Australia's property market faces its biggest test in 30 years

Australia's residential real estate sector will have to absorb the sharpest interest rate increases since 1989. PHOTO: BLOOMBERG

SYDNEY (BLOOMBERG) - One of the world's most expensive property markets faces its biggest test in more than 30 years.

Australia's A$10 trillion (S$9.6 trillion) residential real estate sector will this year have to absorb the sharpest interest rate increases since 1989, if bond markets are right. The Reserve Bank of Australia (RBA) last week began its first tightening cycle in 11½ years, shaking the confidence of consumers with some of the world's highest debt loads.

After surging on the back of pandemic stimulus over the past couple of years, home prices are expected to fall and building to slow as borrowing costs rise, say economists. This turnaround was on display at a weekend auction in the inner Sydney suburb of Darlington, where a two-bedroom home of 104 sq m yielded no bidders.

"A property like that would typically get snapped up within three to four weeks and the auction would typically have five-plus registered bidders," said auctioneer Alex Pattaro at real estate firm Ray White. "But the market is cooling, and as more stock comes into the market place, it will have a bigger hit on the price."

A declining housing market will be a challenge for the winner of a May 21 election as so much of Australians' wealth is tied up in property. The result is likely to be weaker household sentiment and consumption, compounding the effects of higher mortgage repayments.

Australian housing has been surging for much of the past decade, reflecting the RBA slashing rates from 4.75 per cent in November 2010 to 0.1 per cent during the depths of the pandemic in November 2020. Property prices jumped more than 20 per cent last year.

The protracted easing cycle means an estimated 1.2 million home borrowers had not experienced a hike before the central bank's bigger-than-expected 25-basis point increase last Tuesday.

Property consultancy CoreLogic estimated just before this month's rate rise that a 200-basis point increase in variable loan mortgage costs would see monthly repayments climb by A$1,005. The nation's four major banks all raised variable rates by the same 25 basis points.

Money markets are wagering that the RBA will boost borrowing costs every month until December to bring the cash rate to about 3 per cent by the year end from 0.35 per cent now.

"Based on market pricing, Sydney and Melbourne could fall by 20 per cent," said Ms Diana Mousina, a senior economist at AMP Capital Markets. "There is potential for steep falls in these markets because the run-up in prices was larger and households in these two cities are also a lot more under leverage."

But Ms Mousina, like most economists, says the central bank cannot afford to be that aggressive. The last time rate hikes of that speed and magnitude occurred, it almost triggered a collapse in the financial system.

Goldman Sachs is the most aggressive forecaster, predicting that the RBA will lift the cash rate to 2.6 per cent by the year end, with half-point hikes in June and July. The median estimate is a cash rate of 1.5 per cent in December.

"We expect the RBA hiking cycle to get stopped out earlier than most, and far below market pricing, as we think the latter would likely crash the housing market and cause a recession," said Mr George Tharenou, chief economist for Australia at UBS.

Mr Andrew Boak, Goldman Sachs' chief economist for Australia and New Zealand, sees a 10 per cent peak-to-trough decline in national house prices up till end-2024, saying the slowdown will be the "primary headwind" for the economy.

He downgraded his gross domestic product forecast to 2.5 per cent next year and 2.3 per cent the year after from a previous 3 per cent for both. Still, he sees rising wages in a tight labour market and higher rents easing the pace of price declines.

Economists predict building approvals for dwellings will fall further, another risk given residential construction accounts for about 6 per cent of the nation's A$2.2 trillion economic output and 2 per cent of direct employment.

The surge in house prices has seen affordability become an election issue.

The opposition Labor party plans to help lower-income earners get a foot on the property ladder by contributing 40 per cent equity for newly built homes and 30 per cent for existing dwellings. The ruling center-right coalition is supporting first home buyers and single parents through a programme that allows home deposits of 5 per cent and 2 per cent respectively.

It remains uncertain how Australia's households, with A$2.1 trillion in outstanding mortgage debt, will respond to rising borrowing costs.

"Most buyers are worried about consecutive rate rises," said Mr Thomas McGlynn, chief executive officer of Sydney-based real estate firm Bresic Whitney.

"It would be ill-advised to have quick interest rate hikes because it is something that the current group of buyers have not really had to deal with for the last 10 to 15 years."

But Australia's biggest lenders are confident in the position of most borrowers. Households have built up an additional A$240 billion in savings over the past two years, with the average owner-occupier mortgage more than two years ahead in repayments and loan arrears still very low.

The heads of two of the nation's biggest lenders, Mr Shayne Elliott at Australia & New Zealand Banking Group and Mr Peter King at Westpac Banking, acknowledge that rising rates will hurt some people. But they argue that most households are well prepared and aided by a strong labour market.

Unemployment is 4 per cent and expected to fall to around 3.5 per cent, a level last seen in 1974, and job vacancies remain at record highs.

RBA governor Philip Lowe said last week there is "quite a lot of positive momentum" in the economy, which is unlikely to be derailed by "relatively small movements in interest rates". The RBA's quarterly economic forecasts assume the cash rate will reach 1.75 per cent in December and 2.5 per cent by end-2023.

Mr McGlynn expects Australia to avoid a sharp drop in property, pointing out there are still strong buyer inquiries, particularly at the upper end of the market, as people look to capitalise on price reductions.

"Smart money has started to come back over the course of the past two, three weeks," he said. "And that is a good indicator."

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