There is no secret that real estate has been falling for the last 18 months – 2 years across Australia, and particularly in the two big cities Sydney and Melbourne.
However, over the long term, property prices tend to rise. Why is this?
Property – “too big to fail”
The property comes under the “too big to fail” category in most Western economies. Property underpins the banking industry’s balance sheets and is the collateral for most of the debt in our system. Real estate is also the basis of most household wealth.
Property has a lot of spin off industries and employs a lot of people: real estate itself of course, but also construction, banking, retail and homewares, and the trades, to name just a few.
And then there is what is also called “the wealth effect”. When the value of our homes goes up in price, we feel wealthier, and we spend more, spurring economic activity.
Property is therefore the ultimate “too big to fail” entity.
Will the RBA Cut rates?
So, here’s the rub: too much of our economy relies on high property prices, so policy makers won’t let prices continue to fall like this.
Many in the media and the banks are now talking about two rate cuts this year, in part to stop property prices falling further.
Futures markets predict the first rate cut will happen in July 2019.
The RBA Rate vs “The Assessment Rate”
Even if the RBA does reduce interest rates, banks are still assessing loan serviceability at the higher 7.0%-7.25%.
In a sense, it is like the RBA standing at the faucet with the tap turned on full blast. But APRA, the regulator, is kinking the hose so none of this liquidity gets through.
Like a kinked hose, I would expect the pressure in the hose to build and then pop … somewhere.
It could pop in sharply higher rent prices. Or even sharply higher property prices if any of these policies get changed. Either way, the change will be abrupt, and you want to own real estate before the pop, not after.
Policymakers are issuing mixed messages on the housing market. They want lower house prices for affordability, but they need higher house prices to secure bank and household balance sheets.
Policy makers are stuck.
Ultimately, they will most likely loosen credit: either the RBA will lower rates, or APRA will adjust down the assessment rate.
And when that happens, the liquidity that has been on the sidelines will flood back into the real estate market: – just like a kinked hose that is freed.
To many powerful institutes rely on higher property prices. Sooner or later they will un-kink the hose.
Which I why I say, “real estate comes with a central bank guarantee”!