Here’s why home values are falling in Australia

The CoreLogic Daily Home Value Index (HVI) hit a record decline of -8.40% on 7 January 2023 after peaking on 7 May 2022.

The result takes the national housing downturn into new territory, breaking the previous record in peak-to-trough declines, when home values fell -8.38% between October 2017 and June 2019.

While the housing downturn between 2017 and 2019 lasted 20 months, the new record-breaking price falls have played out in less than nine months, with further falls expected in the months ahead.

Reasons for the record fall in home values

The main force behind record home value falls the recent cycle of rate hikes that have risen at the fastest pace on record.

A 300-basis point increase in the underlying cash rate over just eight months has resulted in a rapid reduction in borrowing capacity, lowering the amount buyers can offer for homes.

In addition to constrained borrowing capacity, higher interest costs may dissuade potential buyers altogether.

Australians are also more indebted today than through historic periods of rate rises, with the latest Reserve Bank of Australia’s estimate of housing debt-to-income ratio sitting at 188.5%.

A decade ago this figure was 162.0% and in 2002 the ratio was 130.2%.

Higher household indebtedness may have increased the sensitivity of housing values to interest rate rises.

Higher inflationary pressures, combined with a post-lockdown surge in spending, have also eroded household savings, which could be utilised for a home loan deposit.

This trend is also being reflected in low consumer sentiment figures, which have plunged to near-recessionary levels and traditionally coincide with fewer home sales.

Softer housing demand may also reflect Australia’s ‘hangover’ from the elevated sales and listing activity through the 2021 boom when an estimated 619,531 transactions occurred over the calendar year.

It was the highest volume of housing sales in more than 18 years.

Fuelled by record-low interest rates and stimuli such as HomeBuilder and low-deposit home loan schemes, may have brought forward many buying and selling decisions through the pandemic, resulting in less transaction activity in subsequent years.

Downturn frontrunners

The bulk of the downturn is being led by Australia’s three largest capital cities, which also have the largest weighting in the national home value index.

Sydney home values have seen a peak-to-trough decline of -13.0%, Brisbane values have fallen - 10% and Melbourne dwelling values are -8.6% from the peak.

At the other end of the spectrum, Perth dwelling values have fallen less than 1% from a peak in August last year.

For perspective, the -8.4% drop has come off a high base.

The sharp decline in dwelling values follows an upswing of 28.9% between September 2020 and May 2022, which was the fastest rise in home values nationally on record.

The fall in national home values may be the largest peak-to-trough decline on record, but at the end of 2022 home values were still 16.0% higher than they were five years ago, and 59.8% higher than they were 10 years ago.

Today’s downturn compared to previous declines

Rising interest rates may largely account for most previous housing market downturns. Both the early 80s and early 90s were associated with periods of high inflation, subsequently high-interest rates, and double-digit unemployment rates, which weakened housing demand.

In the mid-90s, Australia saw the second-highest rate lifting cycle on record, with 275 basis points added to the cash rate in the space of five months.

However, the associated peak-to-trough decline in the home value index was relatively low, re-iterating the possibility that higher values and debt levels in 2022 have made housing markets more sensitive to changing interest rates.

Notably, the now second-largest downturn on record (2017 to 2019) was not associated with a lift in the official cash rate target.

Along with the brief 2015-16 fall in prices, this decline was largely the result of tighter lending standards.

The Australian Prudential Regulation Authority (APRA) introduced several temporary restrictions to mortgage lending that coincided with falls in market values.

This was in response to an unusually high level of home lending for investment purposes, along with high rates of interest-only lending.

Temporary tightening policies from APRA included a 7% floor for mortgage serviceability assessment, a 10% growth benchmark for investment housing lending, and the limitation of interest-only lending to 30% of new housing credit.

The policies were introduced at various stages between 2014 to 2017 and repealed by 2019.

Even in the absence of cash rate rises, the credit environment was still very influential on housing market performance.

Notably, these housing market cycles in the mid-to-late 2010s were driven more by changes in housing investment activity.

While the latest housing cycle has also seen new record levels in investment lending, this has been dwarfed by owner-occupier activity.

More weaknesses to come

Over the coming months, housing market conditions are expected to remain soft.

The underlying cash rate is likely to see further increases in 2023, with market expectations pricing a peak of around 4%, while the median forecast from Australian economists is lower at 3.6%.

Ongoing increases in interest rates will further erode the borrowing capacity, and likely prolong the country’s housing downturn until interest rates stabilise.

About Eliza Owen Eliza is head Of Residential Research Australia for Corelogic and a respected property market commentator. Eliza holds a first class honours degree in economics from the University of Sydney