Has the housing downturn already begun?

Is it possible that while our attention drifted to Canberra for the budget, we missed the beginning of the housing downturn?

It’s fair to say that Canberra was the centre of the economic universe this week -- at least for Australians -- but there are a range of other developments worth keeping an eye on.

For example, dwelling price growth appears to have hit a hurdle, with nominal prices down 0.5 per cent in May to date. Prices in Melbourne are now 2.5 per cent off their March peak. Perth prices haven’t grown since November. Prices in Sydney have stumbled.

The graph below shows daily dwelling prices adjusted for inflation. Each city is showing a distinct loss of momentum in recent weeks or months. Growth over the last 90 days -- an attempt to look through daily volatility -- is now at its slowest pace since July last year.

Speculation has driven the Sydney and Melbourne housing markets over the past year, but history suggests that investors can rarely shine so bright for long.

A boom built on speculation is susceptible to changes in lending activity. By comparison, price rises that are driven by income growth or higher construction costs are likely to be more persistent or sustainable.

Evidence suggests that lending activity is approaching its peak and will begin to trend downwards in coming months. On a trend basis, new loan approvals to owner-occupiers fell by 0.1 per cent in March -- the first decline since March 2012.

Investor lending rose by 0.4 per cent in March but the pace of growth has slowed rapidly in recent months. The graph below, showing monthly trend growth, shows a distinct loss of momentum following a period of exceptionally strong growth.

First home buyer activity remains subdued but has picked up modestly in recent months. First home buyer activity has historically been more volatile than lending by either owner-occupiers or investors. First home buyers are more susceptible to changes in the economic cycle; many are younger with a more marginal attachment to the workforce.

They are also affected significantly by changes in the first home owner grant. The grant itself does little to improve housing affordability, with the grant quickly incorporated into price expectations, but does encouraged people to bring forth their purchasing decisions. At present, most states apply the first home owner grant to the purchase of new (rather than established) properties.

There is little reason to expect first home buyer activity to increase significantly in upcoming months. Even if it did, it would be insufficient to fill the gap left by investors and owner-occupiers.

Though slowing demand would be sufficient to push prices lower, it is by no means the only headwind facing Australia’s $5.1 trillion housing sector.

The deficit tax is set to hit investors and could go either way (A day of reckoning awaits for the housing market, May 7). Higher taxes will hit the market at the very top (since high income earners obviously purchase expensive housing), but also towards the bottom (since investors often favour cheap rental properties). On the upside, the taxes themselves could make negative gearing a more attractive vehicle for tax reduction.

The labour market continues to be subdued and, despite recent improvements, the unemployment rate remains elevated. Wage growth is tracking at its slowest pace in at least 15 years and the participation rate is set to drop further over the next few years.

There is also mounting evidence that China’s economic fortunes are beginning to sour. A softening outlook in China could have both direct and indirect effects on Australian property.

Direct foreign investment to residential property may begin to slow, with many investors in China already selling at a discount to find liquidity. There is growing concerns about Chinese residential investment and their housing market looks increasingly overheated (Alarm bells are ringing on China’s property bubble, May 9).

If domestic investments turn sour then it is only a matter of time before they look to Australia to free up liquidity. If that occurs, then the Chinese influence on Australian property could soon revert from boosting prices to driving them down.

The bigger concern emanating from China is the impact a slowdown could have on Australian growth. Though the Australian economy is rebalancing away from dependence on China (or at least trying to), our extreme reliance leaves us particularly susceptible to changes in their economic conditions.

Australia has hitched its wagon to China’s fortune and a mere slowing of growth over there would be sufficient to push iron ore prices lower, slash our terms-of-trade and weigh on domestic income growth. A slowdown in China would hit Australian property from all angles and has significant implications for both investment and prices.

The housing sector appears to be showing some signs of fatigue in recent months. Housing loans are slowing and house prices have been fairly weak over the past couple of months. Building approvals have also peaked and are showing signs of moderating.

These signs may be temporary but there remain a number of significant headwinds to Australian house price growth. Wages and the labour market remain subdued and there are mounting concerns about the Chinese economy, which has significant implications for the Australian housing market.

House prices have been growing at an unsustainable pace for some time and it was inevitable that momentum would slow during 2014. Nevertheless, the number of factors lining up to hit house prices should be concerning for investors and owner-occupiers alike.