Housing market downturn causes investment rethink

December 2018

Safe as houses: is it time to consider alternatives to residential property?

There’s little doubt the Australian housing market is in the midst of a significant correction – the only moot point being the likely severity and duration of the downturn. Tim Lawless from property data group CoreLogic and Citi’s own experts put the downturn into perspective.

By Damon Frith

Why waste a crisis?

The current downturn in the Australian housing market is an ideal time for investors to check the overall health and balance of their portfolio, rather than just maintaining a “buy and hold” strategy that could lead down a dangerous road to complacency.

Most investors are exposed to housing at least through their primary residence and should consider their overall asset allocation in the context of the downturn.

“Investors should be focused on bringing quality to their investment portfolios and clearly the easiest way is through diversification amongst asset classes,” says Citi senior investment strategist Simson Sanaphay.

“Citi’s current preference is for asset classes that will weather the more frequent volatility that is to be expected owing to the mature stage of global growth.”

For the first time since 2016, Citi has not upgraded the near-term outlook for the global economy. While the firm still sees growth, risks such as global trade tensions and the pending Brexit could make life all too interesting for investors.

“Despite all of this, we continue to remain invested and allocate capital into equity markets as we expect earnings to grow given the resilient global economy,” he says.

Balancing this, investors should also consider taking advantage of the growing opportunity created by higher US interest rates, which has translated to attractive Australian yields on investment-grade corporate bonds.

Citi’s forecast for 10 Year US Treasury yields forecast stands at 2.85 per cent for the end of calendar 2019, but could reach as high as 3.75 per cent if growth endures and the Federal Reserve tightens rates in line with forecasts.

“Portfolio stability, stable income and quality in creditworthy investment-grade issuances are the key benefits that investors should be considering especially in this late-game,” Sanaphay says.

Housing crisis or healthy correction?

Recently there’s been no shortage of experts predicting declines of 20 per cent or even as great as 40 per cent. In reality, no-one really knows the likely extent of the downturn.

Citi sees capital city prices eroding 5.7 per cent in calendar 2018 and a further 1.5 per cent in 2019.

As with any sell-off, investors are advised to keep a clear head even if others are losing theirs.

CoreLogic research director Tim Lawless says there’s still the prospect of the market continuing to temper from excessive levels, but without causing undue pain. “Arguably the regulation we have seen in this market has been controlled and slowed the market in a measured way,” he says. “Values aren’t falling off a cliff.”

If history is any guide, the last property downturn saw prices fall by 6.5 per cent from peak to trough between June 2010 and February 2012. Between January 2009 and June 2010 housing values increased by 15.9 per cent, at a time marked by the federal government’s cash handouts (to dampen the effects of the Global Financial Crisis) and a boost to the first home buyers’ grant.

To put the current downturn into perspective, valuations surged an average 70 per cent in the recent boom. “It’s a material downturn, but in a historical context the vast majority of homeowners are in a strong equity position,” Lawless says.

The latest annual results from three of the Big Four retail banks bear this out, with their bad debt experience remaining largely benign. But with household debt increasing, alarm bells could ring for domestic consumption (and the local economy generally) as home borrowers devote more of their wages to home loan repayments.

Putting the downturn into perspective

An overlooked aspect of the unfolding correction is that as with electoral swings, the downturn is inconsistent across geographies and property classes. According to CoreLogic, the overall national housing market declined 3.5 per cent over the 12 months to the end of October, with Sydney and Melbourne values falling 7.4 per cent and 4.7 per cent respectively.

Despite fears of a high-rise apartment glut in the eastern seaboard capitals, units have outperformed: down 3.2 per cent over the 12 months compared with 5.1 per cent for detached housing. Surprisingly, Sydney high-end apartments (those in the top price quartile) are holding up marginally better than more affordable real estate in the bottom quartile: down 4.3 per cent and 4.8 per cent respectively. In Melbourne, ‘top end’ apartments have declined 3.7 per cent in price, but the most affordable have actually gained 3 per cent.

The valuation discrepancies are also evident city-by-city. Overall housing prices in Sydney and Melbourne have fallen by around 2 per cent in the last quarter, but Adelaide, Hobart and Canberra valuations have increased. The Perth market – which boomed up until 2012 along with the resources sector - remains difficult.

For investors, panicking is never a recommended strategy – especially as their properties may well be faring better than feared.

Citi’s view

According to Citi senior product manager Ian Paul, property downturns are generally temporary - especially in Australian cities - so if investors have a long-term view they may be better off not selling.

“Investors should ensure they have sufficient cash flow to service any shortfall between debt (taking into account potential interest rate rises) and rental income so they can hold on to their investment properties for the long-term,” he says. Investors can also protect themselves by locking long-term leases and fixing all or some of their loan.

Paul says forecast population growth will influence housing supply, but there’s generally a lag effect.

“Regulatory changes probably will have the biggest impact in the short-term,” he says. “We have already seen overseas borrowers being marginalised and investor loans being priced higher. The fallout from the banking Royal Commission is yet to be seen but already it is likely that tighter lending standards may have a dampening effect on credit demand.”

For more, visit Citi Insights.

Damon is the content editor for Citi’s wealth business

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