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Home prices up in May for third month as supply shortfall dominates rate hikes… at least for now

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

Key points:
The Australian home price rebound accelerated in May with national average home prices up 1.2%, their strongest pace since November 2021 and their third rise in a row. They are now up 2.3% from their February low.Sydney continues to lead the charge with a 1.8% gain, taking average prices up 4.8% from their January low.A surge in demand on the back of high immigration and constrained supply are dominating the negative impact of higher interest rates (at least for now).We revised our average home price forecasts a month ago to show flat to slightly up this year ahead of a 5% gain next year.However, the risk of another down leg in prices remains high as interest rate hikes continue to impact and the economy slows – with a now very high risk of a hard landing for the economy.

Home prices rebounding

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 2.3%, with prices up for the third month in a row in May and the gains accelerating. Gains were led by Sydney, but all cities saw increases. The upswing in prices is consistent with an upswing in auction clearance rates and housing finance commitments.

Source: CoreLogic, AMP

Surging demand and weak supply offsetting rate hikes

The rebound is being driven by a worsening underlying demand/supply imbalance for homes. Immigration has surged and is likely to reach a record 400,000 this year driving the fastest population growth in 14 years at the same time that the supply of new dwellings is slowing. This in turn is accentuating 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 is strong but supply remains weak with listings remaining below normal. Talk of rising prices and shortages is in turn further boosting demand with an element of FOMO (fear of missing out). At the same time the “sticker shock” of rate hikes appears to have worn off for less interest rate constrained buyers.

Source: ABS, AMP

This all appears to be dominating the impact of higher mortgage rates (at least for now). As such, last month we up revised our national home price forecasts to flat to up slightly for this year (so far prices are up 1% this year) ahead of a 5% gain next year.

The risk of another leg down remains high

However, while the shortage of property is dominating right now 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 the increasing risk of a hard landing for the economy.
The hit to home buyer capacity to pay from higher rates remains high – we estimate the capacity to pay for a borrower with a 20% deposit and on full time average earnings is around 28% lower than it was in April last year. Historically this has had a close relationship with home prices (see the next chart) and points to an adjustment at some point which could come once less interest sensitive housing demand is exhausted.In the meantime the RBA is 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 15% of variable rate borrowers (which covers about 1 million people including families) 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 thereby pushing household size gradually back to pre-pandemic levels, easing some of the tightness in the rental market.Its also the case that the RBA has now on several occasions referred to the rebound in property prices as being a potential 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 late this year or early next.

Source: RBA, CoreLogic, AMP

Source: CoreLogic, AMP

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

Interestingly, Australia is not alone in seeing a stabilisation/rise in home prices. Something similar is being seen in the US, UK, Canada, Germany and Sweden. A number of factors appear to be at work including: the initial rate hike “sticker shock” wearing off; talk that rates may be near the top; constrained supply and a rebound in immigration (Canada’s population is rising almost 3%); still strong jobs markets; savings built up through the pandemic; earlier than normal home price falls in response to rate hikes. If it continues it will worry central banks (with a positive wealth effect possibly boosting spending) but as in Australia, there is also the risk of another leg down in home prices if rates keep rising and economies go into recession with rising unemployment.   


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