With Australian house prices rising at their slowest in nine years and the rate of increase falling from 18.9% in 2003 to 0.2% first quarter 2005, is the experience there a model of what investors in the UK might see?

Figures from the Australian Bureau of Statistics show that Australian house prices rose by 0.2% in the first quarter of 2005 and by 0.4% over the past year, the lowest annual rise in nine years. The 0.2% rise in Q1 2005 is the second consecutive quarterly price rise following a 0.7% drop in Q3 2004.

The Royal Institution of Chartered Surveyors says the slowdown in house price inflation in Australia reflects the impact of several interest rate rises in recent years, with investor activity in the market particularly affected by higher mortgage costs.

As Australia’s housing boom ends, new report from RICS asks ‘is a crash around the corner?’

The first quarter data indicates that the housing market as a whole is experiencing a soft landing due to greater purchase activity by occupiers who have been supported by continued strength in the labour market despite an economic slowdown.

RICS expects Australian house prices to drop by 1% in 2005, as a result of the central bank's most recent interest rate rise of 0.25% to 5.5% in March 2005 will have a negative impact on demand during the latter half of the year.

House prices will not fall far though, as the market will be well supported by owner-occupiers. One would expect the rises in interest rates, themselves the result of the strong domestic economy, to have only a modest impact on owner occupier lending as strong earnings growth and high and rising levels of employment, make households feel secure about their economic future, says RICS.

Can we use the Australian experience to predict the market in the UK?

The Australian situation: high house prices relative to earnings, slowing house price growth after a period of rapid expansion, rising mortgage interest rates, and a strong domestic economy; bear a strong relation to the current circumstances in the UK.

So does the Australian experience give us any pointers to the future of UK house prices? One lesson seems to stand out, says RICS. Many commentators have noted, and worried about, the influence of buy-to-let investors in both markets.

It is accepted that investors did play a role in pushing up prices in the UK, particularly at a local level in northern England. What would happen when these investors lost interest?

Australia’s experience seems to suggest that the UK should not be overly worried about the ramifications of a down turn in investor sentiment. Investors in Australia did severely reduce their activity in the market as was shown in the rapid declines in investor mortgage lending. However this has not caused a crash in the market because of the continued strength in owner-occupier activity due to the strong performance of the domestic economy.

Reduced investor activity in Australia did not cause the severe down turn that some predicted, even though they accounted for around 40% of all mortgages at the market’s peak. As such, it is unlikely that a similar downturn in investor sentiment in the UK would cause a crash when investor activity as a percentage of total activity is significantly lower than in Australia (RICS estimates that it accounted for around 15% of all mortgage lending in 2004).

Also, recent Australian experience gives us an insight into the behaviour of existing investors. They have not sold their investment properties on mass as some had feared. Rather, surveys indicate that investors intend to hold their properties for a long period of time, reflecting the changes in capital gains tax regime. UK investors benefit from a similar CGT regime which reduces the proportion of any capital gain that is taxable according to the number of years an asset is held, with the holding period significantly longer than in Australia if investors are to benefit from the ‘taper’.

Consequently, RICS says, it would expect British investors to react to weaker house market performance and higher interest rates, in the same calm manner as their Australian counterparts have done.