Australian property prices are falling at their fastest rate in five years, putting a definitive end to the debt-fuelled housing boom. The question on many investors’ and borrowers’ minds is whether it has only just begun.

This is the second story in a series I’ve written for Professional Planner on the outlook for property. In the previous contribution, I raised the issue of diversification and whether investor allocations are global enough.

But the bigger, and arguably much more important, question is whether the rapid accumulation of household debt – to record levels – will produce not only weaker economic growth (through a decline in construction activity, home sales, renovation demand and, consequently, consumer spending and sentiment) but also a more painful experience, such as a recession.

More than a year ago, in an article for Professional Planner titled “The property boom may finally be about to bust” , we warned investors of an imminent decline in the property market.

That article noted the Australian Prudential Regulation Authority-induced tidal wave of interest-only mortgages that would switch to principal and interest (P&I), and which would be accompanied by a rise in repayments of as much as 40 per cent. Clearly, this will have a dampening effect on discretionary spending.

We now know that, over the last five years, the banks have written $650 billion in interest-only mortgages. That represents about 40 per cent of the total book of mortgages written. The value of interest-only loans maturing next year will be $133 billion. That figure will peak in 2020 at about $159 billion, with another $135 billion maturing in 2021 and $117 billion doing so in 2022. If 40 per cent of the total book is interest-only and the APRA-imposed cap is 30 per cent of all new loans written (assuming no system growth), that means about 10 per cent or $136 billion will migrate from interest-only to P&I between now and 2022.

ASIC states that the average size of an interest-only mortgage is $347,000, which means there are about 392,000 interest-only mortgagors migrating to P&I between 2019 and 2022. Keep in mind it is the marginal buyer and seller that will determine the price of everyone’s property. It is the behaviour of buyers and sellers next weekend that determines property prices for all of us.

Compounding the situation was Commonwealth Bank chief executive Matt Comyn’s announcement at the bank’s 2018 results that he expected arrears to rise as more borrowers were moved to P&I loans. He also added that home-loan growth was less than 2 per cent, suggesting the pool of buyers is drying up. In fact, Australia-wide, home-loan growth is going backwards at the rate of about 8.4 per cent as at June this year.

The financial strain consumers are under was evident in the AGL Energy financial year 2017-18 result showing bad and doubtful debts jumped more than 20 per cent, to $94 million – equal to fully 13 per cent of the CBA’s bad and doubtful debt charge.

Forced sellers and a shrinking pool of buyers is generally not a great combination for property prices. And we haven’t even touched on the impact of a 65 per cent slump in applications to the Foreign Investor Review Board (FIRB) by foreign entities for investment in housing.

Reinforcing these observations was a Moody’s report stating: “Mortgage delinquencies will increase in Australia over the next two years as a record number of interest-only (IO) mortgages convert to principal and interest (P&I) loans…Moody’s data shows that the 90 days past due delinquency rate for mortgages that have converted to P&I from IO is 0.94 per cent, double that of IO loans that have not yet converted and 0.24 percentage points higher than all securitised mortgages.”

And then there is property development company Mirvac’s 2019 outlook statement that projected a 24 per cent slump in residential lot sales from 3277 in 2018 to 2500 in 2019.

Finally, the banks have responded to the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry by slowing both the application process, and shrinking the volume, of investor and interest-only mortgages (the latter of which re now just 15 per cent of all mortgages written).

The action perpetuates the slump in credit growth, causing house prices to fall faster, providing consumers and borrowers with a negative wealth-effect, while simultaneously casting doubt over the quality of bank assets. This, in turn, raises bank funding costs, forces mortgage rates higher and drives even more borrowers into default.