The debate about the Australian property market rages on. Are we headed for a crash? The Sydney market does look expensive. Citizens are in debt to their eyeballs. Regulators and banks like Commonwealth Bank of Australia (ASX: CBA) and Westpac Banking Corp (ASX: WBC) have seen the writing on the wall, and raised rates and increased their lending standards.
This will act to reduce demand by effectively slowing growth in the amount of loans being written. Will it be enough to cause a housing crash? I think not. Here's why:
House prices are caused by supply and demand
This changes in many ways, with demand from foreign buyers, the availability of credit, the amount of new buildings being constructed, and so on. A likely scenario is one where Sydney over-builds in response to the boom, or if buyers left the market due to higher lending standards.
That could happen, but is unlikely to result in the kind of price shock we would associate with a crash. More likely, prices will normalise steadily as supply and demand even out over time.
Mortgage defaults are caused by mortgage stress
The real housing crash scenario which so many commentators have in mind, in my opinion doesn't have much to do with housing prices. The 'crash' scenario is where debt becomes too much to manage and borrowers default en masse, leading to repossessed houses and forced sales. This creates a supply shock in the market (many forced sellers competing with one another) that causes prices to plunge.
That is the kind of situation that causes a housing crash. If you're watching housing prices soar, in my opinion you're looking at the wrong signal, titillating though it may be. If you were wanting to spot a housing crash in the early stages, you should be looking for signs of mortgage stress like:
- Increasing non-performing loans
Higher non-performing (i.e., in arrears) or impaired (i.e., unlikely to be fully recovered) loans at Australia's Big 5 banks, Commbank, Westpac, National Australia Bank Ltd. (ASX: NAB), Australia and New Zealand Banking Group (ASX: ANZ), and Macquarie Group Ltd (ASX: MQG). Currently the levels of these appear normal.
- Reduced ability to pay
Genworth Mortgage Insurance Australia (ASX: GMA) states that the primary driver for failed mortgages is, believe it or not, an inability to pay them. Rather than following government employment numbers, I would be looking specifically at industries that drive employments in hot property areas.
The mining crash wrecked employment levels and sent bad loans soaring in Western Australia and Queensland, which are resource-centric. If you want to spot a housing crash in Sydney you should ask – what are the primary drivers of employment in Sydney? For sure you can't afford a Sydney house loan on minimum wage. I would look at corporate earnings, and restructures, for one. Again, these are normal.
- Higher interest rates
This relates to the ability to pay. An obvious point, yes, but rising rates are the most likely catalyst for mortgage stress, and those are in the hands of the Reserve Bank of Australia ("RBA"). The RBA could be forced to raise rates, but does it want to cause a housing crash? You tell me.
- Interest-only loans
A caveat to my earlier assertion about house prices is the behaviour of interest-only loans, which are typically held by investors who expect higher house prices. If slowing lending growth and tighter regulation leads to lower house prices, will it cause these investors to exit (sell) their investments? That could spur an un-virtuous cycle of falling house prices and investor selling, although this also depends on demand for property, not just property prices.
Foolish Takeaway
In my opinion, tighter lending standards are unlikely to affect the chance of a housing crash in 2018. The concerning loans are the ones that were written before the lending standards improved and, in that sense, the groundwork for the crash (or not-crash) has already been laid. We will find out in a few years which is the case.
