In this article, we look at what the future might hold for Australia’s favourite asset class: our homes
Like forecasting any asset class, the key is understanding what the drivers of changes might be, and looking backwards provides only part of the answer. The other part is understanding what has changed or is likely to change going forward. We will look at the factors that have made Australian housing one of the world’s top performing assets for the past twenty years. Then next week we will look at some of the economic factors particularly interest rates, household income and household indebtedness that impact property and of course, bonds.
What really drives Australian house price gains?
The six biggest drivers of house price changes in most economies are:
1. Population growth (net birth rate + net migration)
2. Changes in indebtedness
3. Changes in mortgage rates
4. Changes in household income
5. Taxation and social security policy
6. Supply
Over the past 20 years, the first two of these have been by far the largest drivers, although indebtedness has no doubt been fuelled by falling interest rates and strong income growth (until recently), and Australia’s unique supply challenges have added to the boom periods too. Over the next ten years, changes in indebtedness will have far less of an effect as we approach the natural limit, but urban density particularly in Sydney will have an accelerated impact.
In this first part of our series, we start with a summary of each of these factors, including a summary of the past 20 years and the current situation, and then a summary of the outlook.
In the second part of the series we will explore migration, supply and other policy issues, including the aged pension and aged care government policy, to try to get a feel for what future impacts these will have. And then in the final part, we will look at the economic drivers including indebtedness, interest rates and incomes, before wrapping up a with a (brave) conclusion on the outlook for Australian residential property over the coming decade.
Summary of the big six drivers of Australian residential property prices
| Driver | Summary | Outlook |
| Migration | Australia has one of the highest net migration rates in the world, three times higher than the US, UK and the EU. Migration has jumped from an average 60-70,000 in the 1990s to 184,000 in 2017. Migrant households now account for more than 50% of the demand for new homes, and closer to 60% in Sydney and Melbourne.
| Australia will remain a popular destination for those that can get an invite, so the only question is policy. Both major parties currently have a relatively open policy setting as Treasury and the voting public have become addicted to high migration boosting our economy and capital gains.
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| Household indebtedness | Total household debt has risen by $1.6 trillion, a rise from $40,000 per household to nearly $200,000 in 2018. Indebtedness is also “aging” – the faster growing population of borrowers is the 45-54 year old segment – jumping 45% in debt-to-asset ratios since 2002.
| There is a natural limit to how much households can afford to borrow. Few other countries have higher household debt ratios than Australia’s 123% of GDP. The US and UK ratios are 79% and 84% respectively, largely due to Australia’s tax policies which favour household over corporate indebtedness. There is no hard and fast rule about how high this ratio can go, but at third in the world, our peers are telling us that future growth in indebtedness is unlikely to be anywhere near as supportive of housing prices than it has historically.
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| Mortgage rates | Between 1998 and 2002, mortgage rates fell by 45%, sparking one of the biggest home price booms in Australia’s history. Now mortgage rates are at all-time lows, with private bank rates below 3%pa.
| With the current level of indebtedness, any increase in rates will have a considerable impact on house prices and discretionary income. Ironically this is likely to limit the RBA’s willingness to increase rates.
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| Income growth | Household income growth grew rapidly over the past 20 years (until recently), both due to increased numbers of dual income households and wage growth. The overall jump in household incomes was 112% in 20 years, an average increase of 3.8%pa, compared to just 0.2%pa in recent years
| The tailwind from increased participation has peaked and wage growth has been very weak in recent years. This is likely to continue due to the labour-displacing and price sensitive impacts of the digital economic revolution.
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| Government policies encouraging smaller household sizes or negative gearing | Aged pension exemption of owner-occupied homes since the late 1980s and the resulting impact on pension income if the home is sold means that rather than downsize to units or move in with their children or aged care, more people are holding on to property for longer.
| Aged care will be the major policy impact on housing in the coming decade. At-home aged care solutions are much more affordable than residential aged care so it is likely that more people will be encouraged to hold on to their homes longer, having care come to them. This is supportive of house prices in particular as aged care is less land-intensive than separate housing.
On the other hand, housing affordability is rapidly becoming a major political hotspot as Gen Y faces the lowest rate of home ownership in Australia’s history. Of course should a government be brave enough to tackle negative gearing, that would trump any other policy moves, but this seems politically impossible other than token tweaking at the edges.
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| Supply issues and density | Australia’s vast geography and small population create unique issues that foreign commentators constantly miss when calling Australian property overvalued. The 5-10km radii around Sydney and Melbourne have doubled their population densities in the past decade. Greater Sydney’s overall density is now double that of Greater LA, and will pass that of the New York/New Jersey area within 30 years.
| The digital economic revolution will eventually relieve urban transport pressure which in turn will reduce the pressure on inner city suburbs. But these changes are still more than ten years away. Until then, inner city areas will get higher, particularly in Sydney where there is now space for approximately 220,000 residential lots only, but demand for new dwellings is 664,000 by 2031. Clearly going up is the only answer, but the impact on land prices near train lines and the CBD will then be much higher than seen in the past.
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Next week we’ll drill down further on the economic factors above. These factors will always impact property, but as they are obviously crucial to understanding future bond returns too, next week’s article covers these economic factors beyond their impact on property alone.
Conclusion
Over the past two years we have talked about the looming risk for Australian residential property. The near term risks can be summed as:
- Slowing demand due to tougher credit conditions, much lower investor interest particularly from offshore, and fears of an overcooked market particularly in Sydney and Melbourne
- Oversupply of apartments particularly in Sydney, inner city Melbourne and Brisbane, and in Perth.
Over the longer term, say 5 to 10 years from now, conditions for capital gains on land holdings will continue to be very strong in Sydney and Melbourne, in particular where supply constraints are being severely tested by migration, negative gearing and aged pension policies. There is no getting around the fact that Australia needs immigration to maintain its GDP growth and prosperity, and so unless we can find another way to fuel growth, it will be very difficult for either side of politics to execute lower immigration policies.
How strong this trend is will depend upon local government and state government policies around zoning changes. Ironically however, the more zoning changes made to increase the supply of homes in inner city suburbs, the more the demand for land. A home on your own land has always been the great Australian dream, but it is also the strong preference of wealth migrants, so the outlook for this high demand, increasingly supply-constrained asset could be equal demand over the past 20 years, as hard as that might be to believe. When it comes to land, the old expression that they aren’t making anymore rings true.
Apartments are far less supply constrained and so they don’t offer the same long-term potential, although increases in land prices will drag apartment prices up due to the impact on the affordability of houses.
The biggest threat by far to this positive outlook in the immediate term is interest rates. There is no doubt that higher rates in Australia will place severe stress on the largest percentage of Australia’s population we’ve ever seen. The RBA is of course aware of this, but if they choose to increase rates for whatever reason anyway, or if bank funding costs go up forcing up mortgage rates regardless of the RBA, forced sellers and a severe drop in domestic demand will push all property down. More on that next week.