House prices are falling and unlikely to rebound. Bring it on…

But what of our ability to pay? This is the real untold story of rising home values over the past three or four decades, and this is where the brakes are about to come on.

Loading

You can only pay for a home what a bank or other lender is willing to lend you. This is determined by your monthly cash-flow surplus, but also – crucially – the cost of borrowing. The lower the interest rate, the more you can borrow on a given income and level of living expenses.

And for the past three decades at least, rates had been trending in one direction: down. After rates hit an eye-watering peak of 17.5 per cent in the early 1990s, the Reserve Bank’s official cash rate quickly fell to 5 per cent by the mid-’90s. It rose again to 7.5 per cent later in the decade, but has never recaptured that high.

During the mining-boom surge in inflation during the 2000s, it almost did – but then the global financial crisis struck, yielding to a period of economic stagnation, and then the pandemic.

Today, Australian housing debts sit at record highs compared with income. Why? Because every time the central bank made it cheaper to borrow, we went out and leveraged to the max to feed our property desires. And literally no policymaker saw fit to stop us.

As a result, the Baby Boomer cohort now finds itself sitting on large gold mines, which their kids will inherit. But not all kids will be so lucky.

And it’s likely to be a very different story for future generations. Why? It’s simple maths. We’ve recently struck the limits of how low borrowing rates can go. While some countries flirted with negative interest rates, most of the world’s policymakers did ultimately shy away from such a “through the looking glass” world.

Having hit a floor of almost zero per cent, there was only one direction for official interest rates to go: up. Now they’re finally heading that way, borrowing capacity has been reduced. With bidders turning up to auctions with less spending power, property prices are doing what you’d expect: falling.

Sure, if the Reserve Bank were to abruptly change tack and slash rates again, borrowing power would increase. But with rates already sitting so close to their theoretical floor, they simply can’t keep moving lower in the years ahead and boosting borrowing capacity and home values, as happened over the past few decades.

We’ve hit the so-called “zero lower bound”, not only for interest rates but for future rapid increases in home values, too.

Loading

Policymakers could decide to do other things to boost prices, such as relaxing loan serviceability requirements, lifting immigration, pursuing aggressive wage growth or further restricting the supply of homes.

In the meantime, home owners would do best to assume it’s time to hand back most of the rapid price gains seen during the pandemic. AMP chief economist Shane Oliver is tipping home values will fall 15 to 20 per cent from their COVID peak. They’re already down 5.5 per cent nationally, according to CoreLogic, so there’s further to go.

After that, it’s also best to assume the future pace of growth will be lower than in previous decades, says Oliver.

“The tailwind to medium-term investment returns that’s been in place for the last 30 to 40 years from the downtrend in inflation and interest rates is now likely over,” he says.

For future generations of aspiring home owners (and their parents), that can only be regarded as a good thing.

The Opinion newsletter is a weekly wrap of views that will challenge, champion and inform your own. Sign up here.