

Estimates of house price overvaluation range from 5 per cent to 45 per cent depending on the metric but realistically it seems a 10 per cent to 20 per cent reduction is likely in the early stage of this economic cycle accounting for wage inflation of around 3 per cent and also tempered by an increase in demand from renters currently priced out of the market.

The good news is that housing demand is likely to stay robust due to broad agreement of around 190,000 person levels of international migration. This will drive total population growth of 1.6 per cent in Australia but much higher in hotspots like Melbourne and Brisbane.

The key to understanding the interplay of the house price and demand dynamic is the timing of mortgage interest rate increases. While variable mortgage rates offered last year actually reduced, it appears that wholesale funding costs are increasing and that out of cycle mortgage rates could increase before the RBA increases the cash rate from 1.5 per cent.

This will accentuate the gradual decline of house prices which will partly compensate for any “crunch” effect from compounding increases in the cash rate.

In parallel, interest only loans for many investors are switching from interest only to principal and interest. Without an increase in rental levels (which is possible in several hotspots) this will bring more properties to market, compounding price drops.

If the Labor opposition reduces negative gearing benefits early (in the event it won power) this will exacerbate price drops. The timing of cash rate increases is not in the “near term” according to the RBA but is likely in late 2019 or 2020.

Related reading: Would Australian Households Be Better Off if We Ditch Negative Gearing?