Frank Gelber says an expected upswing in the residential property market may not be as long, or as strong, as first thought.
The initial post-GFC recovery in residential property has stalled. While the aggressive prognostications of doom are largely discredited, the market remains tentative. The expectations of substantial price rises, which have driven previous upswings, are largely absent. Both investors and owner-occupiers remain timid, in precautionary savings mode and unwilling to stretch financially to make long-term commitments – particularly given the (well-founded) fear of further interest rate rises.
The outlook set out in our Residential Property Prospects report is for resumption of a subdued recovery, impeded by, and finally defeated by, rising interest rates before we’ve had a chance to build enough to eliminate the deficiency of stock.
We are looking at price rises of 15 to 20 per cent in those markets, particularly Sydney, Brisbane and Perth, where the deficiency of stock is great- est over the next three years, compared with 5 to 10 per cent in markets where the deficiency is lower.
The post-GFC recovery was underpinned by lower interest rates and boosted by Government stimulus to first homebuyers, in particular for purchases of new houses. To us, that was counter-productive. The stimulus brought forward the recovery, leaving a gap afterwards. Further, the focus on new home purchases interrupted the purchase of houses from those who would normally upgrade. We are now wearing the con-sequences as the effect of the stimulus ends. Add to that the new-found caution about debt. It’s probably a healthy sign following the build-up of debt last decade, when the banks built their lending books by effectively converting traditional mortgages into lines of credit. We’ve had to learn to live with this easier credit.
The initial response by Australian households was to go on a spending binge, financing consumption expenditure through increased borrowings. But even before the GFC hit, people had started to worry about whether they were borrowing too much, and savings had started to rise.
Of course, the GFC accelerated the process, with households going into precautionary savings mode and now saving a lot more than they have for a decade. Accentuated by the capital losses triggered by the GFC, this caution has been reflected in investment decisions. In the housing market, it has impacted on both owner- occupiers and investors.
Moreover, there has been a much greater impact on high-value and holiday homes. In much of the economy, both revenue and profits, particularly for small business, remain subdued, making loans more difficult to service. And high- flying investment bankers are in a leaner patch. The result has been that sales of higher-value and discretionary property have met with little demand, with a far greater price impact on these parts of the market. In a sense, residential property is a casualty of the minerals boom. You can see how nervous the Reserve Bank is about inflation. Already, they have been quite aggressive in raising interest rates to “make room for the minerals boom”.
Cash rates are up 1.75 percentage points since the GFC and housing rates are up little more. Given the current weakness in the econo- my, the RBA has now paused. The economy hit a soft patch late last year, just as the RBA last raised interest rates. Cautious consumers, weak private investment (apart from resources), and governments cutting back stimulus were com- pounded by the impact of floods and cyclones on minerals and farm production.
But inflation is not a problem – yet. We expect the RBA to hold off while the economy remains weak with only a few rate rises over the next year. However, underpinned by minerals investment, growth will pick up over the next few years.
Meanwhile, we’re not investing enough and there’s little slack in the labour market. Two years from now, when the strengthening economy is running into capacity and labour constraints leading to demand inflationary pressure, the RBA will be extremely aggressive in raising interest rates. We expect housing interest rates to reach 9.5 per cent three years from now, just as they did in similar circumstances in the lead-up to the GFC. Add to that the impact of budgetary pres- sures on infrastructure charges, and the influences on the housing markets are all operating to constrain both prices and building.
Yet we still hear talk of housing“bubbles”. There is no way that Australia is experiencing anything like a housing bubble. We did have one – in 2002 and 2003 – when expectations of rising prices became self-fulfilling as buyers scrambled over each other in the rush to buy. But the RBA went to a lot of trouble to nip that bubble in the bud. Since then, most Australian residential markets have been weak, not strong, and underbuilding not overbuilding.
The real problem is that we are not building enough housing and there is an expanding deficiency of residential stock. When people talk about “affordability”, they’re usually concerned about the ability to buy houses. But the real problem is about the affordability of rental stock. For years, investors would accept low yields in the expectation of capital gains.
Now, with little expectation of capital growth, yields are too low to attract investment.
For as long as I can remember, there has been a separation between price formation driven by owner-occupiers and the rental market. Perhaps the current course of events will place emphasis on yields and reconcile price and rent forma- tion. Otherwise, who will own the rental stock? Someone has to. If so, we should expect further rises in rates. Indeed, that’s the way market forces are currently operating.
