The signals on the housing market are increasingly positive, says Frank Gelber
We’re still getting conflicting signals on residential property. Will it collapse? Will it boom? Are prices too high? Have we borrowed too much? Can we afford it? What are we to make of falling prices for high-value housing and holiday homes? Is the strengthening of prices at the lower end of the market sustainable, or was it just the First Home Owner Grant (FHOG)? What next? Is it safe to invest or will residential go the way of the other equity markets? To me, the answer is straightforward. BIS Shrapnel’s forecast is that this is the beginning of an upswing that will build momentum, slowly at first, into what will become a boom three and four years hence, with significant rises in housing prices along the way. There may be some initial hiccups associated with unemployment and incomes in the current downturn. But residential will lead the Australian economy out of the current economic wilderness – as it usually does. Let’s get some of the negatives out of the way first. We still hear periodically, usually on the front page of the Sunday papers, from those turkeys who think residential property values will collapse by 40 per cent: “We’ve all borrowed too much; we’ll all be ‘rooned’; and we’re going to have some variant of the Great Depression.” It won’t happen.
Certainly, prices are weak in the current turmoil. But they won’t collapse. Certainly, residential approvals fell in the beginning of this year as the world financial crisis caused a severe credit squeeze on development activity in Australia, tightening equity criteria and requiring higher pre-commitments for development. High-rise development stalled. But that will ease, with construction rising through the next financial year. Certainly, prices for high-value housing and holiday homes are falling as the current economic downturn hits the incomes, and hence the ability to service debt, of those people who stretched to buy them. Not all need to sell; but, with few buyers, those who do need to sell have to accept lower prices. Actually, for me, the anomaly was the strength of these markets post the 2003 housing market downturn, as lower-priced housing fell. Now, the shoe is on the other foot. Lower-priced housing is strengthening as high-priced and discretionary housing continues to fall. That’s driven by financial rather than property factors.
The real point is that we are not building enough residential property and there is a significant deficiency of residential stock. And it is that shortage which will drive the outcome for property markets. Unlike some overseas markets, particularly the US, where excessive boom conditions drove the oversupply which caused the current collapse, and indeed underpinned the world financial crisis, the Australian market is undersupplied. While oversupplied markets require a long period of stagnation to absorb the excess capacity created during the boom, the undersupplied Australian market is on the threshold of an upswing.
RESERVE BANK
We can thank the Reserve Bank for deliberately and aggressively nipping the “housing price bubble” in the bud in 2003. For the economy, that probably saved us from the type and severity of financial crisis being experienced overseas. For the housing market, the result was a fall, not only in housing prices, but also in construction, below underlying demand, thereby building up a significant deficiency of residential stock over the past six years. That pent-up demand, when released, will drive the strength of the recovery. There are three primary drivers of the residential cycle:
• The first is the deficiency or surplus of residential stock – most Australian markets have a significant deficiency.
• The second is affordability, in terms of “serviceability” of debt – and that has improved significantly during the past six years of weakness and as a result of the fall in interest rates.
• And the third is interest rates, which operate as a trigger, both in upswing and downturn – and the upswing trigger has now been pulled.
We think the recovery has already begun. Pent-up demand, improved affordability and low interest rates augmented by the FHOG have set the scene for the upswing. It could run out of steam for a while but will gradually strengthen over the next year, despite the economic downturn, and build momentum into what will become a boom three and four years from now.
JUST THE BEGINNING
This is just the beginning. Some say that the FHOGs are just adding to residential property prices. Well, prices need to rise. Now, buyers are absorbing the residual stock from the last boom at prices below replacement cost. Once that is absorbed, we’ll need higher prices to underwrite the next round of building. And we need to build an awful lot more than we are building now. The key to residential prices is the availability and cost of land, both for residential lots and sites for infill development. Certainly, infrastructure charges have come down, but from pretty high levels, which placed a floor under residential property prices. In fact, it was the magnitude of infrastructure charges which stuffed up – that’s a technical term – the Sydney market.
When housing prices fell in the downturn, development costs were left high and dry, well above market prices, causing a collapse in residential building to 50-year lows, much worse than in other cities. The result was the rapid build-up of the deficiency of residential stock, now more than a year’s underlying demand – that’s huge. (Incidentally, the extent of that deficiency is setting Sydney up for a much stronger boom.) Indeed, for Australia as a whole, we estimate that the deficiency of residential stock is now around 100,000 and increasing. We are building less than 150,000 dwellings per annum compared with an underlying demand of 185,000.
We need to substantially increase building to satisfy demand and reduce the pent-up demand for stock. That will place pressure on prices for residential lots, infill housing sites and general housing. The more sites made available for housing at reasonable cost and with reasonable infrastructure and accessibility, the lower the escalation of housing prices. There are things that state governments can do. But I’m not holding my breath.
RECOVERY
Meanwhile, the recovery has begun at the lower end of the market where low interest rates have allowed more households to service loans on reasonably priced housing. In that market, purchasing a house is cash positive, both for owner-occupiers and investors. Need I say more? Upgraders and home improvers are waiting in the wings, able to service greater debt if only they could sell their current houses at reasonable prices. That will come as the cycle builds from the lower-priced, value-for-money end upwards through the hierarchy.
Higher-value and holiday houses have more storms to negotiate as the economic downturn hits the profitability of the businesses that provide the income to service the loans. But once that stabilises, once the forced sales have been absorbed, this market, too, will follow the lower and mid-value markets into the recovery. This is just another cycle. Is it safe to come back into residential now? It looks pretty good to me.
