Your expert guide to the property market in 2023

Garreth Hanley:
This is With Interest, a business, finance and accounting news podcast, brought to you by CPA Australia.

Dr Jane Rennie:
Hello and welcome to With Interest. I'm Dr Jane Rennie, general manager, media and content at CPA Australia. Last year, many suburbs across Australia experienced declines in residential property values, and it's highly likely prices still have a way to go. Now if you are a homeowner, that could sound like bad news. On the other hand, Australia has some of the most expensive property in the world. So for first home buyers, price drops probably sound pretty darn good. This raises an interesting question. When property prices rise or fall, is it always a binary winner or losers type scenario? Can it ever be win-win or even lose-lose? And which camp the winners or the losers does the economy fall into when property prices decline? Joining me to discuss what the residential housing market will do in 2023 and the pros and cons of falling house values, is Warren Hogan. Warren is chief economic advisor at Judo Bank and has recently commenced doing residential property research as an economic advisor to HALO Technologies. Warren is also former chief economist of the ANZ Banking Group and a principal advisor to the Federal Treasury. Welcome to With Interest, Warren.

Warren Hogan:
Thanks for having me on the show.

Dr Jane Rennie:
Well, to start with, Warren, as an economist, when you're considering what direction the property market may take, what do you base your analysis on?

Warren Hogan:
Yes, so as a macro economist looking at the overall national market, you need to look at the fundamentals, which are essentially household income and interest rates. The Australian market is a good market in the sense that we don't get severe national imbalances in supply and demand. And what that means is that the price cycle for property tends to really just reflect swings in demand, which, of course, the result of changes in income and most importantly, changes in interest rates.

Dr Jane Rennie:
Well, just on that property market cycle, the housing market downturn began last year. Where are we in the cycle?

Warren Hogan:
We are, I think, somewhere between a third and halfway through the cyclical downward adjustment in house prices following the pandemic. We should be careful about being too specific on these things because ultimately where house prices end, will be a function of how high interest rates go, how well incomes perform, and that's obviously subject to a lot of uncertainty and debate at the moment. But the main message I would have is that there's still some ways to go in 2023.

Dr Jane Rennie:
Well, you mentioned the pandemic just now. Is that what's driving the downturn or at least a significant factor or is it broader? Is it interest rates and a whole range of other things?

Warren Hogan:
Well, I mean I don't think we can underestimate the impact of the pandemic on Australia's housing markets. It was profound. In fact, it's probably one of the most significant and enduring effects of the pandemic on the community and the economy in my view. And the big one was of course the massive decline in interest rates to levels we never even thought we'd get to, i.e. near zero in the cash rates, sub 2% fixed mortgage rates. And of course, there was some of those other unconventional monetary policies that the RBA did, such as the term funding facility for banks, which got those fixed rate mortgages down so low and made the market so attractive. So that's what drove prices up. And of course, now we're seeing the reverse that interest rates are heading higher and prices are coming down. So that's the biggest influence on all markets in Australia. The other thing the pandemic did was it had a big impact on our preference for housing. We saw a shift in demand towards houses at the expense of apartments for a whole range of reasons through the pandemic. And we also, I think the big one is the shift towards regional areas away from the cities. And that was essentially hybrid work driving, I think, both of those, that it will continue to be a factor going forward. It's very unclear exactly where it'll all settle, but effectively, it was city incomes going into the country and bidding up house prices.

Dr Jane Rennie:
Well, you've just mentioned two factors that I was very keen to ask you about, and that's both geography and also houses versus units. So let's start with geography. Has the decline been geographically uniform or have some states or territories weathered it better than others?

Warren Hogan:
Oh, there's certainly been a big disparity despite the fact that the big factor interest rates has been so powerful. And I'm being surprised by the disparity because you'd think when interest rates go down so much then go up so much so quickly, that that would just hurt everyone. But the reality is, is that the biggest imbalances and price cycles are across the Eastern side of Australia, including Tasmania and South Australia. And WA and Northern Territory still seem to have been affected by the big mining investment hangover that was clearly apparent prior to the pandemic, but stopped those markets going up by anywhere near as much as the eastern seaboard states in the pandemic. And of course now, those states aren't falling much at all despite rates going up. So that's the big one. But then as I mentioned, we're seeing regional markets in New South Wales and Victoria went through the roof. There's no other way to describe it, particularly those areas close to the city. And they're starting to come off, of course. And then you've got what I call the smaller capitals, which are Hobart, Adelaide and Canberra, which did something that is historically unprecedented and they are markets that are very steady income-driven markets, historically, that just literally went through the roof in the pandemic and are now coming off, with the exception of Adelaide, quite hard. So there is a lot of common factors, but there's also some real diversity. So Sydney house prices are leading the way. They're down almost 14% from their peak. Sydney apartments are down about 8%, but then you can see that some parts of South Australia and WA are near their peak still. So there is some big disparities.

Dr Jane Rennie:
And so I think you've answered my question about houses versus units. It sounds like houses have borne the brunt more so than units. What about though, say if we're looking at higher-end properties versus the more affordable market, have they been comparatively similar in the impact?

Warren Hogan:
No, we're getting evidence from... The dataset we use is CoreLogic and they're excellent, but from a range of sources that the top end is getting hit harder in percentage terms and they went up more. So there is a disparity there. I think the lower the house price in any given market... So you're comparing apples with oranges when you're comparing the lower end of Sydney with the lower end of Adelaide just because of the income differentials. But certainly the top end's been hit harder. Now whether that remains the case in the next phase is up to a question. And I'll just comment on the houses versus apartments. The interesting thing, particularly in the eastern seaboard capital city, so Brisbane, Sydney, Melbourne, apartments lagged the run-up in prices in the pandemic because people wanted to live in houses and the borders were closed and students weren't here. And a whole range of reasons why apartments didn't do as well. But in 2022, apartments actually fell in Sydney, Melbourne and Brisbane, or especially Sydney and Melbourne and not as much as houses, but they're actually now getting close to a fair value, whereas houses are still 20% plus overvalued in Sydney and Melbourne. So it is interesting dynamic that the apartment prices didn't go up as much, but they're getting caught up in this first phase of decline. And I think that's going to be one of the markets that investors start to come back to first, is apartments in Sydney and Melbourne.

Dr Jane Rennie:
Just on that word overvalued, the International Monetary Fund recently called the Australian property market some of the most misaligned in the world. If that's the case, that would seem to suggest we are still in line for a much longer-term correction and that could potentially last for several years. What's your take on that? Are we looking at one more year of stabilising, or do we need that longer term correction and that might be 2024 or beyond?

Warren Hogan:
Yeah, I mean it's all going to be about what happens with the economy and interest rates, but the speed with which inflation's emerged, and I think the resilience of the economy thus far to the rate hikes we've seen, suggest that the RBAs got more work to do and suggesting the house prices will fall this year. We're going to see, this year, the effect of not just higher interest rates on housing, but also a slower economy. Whereas last year, it is all about interest rates. The economy was actually doing very well. It was one of the strongest years for the Australian economy ever, 2022. But 2023 will be a weaker economy. We may start to see some job losses, and that'll add to the pressure on housing markets from higher rates. So I think the adjustment could be quite swift. And swift being by early 2024, the worst will be over. And that's taking prices back to a long-term fair value. And I think that that's a really positive thing in the longer term. It's a longer-term positive development, but it's not a long-term adjustment. I think it'll happen quite quickly.

Dr Jane Rennie:
Taking prices back to that long-term fair value, does that still look like the Australian housing market being very expensive compared to international peers, or misaligned as the IMF suggested?

Warren Hogan:
Yeah, no, it doesn't. It doesn't. I mean there's a number of markets around the world that look very similar to Australia, whether it's in Canada or Netherlands. I mean, we're not alone in this. We do have some of the most expensive property in the world, but there are other examples. And if you get prices back onto the income fundamentals, which is the basis for my analysis and modelling and forecasting, yeah, they're expensive, but property's always expensive to some extent. It's always hard to get into it because it's a long-term asset. It's got a high capital value. So it's always hard to break into the market, whether it's in 1930 or 2030. What I'm saying is that it's not going to be materially different in the next couple of years than it has been in the past. Property's rarely cheap, at least not in places like Sydney or Melbourne. So yeah, I don't think we're going to still be in a long-term misvaluation, I mean, our market does behave differently to the US or Germany or Japan, and I don't think they're the right markets to compare us to. So I'm optimistic that when we go through this adjustment, which is going to put some real stresses and strains into not just the market, but the economy and the banking sector, but that'll set us up for a much better position and a much better outcome for the community. You know, you'll be able to see first time home buyers come back and so forth.

Dr Jane Rennie:
And you mentioned the strength of the Australian economy last year. What is the impact this year on Australia's economy if property prices do continue to decline right throughout the year?

Warren Hogan:
Yeah, I mean it's a big question and for all of us who look at the economy, not least the RBA. And the RBA does put quite a bit of emphasis on the so-called wealth effects of weaker housing. But I don't think we've seen much of it so far. But we do need to watch that. I would note that in 2023 and 2024, that wealth effect, i.e. the effect on consumer spending because their housing asset is worth less, I think it'll be offset somewhat by the massive increase in savings through the pandemic. We've seen something we've never seen in this country before, which is a massive excess saving. And while that wasn't uniform across the whole community, I do think it does reflect the housing market to some respect. And so I think that'll reduce the wealth effect. The other impact of a slower housing market on the economy is through actual activity. So less construction, less turnover. The turnover impacts are already becoming apparent, but that's mainly in the real estate industry and associated industries. And I think that industry is very cyclical and that they're ready for these cycles. The construction side is interesting because the constraints on construction through the pandemic, which are only now just easing, we might have seen a downturn in building approvals and, of course, a downturn in house prices and other indicators. But the number of dwellings under construction in Australia at the end of 2022 is at a record high. And that pipeline's going to sort of, I think, be pretty strong through 2023. So I suppose my assessment is the downturn in the housing market, although it's been one of the quickest and largest in terms of prices that we've ever seen, its impact on the economy so far has been pretty muted. And I don't expect it to be a major reason why the economy might go into recession or be very weak. I think that's not the way it's going to play out.

Dr Jane Rennie:
Well, what about the impact, then, on the public purse if property prices are declining, less money coming in for the government and government projects? Does that have an appreciable impact, do you think, on government spending?

Warren Hogan:
Well, it has a big impact on state governments because they have such an important source of revenue as the turnover taxes or the stamp duties on property transfers. So that's going to be happening already. But the states don't seem to be worried too much about that. If anything, I think the state governments is spending too much and investing too much into an economy that's overheating and suffering from significant capacity constraints. So at this stage, no, I don't think it's a major influence on the government, but in 12 months’ time it might be, particularly if things play out as I expect and that the market could look pretty sick by the second half of this year.

Dr Jane Rennie:
Well, certainly governments do have tools at their disposal to manipulate property prices, and the tax system is a very significant one. Do you think governments, I mean do governments historically ever step in to stop or slow property market spikes one way or another?

Warren Hogan:
No. Well, I don't have a lot of history of governments trying to soften a boom in house prices. That would be politically unpopular. The RBA obviously is left to carry that can with rate hikes. And I don't think this government's any different from any other, particularly as our new treasurer wants to refer to them as the Independent Reserve Bank, i.e. blame them, not us. But on the downside, when the market weakens, there has been a lot of examples of how governments can intervene. And the governments can often use the property market if the economy more generally soft. The first home buyers grants that at various state and federal governments have used over the last 20 years have not always just been because the market itself is weak, but it's because the economy's weak in trying to encourage activity there in construction. I don't envisage anything significant outside of addressing what I think is one of the fundamental social issues related to property. And that is affordable property. And the current government seems to be making some positive noises on that front. And that's essentially about a number of things from financing through to new supply. But look, the reality is, is that the market has got a necessary adjustment to go through and there'll be a lot of headlines in the paper. And then there will be people that are significantly hurt by a downturn in property markets. But the government should try and resist not allowing the market to resettle because it's actually just getting back to a healthier level, which will improve things like affordability, which is good in the long run.

Dr Jane Rennie:
Well, let's talk a little bit about the impact on individuals, then. CPA Australia has been hearing from accountants that many consumers have yet to change their spending habits, notwithstanding that we're in the midst of a cost-of-living crunch. But we know later this year, many people will come off fixed rate mortgages. Do you think this will inevitably increase mortgage stress as a result of exposure to variable interest rates and that could result in increased supply of properties on the market, potentially reducing prices further?

Warren Hogan:
Yeah, I mean think that's fair enough. I think that's the right way to think about it. I'm not as worried about this so-called mortgage cliff as others. I think there are people who are overestimating the impact of it. It's actually quite a small proportion of households in Australia that will be subject to a significant shift in their funding costs, like less than 8% or something. So I think the issue is, is that mortgage stress will rise just because rates generally are rising and it takes some time for it to filter through. And I think we're going to start to really see that filter through. But that stress will be at the margin. And while that's important for the market, and as you suggest there may be some distressed selling, which will effectively increase supply, I don't think it's going to be enough to change the trajectory for the economy. The economy is made up of everyone. And I think we're seeing, particularly over our summer, that it's holding up pretty well. Now, there could be some broader adjustments to spending behaviour, for sure, on the basis of the cost of living shock that we're seeing, which is tragic and putting a lot of pressure on families. But I don't think the mortgage stress is going to be a macro factor. That being said, if inflation proves to be more problematic and the economy proves to be more resilient than anyone's thinking and interest rates have to go up by a lot more than what we're thinking, I mean, I think there's another percentage point of rate increases this year. That's at the top of the market. Most people think there'll be less. But if the inflation was really bad, there might be two percentage points of increases. And that would definitely start to put a lot of people in distress. Now that then that comes down to the banking system. Now banks don't want to be selling a whole bunch of houses into the market at the same time because that just undermines their own position, their customers. So I think that's where the public policy issue, the regulatory issue comes is that if we have a much more problematic inflation outlook and interest rates go up and the distress goes from thousands or even tens of thousands into the hundreds of thousands and is a systemic threat to the housing market and the economy, that's when you need to see some sort of step in. And look, let's hope that doesn't get to that point, but I think that's something that we shouldn't sort of lose sight of as a risk this coming couple of years.

Dr Jane Rennie:
So tell me, if someone's a first home buyer and they've probably been sitting there the last couple of years feeling pretty demoralised at their ability to get into the market, do these price drops now, is this just unabated great news for first home buyers?

Warren Hogan:
Well, it's good in the sense that, yeah, it does improve affordability, but the problem that the, well any buyers, not just first home buyers have got, is that as interest rates go up, their borrowing capacity falls. I mean, the biggest hurdle for most first time buyers is the deposit. And house prices going down by 20% only reduces the deposit by 2% sort of thing, or 4%. So they've still got to save up. But look, I think the reality is in a bigger picture sense, bringing house prices back down to something more in line with long run income fundamentals, even if it's, well, because it's the result of interest rates going back to more normal levels, I think is a healthy thing for everyone. But I think there's a flip side. The price destruction also comes with a higher sort of borrowing or a lower borrowing capacity. And it does help at the margin for sure, but it's not exactly a whole bunch of first home buyers will jump in. But I do anticipate first home buyers becoming more prominent as the market comes down in late '23 and into 2024, and investors as well.

Dr Jane Rennie:
And surely to the extent that they can, taking in account of the declining borrowing power, should first home buyers then be doing everything they can to get into the market? Or is it a case of watch and see? If it's going to decline over the course of this year, maybe the end of the year is the point of time to get in. I suppose it's a bit like trying to pick the bottom of the stock market, isn't it?

Warren Hogan:
It is. And look, this is what I'm doing with HALO Technologies, is trying to offer a very sort of strong analytical product that looks at different parts of the market and looks for valuation. And yes, investors will probably be the biggest users of it, but it's equally important for first home buyers because I think you're hinting at something here. If you're buying property and it's not very overvalued, then you really should just pin your ears back and go for it because it's such a long-term commitment. And we all know that the biggest thing that first home buyers have on their side is not just time, because they tend to be younger, but they also have the chance for income growth and promotion, over and above what is happening naturally within the economy. So I think you're exactly right. We should be recommending first home buyers do what they probably have been doing for a hundred years, and that is to jump in and go for it because it's such an important step in your life. But you need to be doing that when the valuations are right. So I think as I alluded to, we're getting quite close to that with Sydney and Melbourne apartments, and that's a good stepping stone for many first home buyers, an apartment. There's a lot of supply now after the big construction boom of the last decade. But yeah, houses, they should definitely show some patience before diving in. I think they really want to be waiting to see another, at least five to 7% fall in Sydney and Melbourne prices, which I think will be, it won't happen until winter at the earliest.

Dr Jane Rennie:
Well, what about property investors who are, of course, a group that don't tend to generate the same level of sympathy as first home buyers, but we know that investors fled the property market in large numbers last year? So for investors or would-be investors, is now equally a good time for them to prepare to take the leap and buy?

Warren Hogan:
Yep. Yeah, I think that's exactly the right way to think about it. And in a lot of ways, investors are sort of competing with first home buyers because that's the rental market. And investors, I think, are seeing not just the fall in capital values or the price declines is working in their favour, because there is no replacement for any investment from getting in at a good level, whether it's shares or bonds or property. If you can get in at a good price, it's hard to make a bad return. So I think that you are going to start to see investors sort of prick their ears up in certain markets like Sydney, Melbourne apartments because they're looking better value. But the other thing that's going for investors all across the country, and it's part of the difficulty of the market, is that their yields are going up or their returns are going up because rents are going up. And it's actually a double whammy. The overall return to investment's going up, not just because the rent's going up, but also the price is going down. So the overall rental yield is really picking up to some of the highest we've seen in a number of years. And I think that will entice investors, particularly with our share market looking so expensive at the start of 2023. I think we'll start to see investors become more active as the year goes on. That being said, the history is that investors tend to be very pro-cyclical. And what that means is that they tend to enjoy investing when things are good and not investing when things are bad. And the one caveat on that view is that I think the economic conditions are going to be a bit tricky as we move through 2023, even though we're on a pretty solid footing now, more rate hikes, the lagged effect of past rate hikes, global uncertainties could all sort of produce a weaker economic situation later in the year, and that might scare a few investors off.

Dr Jane Rennie:
Warren, you mentioned that rental yields are rising. I admit I don't quite understand why house prices are dropping, and at the same time we've got rents going in the other direction. Can you explain to me why it is that's occurring?

Warren Hogan:
Yeah. Well, I think the rents are ultimately determined by the supply and demand for rental properties. And that is a fundamental market dynamic in any market, but in that part of the housing market. And there's clearly been an excess demand. And I think there's been a few sort of peripheral factors there, like rents haven't moved much in the last five years, they've been quite contained. People have a bit more income because of the JobKeeper and various things and the economy's doing well. And so they feel like they can get it through. And of course, just the cost of owning a rental property has gone up, whether it's utilities or maintenance or all sorts of things. So that market's moving for fundamentals in the rental market, whereas the housing market, of course, is moving because of interest rates. So I know there's a lot of people like to draw a link between the two and thinking that higher rates means higher rents. Well, it's tenuous at best. So yeah, it's an unfortunate set of circumstances because the rental story's, I think, really going to start to hurt. It's hurting in regional Australia. And in parts of regional Australia, it was even before the pandemic. But there's a lot of locals are getting squeezed out of the market by either city incomes coming up there or properties being taken off the rental market and sold, what have you. And I think that all is a reflection of a fundamental imbalance or disequilibrium, as an economist would say, in the market. And it will settle down, but it'll settle down with rental yields and rent levels higher than what they were, and probably house prices a little bit lower. And once we get to that sort of new point of equilibrium in a year or so's time, then we'll be in a much better position to move forward from there. But it's a tricky time right now.

Dr Jane Rennie:
Is it an area where there is capacity for the government to step in and ease some of that rental pressure, or is it a bit like property prices where you mentioned before the governments historically don't like to step in and try and influence property price trends?

Warren Hogan:
Yeah, well, I mean look, it's like a lot of things with government intervention, it is misguided effects. Like first home buyer grants often end up just being first home seller grants. They just end up increasing the price. And the person who benefits are the people selling homes to first home buyers, and it'd be the same with rents. I mean, you could look at some targeted help for low income earners directly to them, but that would just increase their capacity to pay and wouldn't necessarily take pressure off the whole market. I mean, unfortunately, the best government interventions are ones that look to deal with long-term issues. And in this case, particularly around affordable housing, it's about providing supply. And that's where the government should really focus. I mean, look, if things get bad enough, I'm sure this government will intervene and provide some rental support to low-income earners, but let's hope it doesn't get to that.

Dr Jane Rennie:
Well, that's all we've got time for today. Thanks very much to our guest expert, Economist Warren Hogan. With Interest is a weekly podcast. If you like what you've heard today, why not subscribe on your favourite podcast app? From all of us here at CPA Australia, thanks for listening.

Garreth Hanley:
You've been listening to With Interest, a CPA Australia podcast. If you've enjoyed this episode, help others discover With Interest by leaving us a review and sharing this episode with colleagues, clients, or anyone else interested in the latest finance, business and accounting news. To find out more about our other podcasts and CPA Australia, check the show notes for this episode. I hope you can join us again for another episode of With Interest.