According to the latest Corelogic data, the Illawarra real estate market is now clearly in free fall. 

Corelogic’s Illawarra house price index shows that house prices have now fallen for the last six months in a row. 

The total fall over those six months is a staggering 4.8 percent – equivalent to almost 10 percent per annum and matching the fall in Sydney house prices over the same period. 

Unlike the Illawarra, Sydney house prices have fallen for 15 months in a row – since July 2017.

Sydney house prices fell around nine percent over that 15-month period. 

Over the same period, Illawarra house prices have only fallen 4.8 percent. 

This means that while house prices in the Illawarra were initially resilient from July 2017 to May 2018 – essentially moving sideways for 11 months – but they have now joined the Sydney market in free fall.

The reason for the initial resilience in Illawarra house prices is pretty clear.

There was a lot of pent up demand from Sydney buyers looking to enter the real estate market at more modest prices. 

Corelogic data shows that the median house price in the Illawarra is around $700,000 to $720,000, while Sydney house prices are around $1 million.

But it seems that the Sydney buyers looking for a deal have also been exhausted, meaning less demand in the Illawarra. But will this continue? 

In order to understand this, we need to go back to the middle of last year to understand the triggers which led to the falls in Sydney. 

There are two obvious ones: new rules introduced by the Australian Prudential Regulation Authority (APRA) which regulates banks and other financial institutions, as well as increases in interest rates by financial institutions. 

Around March last year, APRA introduced new rules designed to make it harder for financial institutions to lend money to investors looking to buy real estate and rent it out. 

These were added to a rule introduced by APRA in 2014 which sought to limit the growth in investor loans by 10 percent. 

In March last year, APRA introduced a rule which meant only 30 percent of new lending by financial institutions could be to investors.

APRA also discouraged lending to investors of more than 80 percent of the value of the property being purchased. 

The timing of these measures coincided with the beginning of the end of property price rises in Sydney – which flowed through to the Illawarra roughly 11 months later.

Since about the middle of last year, banks have been increasing interest rates. 

The reason typically given is that the banks’ cost of raising funds has increased. 

Banks run a pretty simple business, borrowing money at a lower rate and lending it at a higher rate and in so doing make money to cover their costs and generate a profit. 

Since about the middle of 2017, the cost at which banks borrow money has increased. 

The so-called bank accepted bill rate (the rate at which banks borrow for 90 to 180 days) has increased from around 1.7 percent to around two percent.

So the tightening of lending regulations and the rise in interest rates are the key two factors leading to the free fall in prices that we saw in Sydney around the middle of last year, and in the Illawarra since about May this year.  But what of the future?

In July this year, APRA announced that it was relaxing the caps on investor lending by banks. 

With the Sydney market in decline, it seems that it decided that there was no point in curbing the lending that it thought was causing price rises.

However, prices have kept falling in Sydney and the Illawarra despite the relaxation of the rules. 

Once prices start falling, it takes a lot to arrest the fall.

This leaves interest rates – which are not predictable. If interest rates remain where they are over the coming months then we can expect house prices to keep falling.

But if the gods of bond markets would be so good as to smile and cause interest rates to fall, then the price falls that we have seen could come back. 

So you see, it all depends.

Alex Frino is Professor of Economics and Deputy Vice Chancellor (Global Strategy) at the University of Wollongong.

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