The property boom is on borrowed time

The stage is set for Australian property to finally feel the pain so evident across other sectors of the economy. A series of headwinds -- combined with tighter lending standards -- ensures that the investor property boom is now on borrowed time.

Yesterday, Westpac decided to cut the lucrative interest rate discounts offered to new housing investors -- following similar action from its major rivals last week -- as regulatory pressure from the Australian Prudential Regulation Authority begins to take effect.

The implication of this shift in regulatory policy will be modest at first but could soon snowball into a much weaker period for Australian property. Rarely can a housing downturn be so easily identified.

Nevertheless, right now, prices continue to rise at a rapid pace in Sydney and to a lesser extent Melbourne. By comparison, conditions in the other capitals remain more modest.

Real dwelling prices -- that is prices adjusted for inflation -- have increased by 30 per cent since the beginning of 2013 in Sydney and by 15 per cent in Melbourne. In the other capitals, price growth has better reflected income growth.

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But the tide is clearly turning and the outlook for the property sector needs to be viewed against the broader economic backdrop. The Reserve Bank, for example, was recently forced to cut their economic outlook for the fourth time in the past five quarters. We are currently stuck in the middle of an ‘income recession’ due to the sharp fall in commodity prices.

In the next few years, 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. Alternatively, higher taxes could make negative gearing more attractive.

Meanwhile, the Federal Government has taken clear and decisive steps to reign in foreign investment in established property, while maintaining the existing arrangements for new construction.

We also cannot ignore the possibility that the Western Australia economic bust has significant spill over effects for the broader economy and financial system.

The one bright spot for the economy is the residential construction boom but that too has obvious implications for the property sector and asset prices. Stronger housing supply is set to run into inadequate economic demand and that rarely ends well for investors.

Low interest rates remain the main reason to be bullish about the housing market -- particularly if the recent declines prove to be structural and persistent -- but their impact will be squashed to some extent by APRA’s determination to bring investor activity back to more reasonable levels.

It could prove to be a rude awakening for the Australian public. It goes without saying that Australian property has been an amazing investment for a number of decades. If you purchased a property in the 1980s and 1990s, there’s a good chance your mortgage is paid off, you own an investment property or two and you’re sitting on a million dollar property portfolio.

Some of those gains reflected savvy investment but, for the most part, the high returns on housing reflect a number of structural shifts and favourable government policies. These are factors which cannot, under any circumstances, be replicated going forward.

The truth is that property markets -- and we could say the same thing about economies more generally -- cannot defy their structure eventually. The same structural headwinds -- such as our ageing population and the end of the commodity super-cycle -- will ultimately affect both our capacity and willingness to pay exorbitant property prices.

We don’t know how responsive investors will be to changes made by the major banks but we do know that demand from owner-occupiers is teetering on the brink of decline -- the number of people looking to upgrade/downgrade their home has become exhausted. If investor demand begins to decline, then that’s the ball game; there is no sector that is large enough to fill the gap left by weaker investor demand.

This set of circumstances isn’t without precedent. The Australian housing market has experienced three downturns over the past decade. These downturns occurred despite solid income growth, low unemployment and the mining boom.

There is good reason to believe that the next downturn -- whenever that is -- will exceed the past three due to the sharp rise in investor activity and record household indebtedness. Both the house price-to-income ratio and household debt-to-income ratio are at historically high levels.

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House prices have been growing at an unsustainable pace for some time and a period of much weaker growth is inevitable but the real concern for investors and owner-occupiers is the number of headwinds lining up to take a whack at Australia’s $5 trillion housing sector.

Can the Sydney property market really prosper in the face of elevated unemployment, dreadful income growth and the end of the mining boom? Unfortunately, Australians are set to find out that even the Australian property market can’t defy its fundamentals forever.