Australian Housing Market

The Australian housing market has shown strong performance in the beginning of the year, with national home prices increasing by 1.6% in the first three months, according to CoreLogic. Despite concerns about high mortgage rates, the market is still being driven by a supply shortfall.

Extreme Views on the Property Market

Among property experts, there are two extreme views on the Australian housing market. Some real estate enthusiasts still hold on to the belief that property prices will double every seven years. On the other hand, property pessimists argue that the market is overvalued and over-indebted, leading to an inevitable crash.

However, both extremes overlook the complexity of the market. Here are seven stylized facts about the Australian property market:

1. It’s Very Expensive
2. It’s Also Very Diverse
3. Mortgage Arrears Remain Low (For Now)
4. Interest Rates Still Matter
5. It’s Chronically Undersupplied
6. Forecasting Swings in Home Prices is Hard
7. It Has Similar Long-Term Returns to Shares

1. It’s Very Expensive

The Australian property market has been expensive since the early 2000s, and the situation has only worsened. House price-to-income ratios have doubled since 2000. It now takes an average full-time wage earner 10 years to save a 20% deposit, compared to 5 years 30 years ago. Additionally, the ratio of home prices to rents shows that house prices are around 36% above their long-term average.

In global comparisons, Australian house prices are significantly more expensive than in the US and UK. The 2023 Demographia Housing Affordability Survey reveals that the median multiple of house prices to income is 8.2 times in Australia, compared to around 5 in the US and UK.

The high cost of Australian property, coupled with the high level of household debt, leaves the economy vulnerable to rising interest rates or unemployment, which could make it harder for borrowers to repay loans and exacerbate wealth inequality.

2. It’s Also Very Diverse

While many refer to “the Australian property market” as a whole, there is significant divergence between different localities. Recent trends have shown rapid relative price growth in Adelaide, Brisbane, and Perth. This can be seen in the chart for Perth.

This divergence is influenced by factors such as housing affordability and population growth. Adelaide, Brisbane, and Perth have experienced catch-up price growth after lagging behind pre-pandemic. Brisbane and Perth have also benefited from interstate migration, leading to relative population growth.

Measures of valuation also reflect this divergence. The percentage difference between price-to-annual rent ratios adjusted for inflation, relative to their average since 1983, shows that houses are 36% overvalued, while units are only 9% overvalued. Perth stands out as the least overvalued market for houses and is undervalued by 12% for units.

3. Mortgage Arrears Remain Low (For Now at Least)

Despite headlines about excessive mortgage stress, mortgage arrears rates remain remarkably low. This is partly due to strong lending standards in Australia, a strong job market, and high levels of savings buffers following the pandemic.

However, as savings buffers run down and the labor market deteriorates, the risks of mortgage arrears will increase. Although mortgage arrears rates may be low now, the situation could change if interest rates rise or unemployment levels surge.

4. Interest Rates Still Matter

Historical data shows that interest rates play a significant role in the property market. The downward trend in mortgage rates since the late 1980s has fueled the surge in property prices, as it allowed buyers to borrow more relative to their incomes. Conversely, rate hikes have been associated with cyclical price falls, while rate cuts have often stimulated price growth.

However, the impact of interest rates can be overshadowed by other factors, as seen in the past year. Other factors such as the supply shortfall have had a greater influence on the market during this period.

5. It’s Chronically Undersupplied

The Australian property market has been undersupplied since the mid-2000s when immigration levels and population growth surged, while the supply of new homes did not keep pace. The pandemic briefly relieved the situation by freezing immigration, but the problem worsened with the reopening and the record levels of immigration.

The current demand for housing is estimated to be around 250,000 dwellings per year, while home completions are only around 170,000 dwellings per year. This growing shortfall is responsible for the surprising strength in home prices over the past year.

To address this issue, immigration levels need to be reduced to around 200,000 per year in order to balance the demand and supply of housing.

6. Forecasting Swings in Home Prices is Hard

Forecasting property prices has proven to be challenging, as evidenced by the numerous failed property crash predictions over the past two decades. Even the Reserve Bank of Australia (RBA) has admitted to the difficulty of predicting housing prices accurately.

Given the complexity of the market and the influence of various factors, it is important to approach house price forecasts with humility and skepticism.

7. It Has Similar Long-Term Returns to Shares

The long-term returns of the Australian property market are comparable to those of shares. Investing $100 in Australian cash, bonds, shares, and residential property in 1926 would have yielded an annual return of around 11% for both shares and property.

Property’s low correlation with shares, lower volatility, and lower liquidity make it an attractive diversification option for investment portfolios. Therefore, it has a role to play in investors’ portfolios.

Where to Now?

Forecasting property prices in the Australian housing market is a challenging task, especially considering the opposing forces of chronic supply shortfall and high mortgage rates. The base case scenario suggests a 5% growth in home prices this year, down from 8% last year, due to the constraints posed by high interest rates and higher unemployment.

However, the supply shortfall is expected to provide support, and rate cuts later in the year may boost price growth. Delayed rate cuts and a significant rise in unemployment would indicate downside risks, while the supply shortfall suggests upside potential.

For savvy investors, it is crucial to consider the pressure from high interest rates and low rental yields when making property investments. Properties that offer decent rental yields should be prioritized.

In conclusion, the Australian housing market is characterized by its high expense, diversity between localities, low mortgage arrears rates, the influence of interest rates, chronic undersupply, the difficulty of forecasting price swings, and comparable long-term returns to shares. Understanding these factors is essential for navigating the market and making informed investment decisions.

Bold: Australian housing market