Moderate growth in house prices expected to continue throughout 2020.
Sydney house prices are only 3.7% below their 2017 highs and Melbourne prices have now surpassed their highs. We expect that RBA interest rate cuts will provide additional demand for housing as the cost of borrowing falls and this is likely to see Sydney prices surpass their 2017 highs soon. However, the disruption to economic growth from the Coronavirus and the likelihood of an Australian recession in the first half of 2020 will put downward pressure on housing demand. We were previously expecting home prices to rise by 10% in 2020 and 5% in 2021 but we now expect home prices to rise by 5% this year. Housing price growth will moderate into the middle of the year alongside the hit to the economy from the Coronavirus but prices should rebound into the end of the year as government quarantine measures ultimately work to contain the virus.
We expect a continuation of growth in home prices, but this is likely to slow due to:
- record household debt to income ratios
- tighter bank lending standards
- more unit supply in Sydney and Melbourne
- a weak economic backdrop (including the impacts from the spread of coronavirus).
Low interest rates helping homebuyers
Lending growth is up by 21% from its bottom in mid-2019 with a larger rise for owner-occupiers than investors as lower interest rates have unlocked more demand. But growth is likely to remain well contained between 3-4% a year as households are still focusing on paying down debt.
First home buyers are coming back as a share of the market, making up 20% of total new loans (close to a record high) and the government’s First Home Loan Deposit Scheme is helping, although probably just adding to price growth.
The downturn in home prices from September 2017 to June 2019 was a major drag on the Australian economy, subtracting around 1-1.5 percentage points from consumer spending. Rising home prices will provide some offset but household spending should remain constrained due to low wages growth and the impact of the bushfires and Coronavirus outbreak.
Demand, supply, renting and buying—three graphs that explain how it all works
Let’s look at why Australian house prices have fluctuated over the past two decades.
In the mid-2000s housing supply was running well below demand as population growth took off, creating a shortage of new houses.
Source: ABS, AMP Capital
This supply shortage caused a spike in rental growth over 2006-09 and contributed to a fast increase in home prices.
Source: ABS, AMP Capital
The increase in house prices by nearly 150% between 2012 and mid-2017 in turn sparked a housing construction boom which partly offset years of underbuilding, bringing housing demand and supply closer into balance.
The boom was concentrated in New South Wales and Victoria, which makes sense as these two states account for 40% of the population. The lift in new housing construction over the past few years has closed the supply shortage in NSW but there remains a supply shortage in Victoria. Victorian housing demand is high because of strong population growth in the state (2.1% a year versus 1.5% in Australia and 1.4% in NSW).
Melbourne is experiencing higher rental growth and lower vacancy rates than Sydney, where annual rental growth is now running at its lowest pace in history.
Source: ABS, AMP Capital
Building approvals need to be running at around 18,000 a month to keep up with demand, which remains high because of migration. But approvals are now 60% below their 2018 peak and tracking at around 15,000 a month. The risk is that housing demand will start to track above new supply again, which will push vacancy rates down and put upward pressure on home prices and rents.
State and local governments have a role to play in housing planning, especially through land release. Global experience suggests rules-based planning systems (like in Germany) deliver higher housing construction compared to discretion-based systems (like in Australia), which can often be delayed or blocked by local residents.
What all this means for Australian investors…
Despite only moderate capital and rental growth in housing over the next few years, the favourable tax treatment of housing still makes it an attractive investment, especially while bond yields are so low. Residential property investment has performed well over the long term, providing similar returns to sharemarkets at 11% a year and diversification from listed markets.
While low interest rates are making it easier for Australian homeowners to maintain their mortgage repayments, affordability concerns are still an underlying issue—especially in Sydney and Melbourne—particularly when interest rates eventually start rising again.
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