Updated: Aug 11, 2020
A global recession appears unavoidable; so it makes sense to review experiences from the last global recession (the GFC) to help predict what might happen this time
It was late 2007 at a pre-Christmas lunch, when I first heard of “Sub-Prime Mortgages” and “Collateralized Debt Obligations”. Little did I know that these terms were about to wreak global havoc: banks would stop lending; stock-market meltdowns; mass unemployment; and plummeting consumer sentiment!
“Sub-Prime Mortgages and Collateralized Debt Obligations.... were about to wreak global havoc”
What happened in the GFC?
The GFC was caused by significant flaws in the global financial system; bank liquidity dried-up. Investment stopped; Share markets tumbled; Businesses collapsed; Jobs were lost; and Houses / Apartments had to be sold! Australia experienced all these things but managed to avoid a recession due to:
Pre-existing economic strength: full employment; budget surpluses; wage growth
Aggressive government stimulation:
Fiscal expansion: The government injected money into the economy via capital works projects (school hall building; ceiling insulation) and cash hand-out
Expansionary Monetary Policy…
Interest rate cuts: The RBA dropped the cash rate from 7.25% to 3.0% in just six months, motivating business and households to invest / spend.
Quantitative easing: Which is where the RBA purchases securities from the open market in order to increase the money supply and encourage lending and investment
Below is a summary of the various phases of the GFC impact and three observations:
Unemployment only subtly increased during the GFC ie 2%
Government stimulus worked well because: household debt was much lower than today; few people lost jobs / reduced income, however, within months they also received government handouts AND, mortgage rates dropped by almost >4%
Average Sydney Property Values weakened only a little (i.e. 7.5%), however the impact on premium property was much greater. No doubt this seems counter-intuitive, given the desirability of such suburbs and the fact that these owners rarely must sell. And yet all agents who operate in Sydney’s most expensive suburbs attest that the GFC was tough, experiencing much greater drops than the market average. Why? Because there are significantly fewer buyers at high price brackets, so in weak markets, buyers face limited competition. Note: this also happened between mid-2017 and mid-2019, where the Sydney average fell by 7%, but local property fell by 15-20%. Then again, in good times, the top end rises more than the market average.
The COVID-19 pandemic, has forced Australia (and much of the world) to adopt “Social Distancing” in order to limit the health impact of the virus. However, the economic impact of shutting parts of the economy is likely to affect most people in most nations for some time!
During the initial shut down period (Late March – mid / late May) the impact has been…
The RBA / government took immediate steps to stimulate the economy and save jobs via: incentives for employers to retain staff (Job Keeper); improved unemployment benefits; two interest rate cuts; and a moratorium on rent payments / mortgage repayments for affected businesses / households. But, notwithstanding the huge stimulus spending, the impact has been significant:
Many full-time employees have experienced a cut in hours / pay;
Business profit has eroded - especially for small business and self-employed (landlords too);
Business closure is rising
We’re not yet seeing many distressed sales
One feature of the GFC was distressed sales. Owners who had lost their job or suffered share-market losses needed to offload their properties. In the near future, we are unlikely to see this due to banks allowing distressed customers to freeze mortgage repayments. We’re hopeful that the freeze will end gradually to allow enough time for any distressed clients to organise their affairs in an orderly way.
“In the near future, we are unlikely to see this due to banks allowing distressed customers to freeze mortgage repayments”
And, there are some solid buyers in the market
At the same time, there are some very solid buyers in the market - something that was in short supply during the GFC. These buyers are often people who’ve already sold their property or others whose employment and finances have been unaffected by COVID-19. Often these buyers are taking their time and waiting for the right property to come up, however, they are buying for the long-term, so are prepared to pay a strong price when they find the right property.
Lenders are scrutinising a little more, however, they remain able & keen to lend!
Unlike in 2008, the financial system today is highly liquid. Accordingly, most buyers (with predictable income) can borrow large amounts of money with relative ease.
“they are buying for the long-term, so are prepared to pay a strong price when they find the right property.”
CoreLogic data reveals that Sydney prices fell by just 0.8% during the June quarter. The top quartile was more impacted 1.3%. However, to date, we’re talking modest impacts..
What does the future hold for property?
Despite the relatively brief Australian shut-down, experts predict that Covid19 will leave its mark on the Australian economy for some time.
The government continues to develop a plan to aid economic recovery. Relative to the GFC, the impact of government intervention will be very different this time. Why?
On one hand, the scale of government response (fiscal bailout and quantitative easing) has been far greater during COVID19 than during the GFC. Currently, the financial system remains highly liquid and if we can simply get back to work, then things should recover fast; however
On the other hand, the government response may be less effective this time because…
Leading into the GFC, Australia had enjoyed years of budget surpluses and wage growth. Whereas leading into Covid19, we’ve had years of deficits and wage stagnation. Further, significant growth in property values, has pushed Australia’s household debt to rank near the top of the world
Six months into the GFC, interest rates dropped by 4.25%. Whereas today, interest rates can’t drop further
Few people lost their job or had hours reduced during the GFC. The immediate impact has been much greater during Covid19.
Government bailouts during Covid19 have mostly replaced lost revenue / incomes, rather than adding new cash to the economy. However, during the GFC, a big part of the government stimulus was cash handouts that drove immediate spending in the economy
Below is a summary of modelling from Australia’s major banks to produce two scenarios. I don’t hold these up as the only scenarios, however, they depict the most positive and the most negative scenario I’ve read (from reliable, unbiased economists).
Note: the following information is not provided as financial advice. Any reader should seek specific financial advice that is tailored to their circumstances
I hope these sobering predictions prove to be incorrect. No one wants to live through tough times.
If you ask ten different economists to predict the impact of Covid19, I suspect, you’ll get ten different answers. However, the consensus is that CV19 will have a big impact on the economy.
Prior to the recent announcement to extend Job Keeper, banks (who employ some of the best economists in Australia) predicted the impact on average Sydney property values would be 11%-32%. Extending government support will avoid the worst-case scenario, however, to my knowledge, economists haven’t backed-away from the base case, which is worse than the GFC (7.5%).
But, in previous downturns, premium property values experienced significantly greater declines than average values. And, during the GFC, house values didn’t recover to 2007 levels until early 2014.
At this point, I’m probably best off leaving the macro-economics and deep analysis to the economists. Instead, I want to focus on two things that are specific to local property...
Leading into the GFC, annual house sales in Willoughby Council were 680 p.a. As selling conditions deteriorated, owners decided not to sell. i.e. 2008 sales were 500. This significant reduction in sales volumes helped to stabilise values
However, in recent years, sales volumes have been historically lower. Leading into Covid19, annual house sales in Willoughby Council were 400 p.a. As per the GFC, many owners have decided not to sell. However, it is hard to imagine sales volumes being sustained at 300 sales / year. If supply were to return to normal levels (e.g. 500+ sales) it will negatively impact values
During the GFC, banks had restricted access to funds, so in 2008, lending dried up relative to 2007 when lending practices were incredibly loose!
Since the Banking Royal Commission, banks have been applying greater scrutiny when assessing loan applications. However, liquidity today is much better than 2008. If this remains unchanged, then buyers should continue to borrow, which will have a positive impact on property values. The risk to this is if consumer confidence dives, and people decide not to borrow or borrow less.
What to expect from Premium Property (>$2.5m) in coming years...
I think it will take a while before any deeper negativity kicks-in. In the short-term, I think we’ll see good selling conditions for four reasons:
Buyer confidence has lifted: Sydney-siders are desperate for life to return to normal, so I think they will embrace their old freedoms FULL-ON in the coming months
Much of the pain has been deferred: until late 2020, early 2021, Government spending (Job Keeper; etc) as well as the moratorium on rent payments / mortgage repayments will keep people employed and prop-up fragile businesses and ensure that owners are under no urgent pressure to sell. And, some form of stimulus may continue beyond this time
Interest rates are low, and credit is relatively easy to access for most people. It's getting harder for people with large bonus income and certain industries have been red flagged. However, in the short-term, banks will mostly continue to write mortgage loans as they have been for the past year
Low Supply: listings will remain tight as most owners want evidence of market strength prior to selling
All of which should deliver respectable auction clearance rates and sale prices!
2021... A Possible Tipping Point?
If economists’ prediction are accurate, the following scenarios will become more likely, which will have a negative impact on property market conditions:
Demand may weaken. If the economy remains weaker in 2021, than it was in 2019, potential buyers will be earning less / feeling less confident about making decisions. This will impact:
Whether they buy and / or how much they want to spend
How much they can borrow
Tighter Credit Conditions: There’s no serious talk of the current high liquidity slowing; however, in a weaker economy, lenders scrutinise more and lend less
Supply will grow (regardless of market conditions): 2018 and 2019 saw local supply fall to approx. 70% of the long-term average. The first half of 2020 is approximately 50% of the long term. This is unlikely to endure given that most local sales are motivated by non-financial reasons. E.g. downsizing; upsizing; relocating; nursing-care; divorce; death; etc. Add to that the increased possibility that some owners will sell to reduce debt (especially investors with apartments). Finally, if the outlook looks ‘iffy’, some owners will choose to sell ahead of market deterioration. Higher listings will mean buyers have choice, which will remove FOMO (Fear of missing out) and undermine: competition; auction clearance rates and ultimately value.
If values fall, over time, they will rise even. The big question is when? Not that I wish this upon us, but, it's worth noting that local property values were in negative territory from late 2007 until early 2014. In other words, if the market falls, the next peak may be some time off.
And, should the market weaken, the downside is limited for anyone who is both buying and selling (because it mostly evens-out). And, there is obvious upside for young people who are struggling to get onto the property ladder.
Of course, it’s possible that the pandemic will blow over in the coming months and life will continue unabated, in which case, the economists will be wrong, and we’ll all breathe a sigh of relief.
Regardless of what happens, like the stock market, it’ll be anything but boring! I suspect that the coming years will have a mix of weak markets; stronger markets; and in between markets. It'll be interesting to watch it all unfold.