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Top broker warns that property market is facing the worst conditions in 30 years

Those banking on our residential market holding its ground and recovering in the near-term could get their beliefs tested after Morgan Stanley warned that the outlook for the market is the worst it has seen in 30 years.

You’d have to go back to a time when Bob Hawke led the country and the medium home price in Sydney was $141,000 to find more bearish growth conditions for the Australian market.

The broker’s report, which was carried in the Australian Financial Review, points to a confluence of factors that are hitting the market at the same time and casting a long shadow over the sector.

This will have a direct impact on residential construction stocks such as Mirvac Group (ASX: MGR), Stockland Corporation Ltd (ASX: SGP) and Lendlease Group (ASX: LLC).

But any fallout from a falling residential market will be felt throughout the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) as it will hit consumer and business confidence.

While there have been a few tentative signs that the residential market is coming back from the slowdown, the range of lead indicators that Morgan Stanley looks at to gauge the health of the market are at their lowest point in three decades.

These indicators include credit supply, housing accessibility, market expectations, borrowers’ ability to service their mortgage, demand/supply factors and rental conditions.

While Morgan Stanley admits that the slowdown in the market has so far been mild, the likely increase in compliance costs and regulatory oversight will limit the amount of funding available to those looking to buy a residential property.

There are also concerns about an overbuild of apartments in some major cities, record household debt and the rising cost of debt.

But it isn’t only homebuilders that will be the early losers from a deeper than expected housing slowdown. Retailers like Harvey Norman Holdings Limited (ASX: HVN) and Nick Scali Limited (ASX: NCK) are exposed to new household formation.

House prices have been under pressure over the past six months or so, particularly in Sydney, according to data from Corelogic. That shouldn’t come too much as a surprise as Sydney has been the best performing market during the long boom.

The good news is that the impact of a weakening property market could be contained if the correction isn’t too deep and if corporate earnings hold up as most experts are expecting.

This will create robust conditions for one sector to outperform. This sector is a hot favourite among the experts at the Motley Fool as they believe it will make a big impact on our market over the medium to longer term.

Click on the link below to get your free report on this sector and to find out which stocks to put on your watchlist this year.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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