Over the last long weekend, as we near the Federal Budget, there has been a lot of talk about the cutback in capital gains tax benefits (the 50% discount) and a reduction in the tax benefits associated with negative gearing.
Be that as it may, I don’t think it is in anyone’s interests for residential real estate prices to fall. I also think it’s an impossibility given the supply-line crisis, the immigration program, and the failure of successive government policies to build more housing.
Back to my proposition, however, there are several groups whose interests it is in for property prices not to fall.
The Government
Every government has incentivised people to buy houses. From the current Help to Buy shared equity scheme, the 5 per cent Deposit Scheme, and the First Home Super Saver Scheme, to the Covid-era HomeBuilder Grant, the First Home Owners Boost of 2008-2010, the First Home Owner Grant of 2000, and back to the First Home Owners Scheme of 1983, the Home Deposit Assistance Grant of 1982 and the Home Savings Grant Scheme of 1964, successive governments from Menzies to Albanese have encouraged people to buy real estate.
And you’ll notice that, despite the cries of unaffordability from a third of Australians who don’t own a home, not once has any government said: “let’s bring down house prices”. No, instead, they find ways to give people more money to buy properties. Politically, bringing down house prices would offend the one-third of Australian households who own their own home outright and the other third who have a mortgage, all of whom were incentivised by the government of the day to buy.
The government won’t want to put offside the two-thirds of households who own or are on their way to owning. It’s not in the government’s re-election interests to see house prices fall, and it would not be in their interest to pursue any strategy that would cause them to fall.
Add to this that when people see their home value rising on paper, they feel wealthier (the wealth effect) and are more likely to take out personal loans, car loans, or credit cards. They are more likely to spend, and that’s good for the economy. Any government presiding over a recession is less likely to be re-elected.
Banks
To understand why Australian banks are also sensitive to house price declines, you need to understand that banks are really not banks – the name is a throwback to when they were banks in the 1960s. Rather, they are mortgage businesses. In Australia, the big four banks (CBA, Westpac, ANZ, and NAB) are essentially massive portfolios of residential property debt with small banking businesses attached.
Under Australian Prudential Regulation Authority (APRA) regulations, the amount of capital a bank must set aside (which it can’t use to make money) is tied to the risk of its loans. Loans with a Loan-to-Value Ratio (LVR) of 80 per cent or less are considered ‘safe’ and require less capital. In other words, the bank is forced by law to set aside more of its own capital to back that loan. This reduces the bank’s Return on Equity (ROE) and its ability to pay out dividends to shareholders.
Meanwhile, rising prices allow homeowners to refinance and top up their loans to renovate or buy investment properties. This creates new debt, which is the primary product banks sell. If house prices rise, the average loan size increases. Since banks charge interest as a percentage, and the work on a large loan is similar to that on a smaller loan, they are incentivised to lend on large loans. Banks do not want prices to decline and will do everything in their power to prevent it.
The Regulators – APRA and RBA
While neither regulator has a formal mandate to raise house prices – and they often publicly state they don’t target house prices at all – their core responsibilities for Financial Stability and Economic Growth could make them something of a safety net for the housing market.
Another way to think about APRA is as the Bank Police. Their primary job is to ensure that your bank doesn’t disappear with your savings if the world ends.
Roughly 60-65 per cent of the assets on Australian bank balance sheets are residential mortgages. If house prices drop by 20 per cent, the collateral backing those hundreds of billions of dollars in loans shrinks, and if house prices fall significantly, the ‘Loss Given Default’ (how much money the bank loses when a borrower fails) skyrockets.
In that scenario, banks would protect themselves and their shareholders by ceasing to lend to everyone – businesses, personal borrowers, and new buyers. This is called a credit squeeze, and it would cause house prices to fall even further because fewer people would qualify for a loan to buy them.
APRA’s mandate is effectively a license to stop this doom spiral before it starts.
The Reserve Bank of Australia (RBA), on the other hand, has an incentive similar to the government’s – to maintain economic growth. Thanks to the reverse wealth effect from falling house prices, they would cut rates aggressively and provide emergency, low-cost funding to get credit growth going again. Indeed, they would do it long before prices started falling.
In Conclusion
Residential housing in Australia is a protected species of asset class. Prices cannot crash because it would break the banking system, roll the government and smash the economy. Everyone has an incentive to see stable price increases.
For this reason, and regardless of whatever changes Canberra makes, don’t bet on house prices falling.