The United States housing market rose around 12 per cent in the 12 months to April 2013, according to the S&P/Case Shiller 20-City Composite Home Price Index. This, with the 15-per-cent rise in the US share market during the same period, has taken US net household wealth back to its pre-global financial crisis (GFC) highs.
With the US housing market looking more positive and domestic interest rates at an all-time low, the Australian housing market is under the spotlight.
The remarkable performance of Australia’s economy during the GFC is often attributed to the role of the mining sector in boosting national income. But perhaps more important was the resilience of the local housing market. At September 2012, almost 60 per cent of Australian household wealth was tied up in residential property, according to the Reserve Bank of Australia. This was only slightly lower than two years previously.
Although US household wealth collapsed with the 30 to 35-per-cent decline in house prices following the GFC, the comparative price stability of the Australian housing market protected this large slice of household wealth.
Factors that have helped keep prices high for residential property during the past decade include the preferential tax treatment for owner-occupied housing, the availability of negative gearing and depreciation benefits for investment properties, and the apparent housing shortage.
What goes up…
However, we can’t assume Australian house prices should always rise.
From 2007, the housing markets of the US, Ireland and Spain were battered by a perfect storm of excessive overvaluation funded by an over-leveraged household sector against a backdrop of economic recession. Australia also seems to be afflicted with two of these: overvalued house prices and excessive household leverage.
Research by The Economist has found Australia is in the top tier of countries, in which the rise in house prices has outstripped growth in rents by an average of at least 50 per cent in the past 10 to 15 years. The Economist also found Australia sits in the top tier of countries in terms of poor affordability. The ratio of household debt to household income in Australia also remains stubbornly high.
Does this imply disaster for our housing market?
Expensive housing and a heavily indebted household sector certainly make our housing market vulnerable to shocks. However, the third element generally needed for a major housing correction is an economic recession. This is why the current slowing of the mining sector and the potential negative income shock it may bring could be a risk for housing markets in parts of regional Australia.
However, with the backdrop of poor affordability and high household debt, it’s hard to see broad-based and dramatic rises in house prices occurring without a coincident acceleration in employment and wages growth.
In some segments of the housing market, prices have seemingly jumped in recent months. Historically low interest rates have undoubtedly contributed. The real concern here is what happens to the many highly indebted buyers when interest rates start to normalise.
Consider diversity
Balancing these factors, the outlook for the Australian housing market as a whole in the next few years could be, on average, extended price stagnation, with prices barely keeping pace with inflation. The upturn in house prices seen across the nation during recent months remains quite muted compared with previous cycles, reflecting an environment in which many households are increasingly concerned about uncertainty and reducing debt. This more cautious environment could last a few years.
Many Australians should carefully consider how far housing dominates their wealth. The current low interest rates make investing in residential property seem appealing, but Australian residential property isn’t likely to produce the same returns in future as it has in the last few years and is certainly not likely to produce particularly attractive rental yields. As a result, it may be worthwhile considering a more diversified wealth strategy.
Michael Karagianis is a senior investment strategist at MLC Investment Management.
