Property prices continue to be driven by speculation in Sydney and to a lesser extent Melbourne. Housing multiples are near their peak and, with the unemployment rate rising and wage growth subdued, investors and home buyers should be asking themselves the tough question: does the property upswing have much longer to run?
According to the ABS, nominal house prices rose by 1.8 per cent in the June quarter, easing somewhat since late last year, to be 10.1 per cent higher over the year. Low interest rates continue to support activity in the housing market -- encouraging owner-occupiers and investors to bring forward their purchases -- but lending activity is set to peak over the next few months.
Housing multiples -- which are a reasonable proxy measure for affordability -- show that housing is expensive by historical standards. The house price-to-income ratio is approaching its highest level in history -- a level that in previous episodes has resulted in prices falling.
With the unemployment rate rising to its highest level in 12 years and wage growth subdued, it seems unlikely that the housing market can maintain its momentum for much longer. Furthermore, it remains somewhat surprising -- even with historically low rates -- that households are willing to tolerate housing multiples that were occurring during the midst of a once-in-a-lifetime terms-of-trade boom.
Residential construction is starting to pick-up, which should moderate prices a little, and the economy will continue to ease before it turns the corner. The terms of trade is set to soften further, which will weigh on household budgets and income growth. Based on the outlook for the broader economy, a softening of house prices shouldn’t catch too many people by surprise.
The past decade shows that housing downturns are now a fairly frequent event. We have had three downturns in the past decade, which compares unfavourably with the property-owning experience during the 1990s and early 2000s.
A high level of existing indebtedness makes it more difficult for the market to consistently post growth year after year. A structural shift towards softer income growth -- as a result of a lower terms of trade and ageing population -- will also have a similar effect, resulting in a less appealing property sector for investors.
At the capital city level, the most recent property upswing remains a Sydney-centric affair, with Melbourne playing a key supporting role. Nominal property prices in Sydney are up by 15.6 per cent over the year and in Melbourne prices have surged by 9.3 per cent. Nevertheless, quarterly growth in Melbourne has eased significantly over the past six months.
Prices in Brisbane and Adelaide rose more moderately, while the Perth market has been quite weak, with annual growth of just 3.6 per cent. Of those three markets, Brisbane seems the most likely to break out given its proximity on the east coast and its popularity among tourists.
The graph below, which adjusts capital city house prices for inflation, highlights the differing fortunes for each capital city. Perth prices have been sluggish since the beginning of the global financial crisis -- though that largely reflects the rapid growth over the first half of the last decade.
Sydney prices have surged but have only recently passed their 2003 peak -- which like this episode was driven by rampant investor speculation. The Melbourne market has increased strongly but remains below its peak in 2010.
Unlike the 2010 episode, the housing market is no longer supported by the first home owner boost and the grant itself is now used for new rather than existing properties. First home buyers remain priced out of the market and with youth unemployment at around 14 per cent -- its highest level since 1998 -- they are poorly placed to take on excessive leverage.
Australian house prices posted solid gains in the June quarter on the back of strong speculation in Sydney and to a lesser extent Melbourne. The composition of the market -- more specifically elevated investor demand -- increases the risk to house prices when lending eases. Speculators are particularly sensitive to falling prices, since rental yields on Australian properties are so low.
Based on the outlook for the broader economy, property investors must ask themselves the following question: does it make sense to invest in Australian property if the market is rapidly approaching its peak?
Furthermore, with the economy shifting towards softer income growth -- resulting from a lower terms of trade and an ageing population -- will longer-term capital gains be sufficient to offset such meagre rental yields?