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Australian home prices up in June for the fourth month in a row – but how sustainable is it?

Dr Shane Oliver, Head of Investment Strategy & Chief Economist at AMP, discusses home prices.

Key points:The Australian home price rebound continued in June with CoreLogic data showing national average home prices up 1.1%, their fourth rise in a row. They are now up 3.4% from their February low.Sydney continues to lead the charge with a 1.7% gain, taking average prices up 6.7% from their January low.A surge in underlying demand on the back of high immigration and constrained supply have been dominating the negative impact of higher interest rates in the last few months.Our base case is that property prices have seen the low for this cycle and will rise around 5% next year as interest rates start to fall.However, our confidence in this forecast is low as the risk of another down leg in prices is very high as interest rate hikes continue to impact and the economy slows – with a now 50% risk of a recession at some time in the next year.

Home price bounce

CoreLogic national average home price data shows that after falling 9.1% from their high in April last year to their low in February, average home prices have now rebounded by 3.4%, with prices up another 1.1% in June, albeit the gains slowed slightly from May. The rise was led by Sydney, but all cities except Hobart saw increases. The upswing in prices is consistent with an upswing in auction clearance rates from their lows last year.

Source: CoreLogic, AMP

Surging demand and weak supply offsetting rate hikes

The rebound since early this year reflects a worsening underlying demand/supply imbalance for homes and a degree of FOMO (or fear of missing out) on the back of it. Immigration has surged and is likely to exceed a record 400,000 this year driving the fastest population growth in 15 years at the same time that the supply of new dwellings is slowing with falling building approvals. This in turn has accentuated very tight rental markets, forcing rents up and driving renters to consider buying earlier than they otherwise would have. At the same time foreign demand is returning. So buyer demand has been strong but supply remains weak with listings remaining below normal. Talk of rising prices and shortages has in turn further boosted demand with an element of FOMO (fear of missing out) attracting buyers into the market who until earlier this year were still waiting for lower prices before coming back in. At the same time the “sticker shock” of rate hikes appears may have worn off for less interest rate constrained buyers, although this will likely prove to be temporary as rates keep rising.

Source: ABS, AMP

This underlying demand/supply imbalance has been dominating the impact of higher mortgage rates over the last few months. Reflecting this a few months ago we revised up our national home price forecasts to flat to up slightly for this year (so far prices are up 2.2 this year) ahead of a 5% gain next year.

There is a high risk of another leg down in property prices

However, this is not a forecast we feel particularly confident in as while the shortage of property has been dominating over the last few months the risk of another leg down in prices remains high as mortgage rates are still rising and unemployment is likely to rise significantly over the next year, with a 50% risk of a recession in the next 12 months. Still rising mortgage rates risks hitting home buyer demand again at the same time that a collapse in economic growth and higher unemployment boosts distressed selling and helps alleviate the underlying demand/supply imbalance.
The hit to home buyer “capacity to pay” from higher rates is rising – we now estimate that the capacity to pay for a home for a borrower with a 20% deposit on full time average earnings is around 29% lower than it was in April last year. The long term down trend in mortgage rates since 1990 has been a major factor allowing ever higher home prices over the last three decades, particularly relative to income levels, as lower rates boosted home buyers’ capacity to pay for homes for given income levels (see the next chart). The now rapid reversal in the capacity to pay due to the rapid rise in mortgage rates threatens a downwards adjustment in home prices at some point unless incomes rise dramatically or mortgage rates fall dramatically – both of which look unlikely for now. This adjustment in prices could come once less interest sensitive housing demand is exhausted.In the meantime the RBA is still threatening to raise rates further particularly as wages growth risks accelerating, fixed rate mortgages are now resetting to much higher interest rates and on the RBA’s estimates more than 15% of variable rate borrowers (which covers about 1 million people) will have negative cash flow by year end all of which combined with higher unemployment could lead to an increase in listings by distressed sellers.Rising rents could reduce the tightness in the rental market by encouraging more young people to move into share accommodation or staying at home longer with their parents thereby pushing household size back up to pre-pandemic levels, easing some of the tightness in the rental market. There are some signs that this is starting to occur, with vacancy rates starting to edge up in some cities and CoreLogic reporting that the upwards momentum in asking rents has slowed.Similarly, were the economy to slide into recession its likely that the Government would cut the immigration intake, further reducing the underlying demand/supply imbalance.The RBA has now on several occasions referred to the rebound in property prices as being a concern. In other words, the rebound in home prices could itself spur the RBA to raise interest rates more than it otherwise would have done because rising home prices could drive a positive wealth effect offsetting its efforts to try and slow consumer spending down.In past cycles lower interest rates have been required to drive a sustained rise in home prices (see the second chart below) and this is unlikely until early next. So the rebound lately looks premature relative to the normal cyclical relationship with interest rates.

Source: RBA, CoreLogic, AMP

Source: CoreLogic, AMP

So, while our base case is that home prices have bottomed, the risk of another leg down as the full lagged impact of interest rate hikes on the property market and on unemployment materialises is very high. A recession (which is now a 50/50 risk and still rising risk as rates keep rising) would add to the risk of another down leg in property prices.

Interestingly auction clearance rates which led the property rebound on the way up are now showing signs of faltering again despite still low listings with Domain data showing a slowing in Melbourne’s clearance rate in the last few weeks and a sharp fall in Sydney’s clearance rate. This could just be noise but it may also be consistent with ongoing mortgage rate hikes starting to get the upper hand again and constrain demand. Consistent with this sentiment towards the property market, eg in terms of whether now is a good time to buy a property, remains very weak.

Source: Domain, Core Logic, AMP   


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