Are house prices set to boom?
By Shane Oliver
Key points- While the turmoil in shares may see some investors switching from shares to property, it is unlikely there will be a housing boom like the one that came after the 1987 sharemarket crash or the bear market in shares earlier this decade.
- Housing fundamentals are very mixed. Australia has a shortage of housing, but against this it is very overvalued, affordability is terrible, mortgage stress is at record levels and interest rates are rising.
With shares hitting a major air pocket due to problems in the US economy, it is natural to wonder whether property will boom as it did after the 1987 share crash and after the bear market in shares earlier this decade. This note looks at the outlook for residential property. A subsequent note will look at non-residential property.
What’s been happening to house prices? National average house prices rose by about 12% in 2007, with gains of about 20% in Brisbane, Adelaide and Melbourne, a modest recovery in Sydney and softness in Perth after several years of very strong gains.
nAustralian house prices This meant residential property had similar capital gains to Australian shares last year (although shares came out ahead in total returns thanks due to higher income yields).
Shares and housing
The 1987 share price crash – which saw Australian shares fall 50% top to bottom – and the bear market in shares earlier this decade – which saw global shares fall 50% between March 2000 and March 2003 – contributed to house price booms in 1987-1989 and 2001-2004 as investors switched from shares to real estate. See next chart. Australian average house prices rose nearly 50% between December 1987 and December 1989 and they rose by 60% between December 2000 & December 2003.
nThe sharemarket and house prices With global sharemarkets in turmoil and Australian shares down 20% or so from their high last November, it is natural to wonder whether history will repeat and we will see investors switching from shares to housing, resulting in another nationwide housing boom in the next few years.
A shortage of housing is a big-plus for house prices
The big positive for Australian house prices is the chronic lack of supply. Housing construction is currently running about 30,000 dwellings a year below annual underlying demand. The resulting shortage of housing is evident in very low rental vacancy rates and rising rents.
nLow vacancy rates are pushing up rents Rental property vacancy rates are far lower today, and growth in rents stronger, than was the case in 1987 and 2001.
And maybe Australians have become used to higher mortgage rates in recent times with low unemployment, solid wages growth and tax cuts providing an offset.
But other housing fundamentals are not so positive
However, while there are a number of positives for house prices there are a few negatives as well, and conditions today are certainly very different to the situation in 1987 or 2001.
First, Australian house prices haven’t corrected the overvaluation from the housing boom earlier this decade. This took them well above their long-term trend and they remain about 29% above trend. See chart below.
nAustralian house prices remain well above trend In 1987 and 2001 house prices were running below trend. Similarly, house prices remain very high relative to household income. Median house prices are running about 6.5 times median household income in Australia compared to a ratio of around 3.5 times in the US.
Reflecting all this, housing affordability is very poor today whereas in 1987 and in 2001 it was reasonable. The key drivers of affordability are house prices, interest rates and household income. The interest rate increases of the last few years, along with the recent rises in house prices relative to wages, have pushed housing affordability back down sharply. According to the Commonwealth Bank/Housing Industry Association Housing Affordability Index, housing affordability fell to a record low in the December quarter. See the chart below.
nPoor housing affordability will constrain house prices Third, despite rising rents, housing rental yields remain extremely low. Rents may be rising strongly but according to the ABS, growth in rents of 6.4% last year is still less than the 12.3% rise in average house prices.
Consequently, the average gross rental yield remains just 3.2% for capital city houses and 4.4% for units. This compares to a 5.1% grossed up (for franking credits) dividend yield on shares. With housing rental yields so low, investors are very dependent on continued capital growth to get a decent return.
In 1987 the rental yield on housing was well above the dividend yield on shares and earlier this decade they were about equal. Today the rental yield on housing is well below the dividend yield on shares. In other words, housing is now expensive relative to shares. See the next chart.
nThe yield on housing is well below the yield on shares Finally, interest rates are still rising in Australia with the Reserve Bank quite clearly threatening more hikes ahead and the banks increasing lending rates thanks to an increase in funding costs flowing from the US sub-prime mortgage crisis. This is in complete contrast to the situation in 1987 and earlier this decade when interest rates were falling (see chart two).
And the risk this year is that if house prices rise strongly it will only add to the likelihood of more interest rate increases to the extent that rising house prices are a reflection of strong demand in the economy and hence broader inflationary pressures.
Housing is arguably the Achilles heel of the Australian economy. The problem is that mortgage stress is already at record levels and is getting worse as interest rates continue to rise, which runs the risk of a rise in delinquencies and forced sales at some point starting to put more generalised downwards pressure on house prices.
Although higher interest rates have not yet caused major problems for Australian homeowners, the risk is clearly growing. Australia does not have the sub-prime problem or housing oversupply that is now nobbling the US economy, but we do have higher levels of household debt and, as noted earlier, Australian house price to wages ratios are far above US levels, suggesting that our housing is far more overvalued and hence vulnerable.
The US experience now under way, with national average house prices down 9% or so from their peak, highlights the risks and provides a reminder that housing is not always safe.
So for these reasons we think a big swing from shares to housing investment driving a housing boom similar to the 1987-–89 and 2001–03 episodes is unlikely.
Conclusion
A large and growing shortage of housing is clearly supportive of Australian house prices, and stands in complete contrast to the housing oversupply now troubling the US housing market. However, another housing boom as occurred after the bear markets in shares in 1987 and earlier this decade is most unlikely as Australian housing remains very overvalued, housing affordability is terrible, housing rental yields remain low and interest rates are rising.
The most likely outlook for Australian house prices remains for modest gains on average. However, a growing risk for the Australian housing market is that the Reserve Bank ends up going too far on interest rates, triggering broader economic problems and feeding back to increased mortgage stress, rising delinquencies and forced sales putting generalised downward pressure on house prices.
Dr Shane Oliver is the head of investment strategy and chief economist of AMP Capital Investors.
Interesting reading Trajic,
Ross Gittins poses the point that debt is not such a great problem at the moment?
Check out his article.
I bet you know that the past 15 years or so have seen unprecedented, almost unbelievable, growth in the debts of Australia's households. It's always easy to find figures on how much we owe and the media always give them much publicity. If you're looking for things to worry about, this one's a prime candidate.
But have you ever thought of yourself as having a balance sheet? Every business has one, of course, but so does every household. It shows the assets a family owns on one side and the amount it owes (its liabilities) on the other, with the difference between the two representing the household's "net worth" or net wealth.
These days it's easier to get figures for the combined balance sheets of all households. And the point of a balance sheet is that it puts your debts into context. So if you're a worrier, keep reading.
A recent paper by two economists from the Reserve Bank, Chris Ryan and Chris Thompson, tells the quite remarkable story of the way the balance sheet of Australian households has transformed since the early 1990s. It's not too strong a word.
At the heart of that transformation is the explosion in household debt. Since 1992, the disposable (that is, after-tax) income of Australian households has grown at a rate averaging 6 per cent a year. But the debt of those households has grown at a rate of 14 per cent a year.
As a result, households' total debt has gone from about 50 per cent of their annual disposable income (which was low by international standards) to about 160 per cent (which is among the highest in the world).
I think what frightens people most about that oft-quoted statistic is that it's gone over 100 per cent. But it shouldn't. The questions to ask are why we borrowed all that money – more than $1 trillion – and what we've got to show for it.
If we'd ticked it all up on our credit cards that would be something to worry about. But though we owe more on our cards than ever, the average balance per card is only $3000.
No, the big reason for the growth in debt has been borrowing for housing. Home loans account for 86 per cent of total household debt, with personal loans and credit cards accounting for the rest. And note that about a third of that housing debt has been borrowed for investment properties, not owner-occupied housing. This is high by international standards and is explained by our extraordinarily generous tax breaks for negatively geared rental properties.
This means, of course, that what we have to show for that debt is a lot of expensive – that is, valuable – houses and units.
We shouldn't be so surprised that our debt exceeds 100 per cent of our income. Think about your first home loan – or your latest. Did you borrow more than your annual income? Of course you did. Many times more. Everyone does. So what?
When you think about it, it doesn't make a lot of sense to compare housing debt with your income. If you suddenly had to pay off all your debt, you wouldn't do it out of your income, you'd sell the house. Not that it's likely to come to that.
No, what you have to pay out of your income is the interest on your debt. Total household interest costs now account for 12 per cent of income, up from an average of 7 per cent in the 1990s. Add a couple of percentage points on top for the repayment of principal.
The sensible thing to compare your debts with is your assets. That's the point of having a balance sheet. While we were doing all that borrowing – which we did mainly because interest rates were suddenly so low – we were pushing up the price and value of homes. The average house price went from more than three times average annual disposable income to more than six times.
Since the early '90s, the value of the total assets held by households has grown by about 10 per cent a year. So whereas they used to be worth the equivalent of 500 per cent of annual household disposable income, now they're equivalent to 800 per cent.
As a consequence, the household "gearing ratio" – the ratio of household debt to the value of household assets – has merely doubled to 17 per cent, which isn't especially high by international standards.
Did you get that? All that humungous debt is equal to only 17 per cent of the value of our assets.
(Note that housing accounts for only about 60 per cent of total household assets. Most of the rest is financial assets, including shares and cash in the bank, but mainly the value of people's savings through superannuation. The value of our financial assets has grown strongly over the years, partly because of the booming sharemarket.)
If you subtract our debt from our assets, you find our net worth is equivalent to more than six times annual household disposable income, up from more than four times in the early '90s.
But let's get back to all that debt. Who owes it? Well, a third of households have no debt at all, while two-thirds of households have no owner-occupier housing debt, either because they've paid off their mortgage or because they rent.
Even so, the share of households with an owner-occupier mortgage has increased from 28 per cent to 35 per cent, meaning the debt is spread over a larger base of payers.
The increase has been greatest among middle-aged households (people trading up to a better house) and the increased share of households with investment property debt is also concentrated among the middle-aged.
The bulk of property debt has been taken on by higher-income households, who have low gearing ratios, low debt-servicing requirements and hold significant financial assets.
"In short," Ryan and Thompson conclude, "the households that have done the bulk of the borrowing appear to be well placed to repay it.
"This is not to say that there aren't some indebted households in vulnerable positions, but their number is relatively low and they account for a relatively small share of outstanding debt."
Food for thought,
Ian
I suppose its all pretty simple really-prices will continue to rise as long as people can afford it. SImple as that. If people can aford to pay another $500 a month in repayments they will, when it gets to a point through inflation, interest rates etc that they cant afford any more it will flatten out. And when itgets past that point they will sell. SO all we really need to decide is how much more debt can the general population sustain?
The Gittens article definitely gives credence to those commentators who are suggesting to purchase property in areas of middle to higher affluence. I think Bernard Salt suggested this in an API magazine article a couple of months ago. I guess that is what is contributing to the current 2 tiered market in places like Sydney.
Dr Shane Oliver is the head of investment strategy and chief economist of AMP Capital Investors.
Funny this is the guy who was at the helm of AMP when it fell from $28.00 a share to $5.00 say no more!!
blogs wrote:I suppose its all pretty simple really-prices will continue to rise as long as people can afford it. SImple as that. If people can aford to pay another $500 a month in repayments they will, when it gets to a point through inflation, interest rates etc that they cant afford any more it will flatten out. And when itgets past that point they will sell. SO all we really need to decide is how much more debt can the general population sustain?More to the point prices will continue to rise if people can get the credit to buy them at increased prices and afford the repayments.
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