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UBS is becoming “more bearish” on the outlook for Australian property prices.

It says prices nationally may now fall further than 10% without policy support from the RBA or APRA.

“The risk is rising, not falling, of a negative wealth effect potentially leading to a credit crunch scenario,” it says.

UBS thinks Australia’s housing market downturn has further to run yet, echoing sentiment among most mainstream forecasters.

However, based on recent information, the bank’s Australian economics team is becoming increasingly bearish about the outlook for prices, warning they could fall beyond the 10% level currently forecast.

“We’re even more bearish on house prices,” says George Tharenou, Carlos Cacho and Jim Xu, members of the UBS Australian economics team.

“We previously expected around 5%, but now expect prices to drop peak-to-trough by 10% by 2020 to the lowest level since mid-2015, heavily skewed to Sydney and Melbourne with prices down 15%.

“Auction clearance rates also recently slid to a cycle low under 50%, seeing a drop of around 30% in sales volumes, consistent with price falls accelerating.”

And that’s before a huge wave new housing supply arrives in the quarters ahead, especially in Sydney and Melbourne, markets where prices are already falling at the fastest of the major capitals.

UBS

“[In the June quarter there were] 229,000 dwellings under construction, including 156,000 private multi-dwellings,” UBS says.

“There is still a huge supply pipeline yet to come, which was likely purchased ‘off-the-plan’ around the peak of prices from 2016 to 2018.

“A significant portion of these dwellings are facing the prospect of ‘negative equity’, particularly for those with smaller deposits under 10%.

“This raises the risk of an increase in settlement failures over the next couple of years, albeit from very low levels currently.”

According to Metadata from CoreLogic’s Valex platform, a massive 30% of newly-completed apartments in Sydney, and 28% in Melbourne, settled with a valuation less than their original contract price in September.

Like UBS, Tim Lawless, Head of Research at CoreLogic, said the combination of continued price declines and strong pipeline of newly-completed housing stock means that settlement risks are now “heightened”.

“Many of these apartments would have been sold off the plan, at a time when housing conditions were much stronger and credit conditions weren’t as tight,” he said.

“With the unit construction cycle moving through an unprecedented peak, the settlement phase will be an important facet of the market to monitor.”

“Off-the-plan buyers who find their valuation comes in lower than the contract price at the time of settlement could be in for a rude shock.”

With an unprecedented pipeline of new dwellings on the way, at a time when lending standards continue to be tightened, UBS says this could lead to even larger price declines without an easing in policy from the RBA or APRA.

“Given the main driver of house prices is an ongoing reduction in borrowing capacity for the marginal bid, we are concerned that without policy easing, the largest price falls in decades could break the ‘buy the dips’ mentality and the ‘Great Australian Dream’ of buying property because ‘prices only ever go up’,” UBS says.

“The RBA are unlikely to cut the cash rate, and APRA are unlikely to reverse macroprudential tightening, meaning price falls could end up even worse, particularly in Sydney and Melbourne.”

The bank warns this potential change in buyer mentality could, in absence of policy changes, act to weaken demand even further, creating a scenario where negativity towards feeds upon itself, worsening price declines as buyers retreat to the sidelines in anticipation of an even larger downturn.

“We are concerned that an unprecedented period of falling prices could lead to expectations of future price declines,” UBS says.

Should such a scenario play out, the trio say there’s an increasing risk that weakness in the housing market could spillover into the broader economy.

UBS

“The risk is rising, not falling, of a negative wealth effect potentially leading to a credit crunch scenario,” they say.

“Housing is deteriorating before the full impact of the Royal Commission likely recommending full verification of living expense, the creation of Debt-To-Income limits for the share of new loans above six-times debt-to-income the Labor Party’s proposed scaling back of negative gearing and capital gains tax concessions.”

In response to the concerns raised by UBS and others about the potential impact of falling property prices on the broader Australian economy, RBA Deputy Governor Guy Debelle said policymakers are watching.

“It’s something that we’re paying pretty close attention to. How much of a drag it may constitute.. is just not clear,” Debelle said at Citibank’s investment conference in Sydney earlier this month.

It’s not entirely clear how much of a boost the rising house prices provided to the economy on the way up, which also means it’s not entirely clear how much of a drag it may provide or may constitute on the way down.

“I’m not saying that because I think it’s one way or the other, it’s just that it’s really an uncertainty.”

Debelle stressed that this uncertainty partially reflects that home prices aren’t falling in all parts of Australia at present.

“Not all of the country lives in Sydney,” Debelle told the conference. “They’ve come down in Sydney from their peak, having gone up, sort of, 50% in a few years.”

According to CoreLogic data, Australia’s median home price has fallen for 12 consecutive months, leaving national values down 2.7% over that period.

Much of the national weakness reflected declines in Sydney and Melbourne with median prices in those cities down 6.1% and 3.4% respectively from 12 months ago. In contrast, median home values in Brisbane, Adelaide, Hobart and Canberra rose between 0.7% to 9.3% over the same period.

Based on October’s data so far, it looks like Australia’s housing downturn will extend to a 13th consecutive month when CoreLogic releases its October Home Value Index later this week.

Given recent information on retail sales, car sales and consumer confidence, there are signs weakness in the housing market, along with ongoing political turmoil in Canberra, may be starting to negatively impact the mindset of households.

After a strong June quarter, Australian retail sales were unchanged in July and rose by a modest 0.2% in August. Based on an early reading from the National Australia Bank’s monthly cashless retail sales index, electronic spending conducted by the bank’s customer base in September points to the likelihood of another modest gain of 0.3% in the official data from the ABS.

Separate data from ANZ Bank showed Australian consumer confidence plummeted 6% in the middle of October following the Wentworth by-election, leaving it at a 13-month low.

The weekly drop was also the largest in percentage terms in six years.

Given that backdrop, it suggests concerns towards the outlook for the property market may start to weigh on broader household consumption in the period ahead, creating potential downside risks for economic growth and labour market conditions given it accounts for over 50% of the Australian economy.

While the RBA describes the outlook for household consumption as one ongoing area of uncertainty for the economy, in recent commentary it’s continued to suggest that the next move in official interest rates is likely to be higher, albeit not in the near-term.

Should upcoming data on home prices and household spending remain soft or weaken further, it will only act to create renewed doubt as to whether that outlook is realistic.

CoreLogic will release monthly Home Value Index on Thursday, November 1. That will be followed a day later by Australia’s official retail sales report for September.

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