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House price collapse? Not quite


Business journalist

Australian house prices will finally fall in the coming years given an historic “35 per cent” overvaluation, but a US-style collapse should be avoided, according to analysts at Capital Economics.

The economic research consultancy’s latest report into the local housing sector found the nation’s affordability metrics strained to the extent that a shift in monetary policy could drag prices down by 10 per cent.

That level of pain won’t be seen for several years, however, as monetary policy retains a distinct easing bias, with record low rates to be seen through the next two years at least.

In the meantime, the housing market should consolidate slightly above current levels as inflation levels of recent years prove impossible to maintain.

“Overall, we doubt that national house prices will rise much over the next few years and, if interest rates rise in 2018, prices may fall by about 10 per cent over 2019 and 2020,” Capital Economics chief Australia and New Zealand economist Paul Dales wrote.

The report said certain data points pointed to a vulnerability in the local market that far exceeds that seen in the US prior to the financial crisis.

At the top of the list is the comparative growth since 1990, with Australian house prices up a staggering 350 per cent since the start of the nineties as opposed to the 140 per cent growth seen in the US prior to its 2007 peak.

Meanwhile, the deviation between incomes and house prices points to a 35 per cent overvaluation at the current time, a level similar to that seen in the US before the collapse.

“On some metrics, Australia’s housing boom looks bigger than the one that preceded the bust in the US,” Mr Dales said.

“What’s more, this fantastic run-up in house prices in Australia has only been possible because the household sector has taken on greater amounts of debt.”

The saving grace at the present time is low interest rates, which are reducing the share of income devoted to interest payments.

It leaves the nation heavily leveraged to the low interest rate environment and when the RBA finally moves into a tightening period, those with interest-only loans could be in for a shock.

“Given how far prices have risen relative to incomes, some adjustment seems inevitable. And we suspect the trigger will be a rise in interest rates,” Mr Dales said.

“This may especially be the case for the 40 per cent of borrowers who currently have interest-only loans.”

The concern around the number of interest-only loans is exacerbated by the fact many of those are investor loans, a section of the market that is more likely to sell on signs of market weakness.

The shadows emerging are lightened by the comparative strength of Australia’s banks now against their US counterparts at the start of the GFC, as well as their more stringent lending practices.

On the latter point, Capital Economics notes just 9 per cent of Australian loans are being handed out with loan to value ratios of over 90 per cent, as against 29 per cent in the US prior to the GFC, while only 2 per cent of Australian mortgages are similar to the subprime loans that saw America face severe economic distress.

In the US, the subprime loan share peaked at 14 per cent.

The consultancy’s stress tests of Australia’s major banks found if mortgage delinquencies jump from current levels of 0.6 per cent to a record high of 2.5 per cent, Australia’s banks would be left cradling losses of $8 billion, a manageable amount given the size and strength of their balance sheets.

Even in a scenario of 10 per cent delinquencies, as seen during the direst days in the US, Australia’s big four banks would see their tier-1 capital ratios hold above levels seen before the financial crisis despite shouldering potential losses of $35 billion.

In fact, it could take a surge to an “unbelievable” 25 per cent rate to force the big banks’ tier-1 capital ratios back to the 7.5 per cent levels seen pre-GFC.

“If a US-style plunge in prices was going to happen in Australia, it probably would have taken place during the GFC when lending standards were looser and when the banks were more exposed,” Mr Dales said.

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