Has Australia’s Housing Cycle Peaked?

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-House building ahead of population growth
-House prices at risk of downturn
-Subdued NSW home buyer sentiment
-Focus on US-exposed building stocks
 

By Eva Brocklehurst

Has Australia's housing cycle peaked?  This question has been stealing into broker commentary on the economy and housing related stocks recently. Macquarie and Morgan Stanley suspect the market has indeed peaked and Credit Suisse considers housing has now become riskier than equities.

Australia's population growth has slowed and this in turn will slow the transition to non-mining activity, Macquarie observes. Population, while still growing, is not advancing fast enough to warrant the surge in housing supply which will hit the market next year. Updated government projections reveal population growth has slowed to a 9-year low.

A smaller increase in population means less demand on construction based parts of the economy. Building approvals and housing commencements are around rates of 200,000 per annum, well ahead of estimates of underlying demand.

Macquarie observes, while supply undershot demand for several years and subsequently was calibrated into prices, the unleashing of pent-up demand will also have effects on price. Macquarie expects this surge in supply means real dwelling price reductions may be required in order to accommodate the reduction in the level of real income per dwelling as a result of lower economic activity.

The broker suspects some additional policy support from monetary authorities might be needed to curb the extent of downside in either prices or activity. The next reduction in official cash rates – Macquarie's base case is for another 25 basis points – is unlikely to be passed on in full, given additional prudential requirements for the banks.

In the absence of other stimulus to the economy, a well supplied housing sector is likely to delay the start to a normalising of rates too. Keeping servicing costs low for mortgages will be important in order to sustain growth in consumer spending and cushion a deterioration in balance sheets as asset prices decline.

Some incremental increase in the house price to income ratio could occur through to the end of this year, Macquarie believes, at which time a mild correction in house prices is expected to begin in 2016. The broker does not expect a return to growth in real household income until late 2017.

Through previous cycles policy-makers managed to avoid large falls in house prices, which have a subsequent destructive effect on business and household balance sheets, by easing their adjustments over a number of years.

Morgan Stanley agrees that slower net migration will take underlying demand for housing down by 30,000 per annum – to around 155,000 starts per annum. Although there may be some offset for those companies exposed to infrastructure spending this is expected to be longer dated.

Housing peaked in September and macro prudential policy had already started to tighten as, alongside limits on investor lending and higher mortgage risk weights, Morgan Stanley observed a tightening of lending standards since mid year.

The broker disputes the view that lower-for-longer rates will mean strong housing conditions persist. Instead, the slowdown in housing comes at an awkward time, when the drag on GDP from lower resource capex overwhelms the contribution from a lower Australian dollar and services exports. The broker believes recession risks are elevated while regulators attempt a soft landing in the housing market.

There is likely to be a regional perspective to the housing market too, Macquarie maintains, with declines in Sydney dwelling construction commencements not likely to be as significant, given strong population inflows. Perth, Brisbane and Melbourne apartments are where the regional correction is likely to be more concentrated in the broker's opinion.

Surveys pointing to very subdued home buyer sentiment in NSW have garnered Credit Suisse's attention. The correlation between sentiment and home sales is particularly strong in NSW. This state had previously benefited from both investor and foreign buyers. Macro prudential tightening, out-of-cycle rate hikes for investor mortgages and weakness in Chinese demand have all had a clear impact on sentiment. Sentiment is largely a function of affordability and affordability declines as house prices rise.

Still, this is not the whole story, Credit Suisse maintains. Even after accounting for local conditions, NSW tends to impact the sentiment in other states as Sydney leads the national market.  If high risk continues in housing, the analysts envisage rotation out of this asset class although it is difficult to diversify away from housing risk because it is highly correlated with equity risk.

Policy makers may welcome a cooling in the housing market and more rational pricing of risk, but the broker suspects they would not welcome a sharp decline in NSW housing demand.

This prospect worries the broker. Historical relationships point to home sales declining by more than 40% in the coming months. Should this eventuate, housing prices could flatten out or even fall as supply outpaces demand. Foreign buyers and investors have fueled demand in NSW as well as large net interstate migration. Now many of these supportive factors are weighing on the market.

Against the more challenged domestic environment, Morgan Stanley expects US housing will continue to improve and New Zealand should also be positive on a medium-term basis. This should support stocks such as James Hardie ((JHX)) and Fletcher Building ((FBU)), which were recently upgraded to Overweight. The US improvement is also likely to offset the Australian residential exposure for Boral ((BLD)).

The broker downgraded both CSR ((CSR)) and DuluxGroup ((DLX)) to Underweight at the same time, on the back of a downgrade to aluminum price estimate for the former and a difficult market in Australia for the latter. Morgan Stanley retains an Underweight rating for Adelaide Brighton ((ABC)) as well. The potential for strategies surrounding the Port Kembla steelworks provides support for BlueScope ((BSL)), despite the residential exposure and commodity price weakness.

Macquarie today made a number of changes and amendments to individual stock ratings and forecasts that do not always fall in line with Morgan Stanley's decisions. See the Australian Broker Call Report on the FNArena website today.

Morgan Stanley expects further falls in auction clearance rates and house price momentum, with a negative impact on construction occurring over 2016. Still, a significant backlog in activity should support volumes over the next 12 months especially in multi-dwelling activity.

While renovations tend to lag the upswing in new house construction slightly and prove more resilient, this time Morgan Stanley notes persistently weak activity in this segment. This could reflect a broader de-leveraging trend among householders but also the trend towards re-developing established property into higher-density apartment blocks.

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