The longer term outlook for Australian residential investment property is “messy”, with price growth likely to be constrained because housing is “expensive” and offers very low returns compared with shares and commercial property, says AMP Capital chief economist Shane Oliver.
“Housing is expensive on all metrics and offers very low rental yields compared to all other assets except bank deposits and Government bonds,” Dr Oliver wrote in a new analysis paper following the Reserve Bank’s decision this week to keep interest rates on hold in April at 2.25 per cent.
“The gross rental yield on housing is around 2.9 per cent (after costs this is around 1 per cent), compared to yields of 6 per cent on commercial property and 5.7 per cent for Australian shares (with franking credits).
“This means that the income flow an investment in housing generates is very low compared to shares and commercial property so a housing investor is more dependent on capital growth to generate a decent return.
“So for an investor other assets continue to represent better value,” he said.
Dr Oliver said low interest rates – he tipped a 25 basis point rate cut in May with a “strong possibility rates will fall below that later this year” – would support further gains in home prices, but that growth was likely to be constrained by the “economic environment and the impact of tougher prudential scrutiny of bank lending by APRA”
“Over the next 12 months home price gains are likely to average around 5 per cent, maybe a bit stronger in Sydney and Melbourne (key beneficiaries of the post mining boom rebalancing) but staying negative in Perth and Darwin (as the mining bust continues),” he said.
While he stopped short of warning of a possible housing correction, Dr Oliver said it had long been known that “Australian housing is expensive and overvalued” and that it was “vulnerable” should something threaten the ability of households to service their mortgages.
But he also highlighted that home price gains have been narrowly focused on Sydney (up 13.9 per cent over the year to March according to CoreLogic RP Data) and to a lesser extent Melbourne, that growth in household debt and investor debt had slowed, and that the RBA and APRA had taken the macroprudential path to “contain risk around housing”.
While some like the Housing Industry Association said the RBA had missed an opportunity to support the expanding residential construction sector by not cutting rates this month, Dr Oliver said the RBA was right to be concerned not to further inflate the property market with record auction clearance rates in Sydney a concern.
Further rate cuts are likely though, he said, because “as the RBA has pointed out in the past it needs to set interest rates for the ‘average’ of the economy.”
“And the ‘average’ still points to the need for lower interest rates as the slump in mining investment intensifies, non-mining investment remains weak, iron ore prices are down another 23 per cent since the February RBA cut, the outlook remains for sub trend growth and ongoing spare capacity in the economy and inflation remains benign,” he said.