Is housing about to boom?

Is the housing market back on the rise, or have recent gains been a short-term bounce? Increases over the past few months indicate a rekindling of interest among buyers. Early this month (click here) Eureka Report publisher Alan Kohler tipped the national market was about to lift, led by Sydney. Today we present opposing views from leading economists on where the market is heading.

Stephen Koukoulas
Chief strategist, Asia Pacific, TD Securities.

House price growth accelerates – fastest since 2003
Another brick in the wall for a further interest rate rise

Established house prices rose 3.1% in the June quarter following an increase of 1.1% in the March quarter to be 6.4% above the level of a year earlier. The quarterly rise was the fastest since December 2003, while annual growth is at a two-year high.

House prices in the eight cities surveyed rose, with Perth leading the way with a rise of 11.9%. Sydney lagged with a rise of 1.4% in the quarter. In annual terms, the contrast was more extreme with Perth prices up 35.4%, while Sydney prices were still down 0.5%. Anecdotes from earlier this year of some acceleration in house prices have been confirmed with the official house price data showing a strong gain in the June quarter. Following the increases in the prior two quarters, it is now pretty clear that the housing cycle is in the early stages of an upswing '” the debate should be centered on how strong that growth momentum will be.

If it is strong, which seems more likely than not, the consequences for overall economic growth and inflation are clear. As a driver of wealth, rising house prices are dominant. Rising house prices also present opportunities for equity draw-down, which supports spending and in turn, adds to inflation risks. If house price gains remain high (say 5–10%), consumer confidence and demand will be supported.

The house price data can only confirm a strong bias from the Reserve Bank to lift interest rates before the end of the year. With inflation too high and the labour market experiencing extreme skills shortages, the inflation outlook is precariously balanced. Any slight upside surprise on growth will see underlying inflation accelerate above 3%.

The Reserve will need to head this off with a further interest rate rise. Exactly when it delivers the hike remains open to discussion, but each board meeting between now and year end is alive to the possibility.

Shane Oliver
Chief economist, AMP Capital

Recent bounce unlikely to be sustained

The 6.4% bounce in national prices masks a mixed bag ranging from booming conditions in Perth, on the back of the resources boom, to subdued conditions in Sydney, in the aftermath of the bubble that ended a few years ago.

Even within cities there are divergent trends. For example, the ritzy areas in Sydney remain surprisingly strong as high income earners have continued to do well whereas the western and south-western suburbs have seen some big price falls, probably reflecting a greater vulnerability to higher mortgage rates and petrol prices.

Earlier this year there was a degree of hope that the national property market was on the mend. Housing finance was trending up, sales and auction clearance results were improving and there was hope that a tightening rental market would improve the investment property market. Our view was that whilst there may be a bounce, a sustained recovery was still some time off. This remains our view. There is no doubt that the rental property market is tightening. Vacancy rates are very low, in contrast to the period after the late 1980s housing boom when high and rising vacancy rates only added to the property market’s woes. Low vacancy rates are now feeding into rising rentals and this will eventually lead to an improvement in the investment property market. However, we think the process is likely to be long and drawn out.

House prices are expected to bounce up and down around a flat trend over several years as the excesses of the last bubble are worked off. There are several reasons for this:

First, Australian housing remains very overvalued. Prices remain extremely high relative to average weekly wage earnings. They need to fall about 20% for the ratio of house prices to wages to return to more normal levels. National average house prices remain well above their long-term trend. Since the 1920s Australian house prices have risen on average by 3% pa after inflation. House prices need to fall about 28% to bring the ratio of house prices to rents (the P/E ratio for housing) back to its long-term average (after adjusting for inflation).

Second, housing affordability remains too poor to support a strong and sustained rebound in house prices. The key drivers of affordability are house prices, interest rates and household income and these have been combined in the chart below into a housing affordability index (where a fall indicates deterioration in affordability). The recent rises in interest rates, combined with still high house prices relative to wages, have knocked housing affordability back to its late 2003 lows. The housing boom of the 1990s occurred after several years of strongly improving affordability as incomes rose and mortgage rates fell. So far we are yet to see this.

Source: REIA, Thomson Financial, AMP Capital
Investors. Housing affordability index is household disposable income
divided by (average house prices times the level of mortgage rates)
indexed to Mar 1980=100.

Third, despite rising rents, housing rental yields remain extremely low making them unattractive to investors. The average gross rental yield is just 3.2% for houses and 4.3% for units. This compares to a 5.2% grossed up (for franking credits) dividend yield on shares and a 6.25% or so yield available on non-residential property. Even if low vacancy rates were to result in a 10% rise in average rents this would only push up the average housing rental yield to 3.5% (assuming flat house prices), which is still low. As a result of the low yield it is hard to see investors rushing back into housing in a big way.

Finally, the Reserve Bank remains keen to avoid a surge in housing credit on a scale that would be necessary to get another housing boom under way. It has already lifted interest rates twice this year, citing growth in household debt on both occasions and is threatening to move again. Australia’s high household debt levels mean it is very easy for the RBA to snuff out any housing recovery with higher interest rates. The fall back in auction clearance rates over the last few weeks suggests this is exactly what has happened.