House prices in Sydney and Melbourne could fall by up to 25 per cent this year alone and "there's a chance they could fall by half" in the coming "property bloodbath", an economist has warned.
LF Economics founder Lindsay David, who has been warning of the looming property crash for the past five years, said in a report today the recent house price falls were just the beginning.
CoreLogic data for January showed Sydney and Melbourne prices were now 12.3 per cent and 8.7 per cent down from their respective peaks in July and November 2017, with Melbourne falling at "the fastest rate ever seen".
"We think there's a chance property prices could fall by half in Sydney and Melbourne over the long run," David said.
"I wouldn't be surprised by falls of at least 40 per cent. When all hell breaks loose you've only got so many buyers out there."
His base case of 20 per cent falls in calendar 2019 is significantly more bearish than other experts. AMP Capital is tipping total peak-to-trough falls of 25 per cent in Sydney and Melbourne, while UBS is tipping 25 per cent with a "rising risk of 30 per cent".
David bases his forecasts largely on the "debt accelerator", which is strongly correlated with house price growth six months forward. Latest data indicates the debt accelerator is "falling sharply" in Sydney and Melbourne.
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Growth in mortgage debt slowed from 6.3 per cent in December 2017 to 4.7 per cent in December 2018, with bank bosses tipping that number could fall to between 2 and 3 per cent in coming years.
With a baseline of 3 per cent, the downturn in the debt accelerator "remains negative through to December 2019" at a minimum, suggesting prices could continue to fall through to June 2020.
If that happens, Sydney and Melbourne "will suffer peak-to-trough falls never experienced before, outside of the 1890s depression and real estate collapse".
David's report, Let the Bloodbath Begin, outlines no fewer than 18 separate headwinds facing the housing market, from the A$120 billion ($125.1b) interest-only loan rollover and mortgage broker exodus to the Labor Party's proposed tax reforms.
He argues Australia is in stage two of a five-stage process as the country's debt-financed asset bubble bursts. "The losses are going to mount, and start to mount faster because now you've got those economic headwinds involved with the bubble bursting," he said.
In stage one, prices start to fall after a sharp run-up, with most people believing it's "just a small pullback".
Stage two is when prices fall further, small property developers start to go under or cancel future projects and bank profitability begins to stall.
The mindset in this stage is that the declines are "more than expected" but "orderly". Stage three is when prices "fall well past thresholds owners are comfortable with", banks take a further profit hit, more developers go under and construction job losses mount.
This is when "panic slowly starts to set in", particularly among highly leveraged borrowers, and mindsets "eventually shift from denial to questioning how this can possibly be happening" as "nobody believed prices could fall by this much".
"We are shifting from stage two of the bust to stage three," David said.
Stage four is when the recession starts. Banks suffer a profit "wipe-out", residential construction comes to a "grinding halt", properties go unsold as mortgage defaults and unemployment rise. The mindset is "we're doomed".
The final stage is when the property market finds its floor. Banks have been bailed out or nationalised but credit availability is still limited. Cashed-up buyers or private funds buy distressed debt and dwellings at discounted rates. Prices slowly begin to rebound.
"On the bright side house prices will become very affordable again," David said.
"But it could be a horrible time for the economy. The risk of recession is really high."
The early '90s recession was "the recession we had to have", but David believes by the end of this year we could enter "the recession that's really going to hurt".
In the report he argues that the more time passes, the less chance the government or regulators can arrest the declines with a "bazooka stimulus that hits the bullseye from an ever-increasing distance".
Even if the Reserve Bank cuts rates further from its record low of 1.5 per cent, banks will "only pass on a fraction" due to their reliance on overseas capital markets, where interest rates have been steadily rising.
The only path to reinflating prices would be to relax lending standards — the prudential regulator did lift its cap on interest-only loans last month — but the banking royal commission fallout has made that unlikely.
David said the downturn signalled the end of the "Ponzi finance model". "People have to understand that there are simply too many investors already tied up in the housing market and they can't go and buy more real estate unless the value of their home rises," he said.
"That's how everyone was able to accumulate so many properties in such a short time. They bought a A$500,000 investment property, 12 months later it's worth A$600,000, with that A$100,000 equity you're able to go and buy another A$500,000 property. You can't do that anymore, it's in reverse."
David, who has often been criticised as a doomsayer, said the house price falls were "nothing to feel good about". "It's safe to say we have for quite some time been the most hated macroeconomic research company in Australia," he said.
"But everything we have warned about has come to fruition — the mortgage fraud, illegal lending practices, the stupidness of the RBA to cut interest rates too early. But in reality these are people's livelihoods we're talking about."