Speaking at the Urban Development Institute of Australia in Perth on Wednesday (20 March), RBA assistant governor Michele Bullock noted that the threats to Australia’s financial stability are now greater than they were six months ago.
“Six months ago […] we noted that global economic and financial conditions were generally positive and that the Australian economy was improving. At the same time, housing prices were declining. In this context, we highlighted a number of vulnerabilities – issues that, were a shock to occur or economic conditions take a turn for the worse, could manifest in a threat to financial stability. At that time, we highlighted two domestic vulnerabilities that are relevant to my talk today – the level of household debt and the slowdown in housing and credit markets,” she said.
“Six months on, these vulnerabilities remain. If anything, they are a little more heightened.”
The assistant governor noted that property prices nationally have fallen by approximately 7 per cent since their mid-2017 peak, with greater falls in Sydney and Melbourne. For now, however, this poses little risk to financial stability and economic growth.
The bigger risk comes from apartment developments, which Ms Bullock warned could put even greater pressure on falling property prices. She noted that in Sydney, there have been more than 80,000 apartments completed in recent years, adding roughly 5 per cent to housing stock in the city.
“Our main concern with this from a financial stability perspective is the potential for this large influx of supply to exacerbate declines in housing prices and so adversely impact households’ and developers’ financial positions,” Ms Bullock said.
“By its nature, high-density development can tend to exacerbate price cycles. Large apartment developments have longer planning and development processes than detached housing. Purchasing the land, designing the development, getting approvals through relevant government bodies and then actual construction of the apartment block all take time.
“In a climate of rapidly rising prices, developers are willing to pay high prices for land on which to build apartments. Households, including investors, are willing to purchase apartments off the plan, confident that the apartment will be worth more than they paid for it when it is finally completed. This continues as long as prices are rising. This large increase in supply, however, ultimately sows the seeds of a decline in prices which, if large enough, results in development becoming unattractive, new supply falling and the cycle starting again.”
This presents two risks: the first to household balance sheets and the second to developers themselves.
“A decline in apartment prices could negatively impact households that purchased off the plan and are yet to settle. They might find themselves in a situation where the value of the apartment in the current environment is less than they contracted to pay for it,” Ms Bullock said.
“And as market pricing falls, lenders will revise their valuations down and so will be willing to lend less. Households will therefore have to contribute more funds, either from their own savings or loans from other sources.”
The second risk is to developers who are delivering completed apartments into the cooling market.
If people who had pre-purchased are having difficulty getting finance, or decide it is not worth going ahead with the purchase, there would be increasing settlement failures, Ms Bullock said.
“Developers would be left holding completed apartments, reducing their cash flow and their ability to service their loans, and impacting banks’ balance sheets.
“Currently, the risks here appear to be elevated but contained. The apartment market is quite soft in Sydney; apartment prices have declined since their peak; rental vacancies have risen and rents are falling.
“In Melbourne and Brisbane, however, apartment prices have so far held up. Liaison suggests that settlement failures have not increased much and, to the extent that they have, some developers are in a position where they can choose to hold and rent unsold apartments.”
Further tightening in lending standards might, however, impact both purchasers of new apartments and developers. Contrary to popular opinion, RBA doesn’t believe the recent decline in house prices is the result of tighter credit, nor is tighter credit the consequence of the royal commission.
Ms Bullock believes that declining demand for housing credit is a more important factor.
“Nevertheless, it is possible that tighter lending standards could be impacting developers of apartments. This could be direct, reflecting banks’ desire to reduce their exposure to the property market, particularly high-density development. But it could also be indirect by banks tightening their lending standards for purchases of new apartments, hence impacting pre-sales for developers and their ability to obtain finance,” she said.
“The deputy governor noted this in a speech in November 2018 and concluded that this was of potentially higher risk to the economy than household lending standards.”
