The outlook for Australian house prices

This is not to say that it is the rise in debt that has caused the rise in Australian house prices relative to income levels, although it has probably played a role. Household debt has also increased in the US, UK and other countries but housing in those countries is a lot more affordable. Rather, the key driver of Australia’s poor housing affordability appears to be a combination of restrictive land supply policies, high urbanisation and centralisation (i.e. we have all congregated in a few coastal cities and then put land release barriers around them). Numerous US cities have grown in size as quickly as, if not faster than, Australian cities. However, house price to income levels there have changed little over the last decade because land supply polices are far more liberal.[1] Rather, the rise in debt has mainly been an outworking of deteriorating affordability on the back of constrained land supply.

This rise in the ratio of debt to income has seen Australia move from the bottom of the pack in terms of comparable countries to near the top.

The combination of overvaluation, poor affordability and very high household debt has left the Australian housing market very vulnerable to anything which discourages buyers or threatens the ability of existing borrowers to service their debts.

Which brings us to the third point – rising mortgage rates are now proving to be a major problem for the Australian housing market, with the threat of more to come if the economy does not slow further and if funding costs remain difficult for the banks. While Australia does not have the problem with poor lending standards that is now driving a collapse in US house prices, it does have rising interest rates (leading to record mortgage stress) at a time when household debt and house price to income ratios are very high. This runs the risk of a rise in delinquencies and forced sales and puts more generalised downward pressure on house prices.

Finally, there is much evidence to suggest that the Australian housing market is now deteriorating. After rising by a strong 13.8% through 2007, average capital city house price gains virtually stalled in the March quarter, with house prices actually falling in Sydney, Perth, Hobart and Darwin. A range of other indicators confirm that the housing market has slowed significantly in the last few months. Housing finance commitments are weakening, new home sales are falling, listings are up and auction clearance rates in Sydney and Melbourne are running around 10 percentage points lower than a year ago. With a rise in the standard variable rate from 8.05% a year ago to 9.47% now, it appears that the Australian housing market has hit a brick wall.

Reasons not to get too gloomy

There are two favourable differences between Australia and the US. First, while America has a housing oversupply, Australia has a huge shortage. Housing construction is currently running around 30,000 dwellings per annum below annual underlying demand, which is driven by immigration and natural population growth. This is more than evident to anyone seeking rental accommodation – capital city vacancy rates are very low and rents are rising. (But with rental yields around 3% or 4%, several years of strong rental growth are required to make yields attractive for investors.)

Second, Australia is receiving a huge boost to national income from strong commodity prices. So the downside to the Australian economic outlook is nowhere near as significant as in the US, UK and Europe. This means that a massive round of delinquencies, defaults and forced selling is unlikely. These considerations suggest that a 30% fall in house prices is unlikely, however they are also unlikely to prevent modest falls.

Concluding comments

A shortage of housing, a huge boost to national income from commodity prices and higher lending standards suggest that a US-style collapse in Australian house prices is unlikely. However, rising mortgage rates (leading to record mortgage stress at a time of massive overvaluation), poor housing affordability and very high debt levels suggest that average Australian house prices are more likely to fall than rise over the next year. On balance, national house prices are likely to fall by 5% or so over the next year but, as always, this will mask a huge variation across locations.

Dr Shane Oliver, Head of Investment Strategy and Chief Economist

AMP Capital Investors