As house prices soar to “flashing red” levels driving up debt-to-income ratios to nosebleed heights, there seems to be no end to Australia’s property boom.
Australian household debt has hit a record 177 per cent of disposable income, with residential property prices equating to 4.3-times annual incomes and 28-times annual rent.
With the Australian dream of home ownership increasingly becoming unaffordable, economists at Australia’s biggest bank, Commonwealth, have attempted to demystify the excitement surrounding house prices.
Here’s 16 questions that CBA says bores straight down to the facts about the residential property market,
What are the latest house price trends?
Dwelling price growth has stepped up significantly over the past year:
- house prices rose by 10.7 per cent over the year to March
- unit prices rose by 9.6 per cent over the same period.
- Both measures are running at the upper end of the range of the past decade.
Are price trends uniform across the country?
Dwelling prices are rising everywhere but growth rates vary significantly.
Here are the annual percentage increases for the 12 months to March this year:
- Sydney – 15.6 per cent
- Melbourne – 11.6 per cent
- Brisbane – 4.8 per cent
- Adelaide – 4.6 per cent
- Perth – 4.7 per cent
- Hobart – 0.9 per cent
- Canberra – 1.7 per cent
- Darwin – 3.8 per cent
- Regional – 4.5 per cent.
Why are prices rising?
Like any market, price reflects the interaction of supply and demand.
But the housing market is also different. Enter a supermarket and everything on the shelf is for sale. In housing, however, the “liquid” part of the market is quite small. About 4 per cent to 6 per cent of the dwelling stock is turned over each year and new construction adds 1.5 per cent to 2.5 per cent to the stock. The rest is locked up. The limited amount of stock in play magnifies the price effect of changes in the supply/demand fundamentals.
Housing is a big-ticket item. So affordability also matters in price outcomes. Exceptionally low mortgage rates have boosted housing affordability and are helping to turn underlying demand for housing into real demand.
What is driving demand?
The demand fundamentals are strong courtesy of rapid population growth. A lift in the birth rate and net migration inflow means that population growth is at the high end of the range of the past 40 years. The skew in the intake towards skilled migrants is accentuating the impact on the housing market. Skilled migrants are typically cashed up when they arrive and quickly add to housing demand.
There are also temporary skilled migrants (457 visas). And a strong education-related inflow as well. These groups are not necessarily permanent settlers. But they do need to live somewhere while they are here.
What is driving supply?
New dwelling supply has run at a little over 150,000 dwellings per annum in recent years. Competition for skilled labour and materials with the mining and infrastructure booms has limited supply.
With “demand” running ahead of “supply”, there is an excess demand for dwellings. This excess demand has been in place for a number of years. So a pent-up or accumulated demand exists as well.
Dwelling prices are responding to this demand/supply imbalance.
Are investors distorting the market?
The investor segment is accounting for an unusually large part of housing activity at present.This investor interest is a rational response to the environment created by central banks. Central banks responded to the financial crisis by boosting liquidity and pushing interest rates to “emergency” low levels. This approach encouraged a search for yield, lifted risk appetite and boosted asset prices.
Are SMSFs distorting the market?
The rising exposure of SMSFs to property is another outcome. This exposure is small in dollar terms but the Reserve Bank notes that SMSFs represent a “potentially speculative demand for property that did not exist in the past”.
Are foreign investors distorting the market?
Only limited and dated information is available on foreign-investor activity. This data comes via the approval process for such investment run by the Foreign Investment Review Board. The data shows foreign investor activity in 2012-13 was equivalent to 0.1 per cent of the dwelling stock or 2.8 per cent of transfers (i.e. sales). Foreign investor activity is also skewed by the legislation towards new construction. So demand is bringing forth some additional supply and more residential construction is a policy objective.
The FIRB data implies that the average value of a foreign approval is $1.5 million. So most of the activity is at the top end of the market and is unlikely to be unduly influencing affordability.
Are lenders distorting the market?
Regulators regularly warn lenders and borrowers of the need for caution. The RBA in its recent Financial Stability Review, for example, argues “it will be important for financial stability that banks do not respond by unduly increasing their risk appetite or relaxing their lending standards”.
But there few signs of a significant easing in lending standards. Low-doc loans account for a negligible share of new housing lending. And the share of lending accounted for by loans with a high loan-to-valuation ratio has not shifted appreciably.
Will dwelling prices keep rising?
There is some undoubted momentum behind house prices at present. But there are also some natural corrective mechanisms at work:
■ rising prices are now denting housing affordability. There have been no offsetting rate cuts since August 2013 and the debate is turning towards the possibility of rising interest rates. Deteriorating affordability will dampen interest from potential owner/occupiers.
■ rising prices are reducing rental yields. Some renters have transitioned to owner/occupiers. More supply will come on-stream as residential construction lifts. Vacancy rates are rising and rental growth is slowing. Lower rates of return will dampen interest from potential investors.
Is it a bubble?
Some perspective on recent price trends is needed. Higher prices today follow a period of falling prices. Dwelling prices are up by 16 per cent from the mid 2012 trough but are only 7 per cent above the previous (late 2010) peak.
For a true bubble, rising prices need to be backed up by an acceleration in housing credit growth over a relatively short period, an easing in lending standards, and an expectation that dwelling prices keep rising.
Housing credit growth has picked up but remains at the low end of the range of the past three decades. As noted, there are few signs of a significant easing in lending standards. House price expectations have lifted however. The limited data available makes assessing these expectations difficult. But it is a trend to monitor.
Is the RBA surprised?
The RBA is not surprised by rising house prices. You do not embark on a mission to stimulate housing activity without expecting some sort of price impact. Rising dwelling prices are indeed part of the transmission mechanism.
Rising prices boost household wealth and generally lift sentiment. Consumer spending benefits. Rising prices make new construction more attractive (one reason why rates were cut in the first place) and they encourage renovation activity as well.
Do valuations matter?
House price-to-income ratios are also rising again. And fears about overvalued housing are rising in tandem. Our consistent view has been that a significant part of the rise in price-to-income ratios reflects a shift in household preference for and ability to access credit. And a shift in the type of housing we want to inhabit.
Sustained low inflation allowed lower interest rates. More households can access credit markets as a result. Housing demand lifted relative to a supply that doesn’t change very quickly. A lift in house prices relative to incomes was inescapable. The shift in housing preference reflects the desire to build bigger and more elaborate dwellings. The “house” part of valuation calculations is higher as a result.
What would it take to kill the boom?
A “black box” rule we have followed over the years is based on the connection between mortgage rates and house prices. This “rule” is that a 20 per cent rise in the mortgage rate is typically sufficient to choke off whatever house price boom is under way at the time.
A 20 per cent rise would take the mortgage rate to around 7 per cent per annum. To get there would require the RBA to lift the cash rate by 100 basis points to 3.5 per cent.