Precis of Oliver's Insights 15 March and 4 April 2017
By Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital
Over the last five years Sydney dwelling prices have risen a ridiculous 75% and Melbourne prices are up 50%. So it's no surprise the Australian housing market continues to cause angst around poor affordability and high household debt.
On most measures Australian housing is overvalued:
- Australian houses are 39% overvalued and units 13% overvalued (based on the ratio of house prices to rents, adjusted for inflation relative to its long term average).
- The median multiple of house prices to household income is 6.6 times in Australia versus 3.9 in the US and 4.5 in the UK. In Sydney it's 12.2 times and Melbourne is 9.5 times (2017 Demographia Housing Affordability Survey in cities over 1 million people).
- The ratios of house prices to incomes and rents are at the high end of OECD countries
Why it's so expensive
There have been two main things driving cost and household debt over the last two decades.
- Low interest rates have boosted borrowing and buying power.
- Housing supply has not met demand.
Other influencing factors
Other factors may also be playing a role in driving the demand for property beyond population growth, such as:
- Negative gearing. It's just part of the normal operation of our tax system, but the capital gains tax discount that enhances the after tax return for property investment may have increased investment activity. Lending to property investors has also bounced back to what it was before 2015.
- Foreign buying, which is around 10-15% of demand, but is also concentrated in particular areas.
A crash remains unlikely
The surge in prices and debt has led many to conclude a crash is imminent. But we’ve heard that many times over the last 15 years, and it's unlikely.
To see a general property crash (e.g. an average price fall of 20% plus) we'd need to see one or more of the following:
- A recession - this looks unlikely.
- A surge in interest rates - but rate hikes are unlikely until 2018 and the RBA will take account of the greater sensitivity of households to higher rates.
- Property oversupply - this would require the current construction boom to continue for several years. However, the risks on the supply front are high in relation to apartments.
What can be done
APRA recently announced measures designed to tighten lending standards. This should help cool the hot Sydney and Melbourne property markets in the short term, in an environment when it’s too early to for the RBA to consider raising interest rates.
More fundamentally, policies to help address poor housing affordability should focus on boosting new supply. This includes relaxing land use restrictions, releasing land faster, speeding up approval processes and encouraging greater decentralisation.
Policies designed to make better use of the existing housing stock (eg by relaxing constraints on empty nesters downsizing) could also help.
Tax reform should ideally be part of the package too, and include replacing stamp duty with land tax, removing the capital gains tax discount, and lowering income tax rates to discourage the use of negative gearing as a tax avoidance strategy.
What won't fix it
Policies that are unlikely to be successful include:
- Increased first home owner grants (periods of high demand just result in higher prices).
- Allowing first home buyers to access to their super (the consequence will be higher prices unless supply is fixed before, and less retirement income).
- Piecemeal cuts to stamp duty targeted at first home buyers. This will result in higher home prices.
- Abolishing negative gearing. This would inject another distortion in the tax system and could adversely affect supply (although I can see a case to cap excessive benefits).
While strong population growth means that underlying property demand remains strong, the threats to the hot Sydney and Melbourne property markets are building:
- More measures to slow lending to investors and to more risky borrowers have been announced.
- The banks are raising rates out of cycle particularly for investor.
- The May budget is likely to see a reduction in the capital gains tax discount.
This is all at a time when the supply of units is surging; and home prices are ridiculous. Taken together these moves are likely to result in a significant dampening impact on home price growth.
We continue to expect a significant cooling in price growth in Sydney and Melbourne this year followed by 5-10% price falls commencing sometime in 2018 after the RBA starts to hike rates.
By contrast Perth and Darwin are getting close to bottoming (as the mining investment slumps nears its low) and other capital cities are likely to see continued moderate growth.
Unit prices are most at risk given the increasing supply of units.