cent is highly unlikely, at this stage it is quite possible that Sydney prices will decline by 10 per cent and Melbourne by around 5 per cent.

Next year, with the Royal Commission complete, greater political stability and wage rises, it is likely that prices will stabilise. That is, unless a trade war intervenes.