One of Australia’s best property economists reveals his worst nightmare.
What does the worst-case scenario look like?
In a reasonable world, obviously. The ultimate worst-case scenario is that our recovery efforts reawaken Godzilla out of his slumber to wreck havoc on Neo-Tokyo.
But as investors, what is the range that we’re reasonably working with here?
I reckon we should ask Louis Christopher. He’s the head of SQM Research, and has consistently been one of the most sensible voices in property for a long time now.
He reckons that the best case scenario is a quick “V-shaped” recovery, with minimal disruption to prices.
The worst case scenario ends with prices down a massive 30%!
Let’s lay out his thinking.
The best-case scenario
Christopher reckons we’ve already locked in modest declines for the month, but that could be reversed if we find our way out of the crisis quickly.
I think housing price expectations have already corrected by 5% to 10% from their very highs…
The best case scenario from here for property owners and investors is one where we get to zero new Covid-19 cases before April is over with. And on that front the numbers have been looking promising. I believe it is now a 50% chance that our three major states will record a zero new Covid-19 cases day before the month is over.
… If we are able to get back to close to normal business by end of May (I certainly don’t think all restrictions will be lifted by that time), then I think confidence in the housing market is going to return. Assisted with all the stimulus announced and the economic damage relatively limited, it would mean a fall in housing prices recorded for the June quarter but a bounce back in the September and December quarters.
It should not be underestimated how much expenditure has been announced (including RBA money printing via quantitative easing) and how low lending rates are now. A
borrower with a good credit rating can now expect a variable owner occupier lending rate somewhere between 2.5% to 2.8%. Average capital city gross rental yields are running at about 2.9% for houses and 3.9% for units…
So falls of 5-10% in the short term, with those falls being unwound by the end of the year.
I personally don’t think the dip will be as shallow as that, but it is possible that the rebound could be as quick.
The worst-case scenario
The trouble with predicting the course of this economic crisis, is that we don’t know how things are going to play out with the virus itself. The (totally possible) worst-case scenario involves the virus flaring up again before it is defeated, throwing the country into another round of lock-downs.
If this second wave were to occur, we think the housing market will have a much deeper correction.
Such a scenario would mean current restrictions would stay with us for longer. Probably more than six months. Or worse, more restrictions added. A second wave of infections may be more deadly as it would potentially occur over the course of the Southern Hemisphere winter. A sharp rise in deaths may result in more panic at the shops and most certainly a new low in confidence.
Damage to the economy would be deeper and longer lasting. Many businesses, including those that are currently on life-support, would not last the distance and will be liquidated.
You see, even with the generous measures announced for small business, it won’t be enough to keep much of the sector alive for half a year. When there is little to zero revenues coming in, month after month, PAYG relief is not enough. Being subsidised to cover employee wages at $1,500 a fortnight is not enough. Neither is a $10,000 cash grant for most. And forget about asking small business to go into debt. Most of them, particularly in retail, hospitality and tourism, will refuse to do so. And so job creation would occur at a far slower rate when a recovery would eventually return.
With the surging and sustained unemployment rate, the banks could start to get nervous on mortgages. Potentially, after the six-month hiatus, banks may be backed into a corner where they are forced to repossession on defaulted housing loans. Now I believe the RBA and/or the Federal Government would come to the rescue to enable banks to avoid a mass repossession event.
So I am not convinced we will see a lot of forced sales activity, even in this bleaker scenario. All the same, there will be many property owners who will want to sell out if this crisis goes on for six months or more. They will see the falls in dwelling prices over the course of the June quarter. And they will be very protective of what is left of their net wealth.
The buy side of the property equation would be hit very hard as it is being hit hard now. But far worse than what we had in 2018 or indeed 2008. You see it’s not just the
loss of employees representing many first home buyers, but, as mentioned above it is also the potential wipe out of many thousands of small business owners, who themselves employ nearly 50% of the total workforce. Small business owners actually represent a very large component of the home-buyer market. As at the 2016 Census there were over two million small businesses.
So this is very much a buy side issue in my view. Anyone that is worried they will lose their job or their business, won’t be seriously thinking of taking out a home loan to buy into the property market. Let’s also remind ourselves that our international border is closed to most except for permanent residents, citizens and some temporary visa holders. And I believe it will remain closed for many months to come. So underlying demand for housing, which has been predominantly driven by net overseas migration has now stalled for this year.
Up to a 30% peak to trough price decline cannot be ruled out.
That’s a grim outlook, but is entirely possible if the health crisis keeps escalating.
And look, a lot of investors will be licking their lips at the thought of buying into the market at 2016 prices, but such a sudden crash will give Australian society whiplash.
I wouldn’t wish those unemployment levels and economic pain on anyone.
But look, this is the worst-case scenario. I don’t expect we’ll get there. And there’s every chance we could just sail straight through this, and strap on a rocket launcher on the other side.
More news as it comes to hand.