As we prepare to open back up sooner than we thought property prices might boom sooner than we thought. In this update we talk about property prices and how banks’ profits have been smashed by the virus crisis and how that will affect property.
Returning to normality
If the economy opens back up this month and starts to feel normal we should expect the losses in property prices to stop.
Over the past few months because of the virus crisis and the ‘Great Lockdown’ real property prices have seen a sharp fall.
The reality is the lockdown lasted less than half the time the government thought it would and is now looking to get us back to as normal life as possible. This is because we are ahead of the curve and things will open bit by bit.
The exact number of property prices declines is vague and difficult to rely on, but it would be reasonable to state that the YTD fall in prices has been between 5% and 15% depending on the property, price range and location.
Averaging out to 10% which is what I see being the base case for price declines.
The fall has been because of the virus crisis which has caused a sharp slow down in lending and general market activity.
Indeed, only a month ago when it looked like a 6-month hibernation was happening we predicted a severe property price slide of up to 20% and at least a 10% drop based on lending slowdowns, unemployment and the restrictions on auctions and open houses.
But now things have changed where will prices go now?
Probably sideways.
There are strong contributors to positive ‘recovery’ in prices and activity, but they are still weighed down heavily by larger issues of credit and unemployment.
The driving forces for prices to recoup lost ground are low rates and that culturally we are addicted to property.
The premise is simple enough – we know low rates lead to activity in the property market and we know increased activity leads to higher prices.
Therefore, once the sales and auction process normalises we could reasonably predict that the latent demand, largely driven by low interest rates, will return in force and positively encourage a recovery in property prices.
With historically low interest rates available people will come back in force to buy. A 2.19% mortgage rate is very appealing and if it appeals to you Let’s Talk.
However, there remains negative downward forces on property prices. Namely unemployment and access to credit/home loans.
While people might see low interest rates and think they can get a good deal, the truth is that banks have tightened lending a lot and to get a new loan approved takes more time and more information than it did pre-virus crisis, probably even more so than during the credit crunch of the royal commission.
If credit remains tight no matter how much demand there is prices will only experience a soft recovery and at most recover the early 2020 price points towards the end of this year.
If credit eases, which is more unlikely then likely, at least until the banks see what their ‘real’ losses will be (see below), we could see a full boom run again from the start of 2021.
For now, it is wait and see if we recover lost ground this year and what the market looks like leading into summer.
Unemployment will also be a key factor because so many would be buyers lost their jobs and either need to use money to live and pay for life and things rather than on a property.
Estimates on unemployment for the June quarter will probably be around ~10% which is the highest it has been since the 1990’s and means almost one and a half million Aussies will be out of a job. The worst employment situation since the Second World War.
There is of course less demand from overseas investors and buyers who can’t even get into the country, but I see this impacting the rental market more than the owners market for now.
However, we could further predict that if the normalisation continues and life as we remember it is largely back to normal by the end of the year, we could realistically see 2021 starting off with a boom.
Canary in the coal mine
The big banks are somewhat of an early indicator of things to come and things are not looking good.
This week NAB and ANZ released their half year results and they all showed huge drops in profit and provisions for expected future losses. Westpac will release theirs next week and it will look similar. Talking numbers, cash earnings for NAB dropped 51%, ANZ 60% and when Westpac’s will look similar, if not worse.
Less profit makes the banks want to take on less risk.
Less risk means less loans being written.
Less loans being written means struggling small businesses, a slower property market and downward pressure on property prices.
One of the key reason’s banks are a good indicator of the recession we are in is that they make provisions for bad debts.
That is to say they write off loans they don’t expect to ever get paid back on and take that as a loss.
All of the big banks are putting billions of dollars into provisions.
This means that they each expect hundreds and thousands of their customers to fail to repay their debts.
The losses can include any type of loan going sour, from credit cards to car loans but the major losses will be home loans, commercial property and business loans. The more bad debts that blow up in their books will push them to be more risk adverse. They will tighten lending in being fearful of further losses which will result in the availability of credit being reduced.
And guess what, the more bad debts they have the lower their profit.
One of the predictions I made in the last Finance Market Update of 2019 was that “bank profits and market share decrease” which would be driven by government fines, customer remediation and investments in technology. While this is proving to be accurate the amount of the decrease in profit from the virus is crazy.
As we talked about a few weeks ago the access to credit is a key driver of property prices in the short term so if the big banks, who control about 80% of the mortgage market, slow down lending there will be a direct negative consequence for property prices.
The banks are telling us things are going to get bad, really bad.