Why falling house prices are good for the economy

 

Pop!

That sound you just heard was the bursting of the Australian house price bubble.

There are clear signs that the over-inflated housing market has screeched to a halt with auction clearance rates falling, there is a strong pick up in new dwelling supply from a construction boom and there is a free-fall in investor loans on the back of tighter regulation and dismally low rental yields.

Also read: Australia's housing boom is over

House prices are falling in Sydney, Perth and Melbourne, according to the Corelogic RP Data Daily house price index.

Compared with the recent peak levels, prices in Sydney are down 1.6 per cent, Melbourne is off 2.8 per cent while Perth, which is under pressure from the fall out of the mining downturn, house prices are down 6.5 per cent from the January 2015 peak.

Also read: Seven factors that will shape the 2016 property market

For those interested in the sustainability of the economic expansion, this is not bad news.

The surge in house prices was distorting investment decisions and making it harder for first home buyers to save the deposit needed to enter the housing market.

The falls also need to be viewed in the context of the quite phenomenal price increases over the prior few years.

Indeed, the falls in Sydney and Melbourne, for example, have only trimmed the price gains of the prior month or two.

The price falls are no surprise.

Some house price moderation was always inevitable after the frenzied boom of the last couple of years.

This means that policy makers, most notably the Reserve Bank, will be watching housing market with no fear.

Also read: Aussie house prices to drop

We also know that with the dwelling construction boom and a sharp slowing in immigration inflows into Australia, the demand and supply dynamics are pointing to weaker house prices.

This will not be a short term issue – it will likely last a few years until either immigration picks up again or new dwelling construction falls away.

It would be no surprise if we hear more about a dwelling glut, particularly where the new construction has been strongest.

The big question that will no doubt be thrown around in the months ahead, is whether these price falls are the start of a crash like we saw in Ireland, England, the US and Spain and elsewhere.

House price collapses in these countries crippled banks and drove each of those economies into severe recession.

Or is the moderation in house prices in Australia a healthy correction that will, in time, improve affordability, lead to more prudent investment decisions and see investors look to more sensible and sustainable asset classes for their investment dollars?

My money is squarely the latter, that is, we are seeing the start of a healthy trend towards flat or even slightly lower house prices.

Also read: Melbourne property to outperform Sydney

Healthy, because the price boom was creating too many risks for the Australian economy.

Flat to slightly lower house prices are a trend that should persist for a couple of years by which time, affordability will further improve.

Prices, peak to trough, should drop by between five to 10 per cent, with the bigger falls in the areas where the prior growth had been excessive.

When the dust settles and house prices normalise, the economy will be all the better for it.

That will not, unfortunately, stop some doomsayers creating fear about a house price collapse.

 

Stephen Koukoulas is a Yahoo7 Finance expert with 

more than 25 years experience as an economist in government, as Global Head of economic and market research, as Chief Economist for two major banks, and as economic advisor to the Prime Minister of Australia.