Is the housing market in a ‘bubble’ or does the recent rise in property prices reflect a shift to a ‘new normal’? Alan Kohler certainly believes it is the latter (The ‘new normal’ for house prices, July 20). But structurally the market appears poised for much weaker price growth than most Australians have become accustomed to.
Separating the cyclical from the structural is difficult in the housing market. The sharp rise throughout the 1990s and early 2000s was largely structural in nature, reflecting a combination of banking deregulation, shifts in the tax code and the rise of two-income households.
These factors led to what was effectively a level shift in dwelling price. Though the effect wasn’t immediate; instead it took around 10 to 15 years for these factors to be fully absorbed. As a result, price growth throughout this period was elevated -- running at a clearly unsustainable pace -- which hasn’t been replicated in the past decade.
More recently, the property market has been boosted by the terms-of-trade boom, which pushed household income growth into the stratosphere and supported employment growth.
Nevertheless, housing downturns have become a regular feature of the Australian property market over the past decade. They have occurred despite a mining boom and a favourable set of demographics, which begs the question: what might happen to the Australian property market when we suffer a recession?
Real dwelling prices in Sydney fell 17.5 per cent peak-to-trough between 2003 and 2009; they also fell 7 per cent peak-to-trough between 2010 and 2011. It also took a decade for Sydney prices to surpass their December 2003 peak.
This isn’t unique to Sydney though. Real dwelling prices in Perth, for example, are currently 6.4 per cent below their 2007 peak. Prices in Adelaide and Brisbane remain around 7.5 per cent and 6 per cent below their peaks, respectively.
It simply isn’t true to claim that Australian property always goes up and serious questions need to be asked of anyone who suggests otherwise. This is the frame through which we now need to assess the structural factors that will drive Australian property over the next decade.
The most readily identifiable factor is the prospect of persistently lower interest rates. The cash rate has fallen to 2 per cent and, based on the underlying dynamics, they are unlikely to rise over the next few years. The risks to the cash rate currently sit to the downside and it is likely that the Reserve Bank will cut rates again in the near future.
Persistently lower interest rates are commonly cited as the main reason to be optimistic regarding the outlook for dwelling prices. There is a distinct possibility that the cash rate never returns to 4 per cent or at least doesn’t do so over the next decade.
Nevertheless, the Reserve Bank doesn’t set the cash rate in a vacuum. Instead it reflects the underlying momentum across the broader economy and the relationship between investors and savers. There is a reason that the cash rate is at 2 per cent and it isn’t because the bank is generous of heart and soul.
The main reason that interest rates will remain at a low level is the unravelling of our terms-of-trade boom and its impact on household and national income growth. We are already in an ‘income recession’, even though we have avoided a technical recession, and this will put downward pressure on real dwelling prices and our capacity to service our residential mortgages.
So while low interest rates should support dwelling price growth it may be, in reality, a poisoned chalice. The market would undoubtedly be better off if the economic environment was sufficient to support moderately higher interest rates.
Against this backdrop we have a distinct shift in sentiment against the property market. While we once celebrated rapid house price growth, there is now greater concern regarding not just its sustainability but whether the market constitutes a systemic risk to Australia’s financial system.
This was most clearly communicated in the financial systems inquiry released last year. The Murray inquiry articulated these issues in a simple and approachable manner and they appear to have been embraced wholeheartedly by APRA.
Higher capital controls will reduce the amount of leverage with which banks can operate, which will flow through into smaller loans to households. Meanwhile, investor activity, which now accounts for over half of new mortgages, continues to come under closer scrutiny.
Finally, we cannot ignore the increasingly unfavourable demographics that underpin the Australian economy. Population growth has slowed considerably over the past 12 months, consistent with weaker economic prospects, which has coincided with a sharp rise in dwelling construction. The combination of the two should put downward pressure on prices in the near-term.
However, an ageing population may be the more significant factor in the medium term. This will fundamentally shift market power away from baby boomers towards the less wealthy and financially secure Generation X and Y’s.
Unfortunately for baby boomers, they tend to be asset rich but cash poor and typically possess inadequate superannuation to maintain their standard of living. Some will manage to live off a combination of the pension and their rental income but others will look to downsize or liquidate their property assets.
By this point though, market power will rest with a generation of Australians who for years have been shut out of the property market. They won’t have the same purchasing power and, in any case, will enjoy inferior job security and dimmer economic prospects owing to the end of Australia’s terms-of-trade boom.
Whether or not the Australian property market is in a ‘bubble’ is largely immaterial at this point; there has clearly been a period in which Australians have had the capacity to pay extraordinary amounts for ordinary property. But that doesn’t mean that this capacity or willingness will last forever.
A recession is obviously the most immediate threat to property prices but the long-term trend will be determined by weaker income growth and unfavourable demographics. Dwelling prices may continue to rise despite these factors but it is likely that dwelling price growth will be lower on average and there will be a heightened risk of more regular property downturns.