Peaking housing market puts pressure on consumer spending

Thursday, February 23rd, 2017

Animal spirits is the term John Maynard Keynes coined to describe the instincts, proclivities and emotions that ostensibly guide human behaviour. He argued that economic indicators, like consumer confidence, were direct measures of these animal spirits. A person’s impression of their own level of wealth can then be seen as a strong bellwether of their willingness to spend. For most Australians, the largest portion of their wealth is tied up in their own homes. The belief that prices will keep rising indefinitely has inflated their sense of wealth, encouraging them to increase their spending.

What happens then, if housing prices peak in Australia’s major cities? Recent data (illustrated in the charts below) suggest we may be nearing this point.  First, commencements have begun to fall in line with greater developer caution – a result of tighter lending conditions and perhaps some capacity constraints following the record levels of activity observed in years past. We believe commencements will fall back towards historical levels over the next two years, as shown below.


Figure 1. Residential dwelling commencements (4-quarter sum)
Source: ABS, Clime estimates


A reduction in development won’t necessarily mean falling prices but simultaneously, tighter capital controls in China are weighing on foreign demand. Stricter documentation requirements have been imposed on FX transactions despite the official quota remaining unchanged. This may increase the risk of non-settlement, particularly in off-the-plan apartments.

Other signs, such as the reduction in the number of renovations and an expectation of flattening total housing investment, have already begun to weigh on the minds of consumers. Two charts from a recent UBS report looked at recent responses to the WMI consumer confidence survey questions: ‘Is this a good time to buy real estate?’ and ‘Is real estate the wisest place for savings?’ – both have fallen dramatically. Answers to the first question have typically been an accurate leading indicator of future housing activity, which does not bode well. In the case of the latter, despite enjoying record low interest rates courtesy of the RBA, consumers clearly have lost faith in real estate as an asset class.


Figure 2. Time to buy a dwelling consumer sentiment remains depressed
Source. ABS, Westpac, Melbourne Institute, UBS


Figure 3. Share of consumers saying ‘wisest place for saving’ is real estate, slumped to a ~record low

Source. ABS, RBA, Westpac, Melbourne Institute, UBS


For now, none of this has translated to housing prices, which continue to climb at unprecedented rates. In fact, housing affordability is worse than ever, with the benchmark house price to income ratio climbing above 6x in 2016 (and almost 12x in Sydney). This is not surprising given the massive decline in mortgage rates over the last 30 years. With people struggling under the weight of their mortgages and many utilising negative gearing to extend the viability of property investment, even a ‘soft’ correction of 5-10% in housing prices could be extremely damaging.


Figures 4. House price to income ratio, nationally
Source. CoreLogic-RPData, RBA, UBS


Figure 5. House price to income ratio, Sydney 
Source. Abelson and Chung, ABS, REIA, Stapledon


The obvious casualties are the banks, REITs and household goods retailers. But if we think back to the Keynesian concept of animal spirits, with so much leverage in the system and mounting trepidation over our housing market, it wouldn’t take much for this to translate into a massive loss in consumer confidence more generally. This would impact most retailers, whose products and services are non-essential and for which demand can quickly disappear. The perception of a decline in wealth can quickly translate to compensation via reduced spending.

This has yet to happen and the widespread belief remains that current homeowners will continue to enjoy capital appreciation, even if growth does moderate. We believe the inflexion point for consumers would be the point where mortgage rates surpass capital gains – currently around 2%. This is the point where the massive leverage buttressing our housing market would begin to unravel.

In the meantime, retailers are under pressure from a disappointing Christmas trading period, the result of both weaker demand and aggressive discounting in November. Retail appears to be particularly vulnerable to changes in sentiment right now and, with the exception of a few high product segments and individual operators, we are generally bearish.


4 Responses to “Peaking housing market puts pressure on consumer spending”

  1. Adrian says:

    Good article. Good to see Clime come out with some counterpoints to widespread belief.

    I have heard people talking about a housing bubble for about the last 15 years. They have never been wrong as property has been overvalued for a very long time. Just because it is a bubble doesn’t mean it is about to pop in the next month, 6 months, or even in 5 years, though it could in any of those time frames. Japans 1990 housing bubble took 12 years to form and 12 years to correct. Unfortunately we don;t have the same luxury as Japan, we have used up all of our monetary policy limits. We have used all of our interest rate firepower on keeping the housing bubble extended.

    It’ll be another recession we had to have.

  2. Bruce Aulabaugh says:

    Please confirm/ correct my rephrased understanding of the statement: ‘inflexion point will be reached when mortgage rates are greater than expected capital gains; ie when current 2pct gap between them is closed’. And what about tax breaks on negatively geared properties? Surely that must be a very significant factor in the decision to buy investment properties, even as mortgage rates rise.

  3. Stuart says:

    The Government is not daring to discourage foreign investment, just in little old Tassie of the large farms sold 7 out of 9 are to Chinese, stone fruit tree out and cherries in. I am a small developer (sub-divisions) last month I visited six houses with potential for sub-division, in each case two Chinese couples (under 25 y.o. and obviously students) were visiting and bidding. I was out bid twice both times by these Chinese couples. I think the margin was too small at their prices, but they will use Chinese labour (on a holiday visa), so can pay more. Just fact. I don’t think there as many of the 12x income buyers, that is simplistic division of sales prices by average wages many houses are purchased by international students (legally for them to live in while studying) and there are no one checks if they sell them when they finish studying. I have also taught in UTAS and I know students whose parent buy them houses and even if they don’t get PR leave them rented out when they go back home.
    I think this investment is a large part of what is keeping it all bubbling. Huge, mainly Chinese investment. It is the same in many Western cities including London, where my brother lives.
    The longer it goes up the harder and longer it will fall, the question is when, unfunded pensions and other payments causing fear with tax rises, interest rate rises, global recession. It is a risky time, but if you rent it could still be another decade before it pops and then what do you do, buy at 40 after renting avoiding children and saving like mad in a low interest environment? The options are still very difficult to evaluate.

  4. Robert N says:

    Interesting that used cited Keynes. One of his most famous quotes; “The market can stay irrational longer than you can stay solvent.” does not just apply to the share market. If you believe in animal spirits then fundamentals, no matter how compelling, become also rans. You can’t use animal spirits to make one point and then ignore it in the next.


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