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Do Australian house prices drop in a recession? Will they ever crash?

A recession doesn't mean Australian house prices crash. They can even rise in a downturn. Prices are more likely to drop when it's harder to get a home loan.

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Australian house prices seem to keep on rising. So it's not surprising many would-be home buyers ask, "When will Australian house prices crash? Will they ever fall?" But taking a long, historical view of Australian property prices, they have never really crashed, even though prices have dipped at times.

There's no clear evidence that a price crash is coming. Even in times of economic turmoil prices aren't guaranteed to fall. Australian house prices actually rose during the recession of the early 90s (in most markets), and they fell during the 2008 global financial crisis (GFC) despite Australia avoiding recession then. This is because availability of credit (how easy it is to get a home loan) is the factor most likely to send house prices downward.

What happened to property prices in the 1990s recession?

Australia went through an infamous recession in the early 1990s. This was a period of severe economic downturn, one of the worst since the Great Depression. Did house prices crash, then? No. According to price statistics from the Australian Bureau of Statistics (ABS), property prices actually rose in most parts of the country during the worst months of the recession.

This data comes from the Established Home Price Index, and shows that prices continued to rise nationally during the recession.

This is national data. But in Melbourne during this time, property prices fell and didn't recover to 1989 levels until 1996.

Falling interest rates drive price growth

Interest rates explain part of the recovery. At the beginning of 1990, the official Reserve Bank cash rate was a shockingly high 17.50%, but it fell steadily throughout the following years.

"Interest rates rose for a while at the beginning of the recession but quickly dropped again," explains property expert Michael Yardney. "At the same time our Big Four banks, which were up till then concentrating on commercial loans and business loans, moved into the home lending market as their traditional business lines dried up. This availability of easy credit kept our residential property markets alive."

Melbourne's misfortunes then are due to what Yardney calls "the excesses from the late 1980s leading up to the recession [causing] a significant property boom fuelled by investor speculation". This, combined with higher unemployment in Melbourne relative to the rest of Australia, led to years of stagnant prices.

The Melbourne experience is an important reminder that "the Australian property market" is in fact a collection of smaller markets, each with their own strengths and vulnerabilities.

What happened to house prices in 2008?

The global financial crisis provides another instructive lesson. Australia famously avoided recession after 2008, and yet the same data shows that property prices actually fell around this time (although they recovered as interest rates fell).

The graph below again shows the Established Home Price Index from the ABS. Notice that the index drops during 2009 (the main events of the GFC began in late 2008) before quickly recovering.

How do we account for rising prices during a recession and falling prices when Australia actually avoided a recession?

"The GFC caused our financial institutions to take a look at what their risk level was and to take a look at what credit was in Australia," says expert property adviser Christine Williams. "Pre-GFC banks were lending anywhere between 103% and 120% of the asset value. And credit was so free and so open. The GFC really just brought it back into line."

"And that was why property hit and we avoided the GFC. It was a credit squeeze."

Williams said these restrictions remain more or less in place today, further protecting the property market against strong price falls. Our financial institutions have, in effect, learned their lesson. It's no longer possible to get a true no deposit home loan.

While property prices have risen in many periods since 2008–2009, the lending environment is more cautious. You can only borrow 100% now with a mortgage guarantor.

Why did Australian property prices fall in 2017–18?

Property prices fell during 2017–18. And again, the main cause for this was not economic downturn. There was no economic crisis, and property prices had been rising steadily in the years before.

Interest rates were comparatively low too. But these price falls were caused, in large part, by much stricter lending policies.

Williams says that "Lenders became very strict and APRA came down with some very hard-hitting policy changes" as a result of the Financial Services Royal Commission. "People just couldn't borrow the money because policies were so strict."

APRA has since loosened this lending policy and interest rates have fallen even lower with recent cuts to the official cash rate.

And the result? Prices in the major property markets are moving upward once again.

Interest rates and lending policy are the key to property prices

We've outlined a fairly strong case that suggests low interest rates and lending policy drive price growth more than almost any other factor. Now, we haven't factored in basic supply and demand, which of course drives prices for any commodity, housing included. Housing supply and housing demand are complex, and the shifting factors are harder to quantify.

But the lessons of history really do suggest that an economic crisis doesn't mean a property price crash. When it's easy, and cheaper, to borrow money, property prices tend to grow.

So, if you were in charge of the Australian housing market and wanted to crash (or at least drop) house prices, you could:

  • Hike interest rates up. Higher rates mean borrowing gets expensive, putting a ceiling on how much people can borrow.
  • Restrict how much people can borrow. If APRA imposed restrictions on how much people can borrow relative to their income (borrowing power) or relative to their property value (loan-to-value ratio) this could drag prices down.
  • Put a cap on investor lending. Limiting investor numbers affects supply and demand, but also fits under the category of lending policy decision. This has happened before too.
  • Get regulators to scare the banks. The Financial Services Royal Commission made lenders incredibly cautious for a while, even if regulatory changes ended up being minimal.

But don't bet on a property market crash happening just because prices are high. Even if a recession hits, it's no guarantee.

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