Can falling house prices be good for Australia?

Australians have spent decades cheering rising home values. But could falling house prices actually be good for affordability, inflation and future buyers?

According to property research company Cotality, property prices were down 0.7% nationally in July, with Sydney and Melbourne falling 1.4% and 1.2% respectively.

Over the quarter, national prices were down 1.9%, although this was largely due to 4% and 3.4% falls in those major capitals.

Cotality says the falls were also heavily weighted towards higher end properties with upper quartile home values falling 3.2% over the quarter, compared to a 0.3% gain across the lower price tier.

Why are Australian house prices falling?

The falls are partly due to the less generous rules on capital gains tax (CGT) and negative gearing that came in after the Federal Budget. But these changes have hit alongside other pressures - rising interest rates, high fuel prices, poor housing affordability and lower consumer confidence - which has exacerbated the downward pressure on prices.

How low can they go? That's the big question, but some forecasters have put the drop as high as 10%.

In August, National Australia Bank revised its outlook downwards to predict a 5% fall across all capital cities this year, led by about 10% falls in Sydney and Melbourne. In May, Morgan Stanley predicted prices could fall by 10%, although not all estimates are this gloomy.

For example, in its August Residential Property Market Outlook, KPMG predicted a V-shaped trend with prices falling by 1.1% for houses and 2.2% for units nationally in 2026, followed by a recovery in 2027.

It said the depth of the downturn and pace of recovery are likely to vary across markets, influenced by things such as differences in affordability, supply conditions, population growth and general economic conditions.

Why falling house prices affect everyone, not just homeowners

The rationale behind the government's crackdown on negative gearing and CGT concessions was that it would make it easier for young people to buy their first home. But lower home prices also have a wider impact, driven in part by the so-called wealth effect.

As home prices have risen, Australians have enjoyed greater wealth - at least on paper - with median prices in Sydney, Brisbane and Perth all now into seven digits.

Being richer makes us more inclined to spend, so the theory goes. We're more likely to spend on consumers goods, for instance, such as cars, travel and entertainment, and we're also more likely to reinvest in our main asset through things like renovations. So, all being equal, when house prices are falling, household spending and consumer confidence should also pull back, potentially slowing economic growth.

Bloomberg economist James McIntyre said recently falling house prices could trigger a drop in consumer spending of up to 0.3% in coming months, which would spread across the economy.

He also said housing construction could take a hit as construction costs have been rising and builders may no longer be able to pass those costs on through higher prices. He said housing construction activity makes up 4%-5% of the economy.

But it's not just housing construction that is vulnerable to falling prices. Housing has flow-on effects for sectors such as banking, legal conveyancing, removalists and retail - the furniture, appliances and other items people buy when they purchase a home.

Could falling house prices lead to lower interest rates?

But here's the thing. The Reserve Bank is determined to bring inflation down and to do that it needs to curb spending.

In its August rates decision, it said it would increase rates further if needed to curb inflation.

The silver lining is that home buyers could be looking at rate cuts if the heat is taken out of the housing market and the economy more generally, which would then ease downward pressure on house prices.

Is this a housing crash or just a correction?

Perspective is important. Cotality says house prices rose 7.3% nationally in the year to June with prices in all capital cities except Sydney and Melbourne still at record highs.

Treasurer Jim Chalmers said on Budget night that house prices are up more than 400% since 1999, while AMP deputy chief economist, Diana Mousina has said national home prices are up more than 50% since the COVID-19 pandemic.

A 5% to 10% fall might be challenging for recent buyers, but it is arguably only a minor correction considering these massive gains and certainly not indicative of a major crash.

The huge run up in prices also means negative equity (where values fall below the level of mortgages) has not emerged as a significant problem.

In July, Reserve Bank governor Michele Bullock said negative equity was affecting less than 1% of borrowers with the biggest falls at the top end of the market. With lower end prices holding up better, claims of widespread negative equity for borrowers using the government's 5% deposit scheme seem overblown.

A more severe downturn would have a wider impact, but the chances of this need to be balanced against the continuing shortage of 200,000 to 300,000 homes, according to AMP chief economist Dr Shane Oliver.

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