6 reasons to expect a gradual slowing in the pace of capital city dwelling gains: Shane Oliver

EXPERT INSIGHT

Australian capital city average dwelling prices rose 1.8% in April according to CoreLogic and are up 6.4% on a year ago.

This is their seventh monthly gain in a row.

While down from the break neck pace of 2.8% seen in April, price growth is still strong and average capital city prices are now 5.4% above their September 2017 record high.

All capital cities saw prices rise solidly in April with Darwin the strongest at +2.7%, followed by Sydney at +2.4% and Adelaide at +2%. See the table below.

All capital city prices are at record levels except for Perth and Darwin which are recovering from 22% and 33% falls respectively between 2014 and 2020, which was in the aftermath of the mining investment boom.

Regional dwelling prices rose 1.9% in April and are up 13% on a year ago with their relative strength over the last year reflecting lower levels of indebtedness and hence less vulnerability to the financial stresses caused by the pandemic driven economic downturn, less exposure to the slump in immigration and increased buyer interest as people seek to relocate from cities as part of a secular trend towards working from home and a greater focus on lifestyle.

Capital city house prices rose 2% in April and 8% over the last 12 months whereas unit prices lagged with a 1.2% gain in the month and a 1.8% rise on a year ago, with the relative underperformance reflecting a shift in preferences towards houses as a result of more working from home and a lifestyle choice and as weak rental conditions made worse by the slump in immigration constrained the inner city unit markets in Sydney and Melbourne. However, the Sydney and 

Melbourne unit rental markets have shown signs of stabilisation and improvement in recent months and this appears to be helping unit prices, although they are still lagging.

The slowdown in price growth compared to March was inevitable given that the 2.8% average gain that month was the strongest since October 1988 and was always going to be hard to beat. Moreover, the moderation is also consistent with some pick up in new listings which has seen auction clearances slow a bit from March, some easing in the impact of government incentives and perhaps some of the initial boost from four year fixed mortgage rates below 2% having run its course.

However, average home gains of 1.8% a month are still very strong, housing finance commitments remain around record highs suggesting more demand to come and auction clearance rates in Sydney and Melbourne remain very high and at levels consistent with strong home price growth. While first home buyers led the initial recovery, spurred on by various incentives, housing finance data suggests that first home buyer demand may now have peaked but that investors are now jumping in to take over from first home buyers and that demand from owner occupiers generally remains very strong.

The fundamentals of still ultra-low mortgage rates, ongoing government incentives, economic recovery, the strong jobs market and an element of FOMO (buying now for fear of missing out) point to further home price increases ahead. We expect average home prices to rise another 10 to 15% out to the end of 2022, but this to mask a slowing from 15% this year(of which they have already done 7.5%) to 5% next year. 2023 could start to see another cyclical downturn in property prices as the interest rate cycle starts to move up more decisively.

There are six reasons to expect a gradual slowing in the pace of capital city dwelling gains going forwards:

First, government housing incentives are likely to be wound back a bit. The First Home Loan Deposit scheme is likely to see home price thresholds increased in the Budget, but HomeBuilder has now ended and some states may start to wind back various incentives.

Second, poor affordability is starting to become an increasing constraint again and is likely already starting to weigh on first home buyer demand going by housing finance data.

Third, the RBA and APRA are expected to reach yet again for macro prudential controls to slow housing lending sometime in the next six months. While they don’t target house prices and are of the view that we have not yet seen a significant deterioration in lending standards, past experience indicates that surging house prices leads to a deterioration in lending standards and increasing financial stability risks. And the metrics APRA and the RBA look at are starting to push up in the direction of a deterioration in lending standards with record housing finance, an acceleration in housing debt (see the next chart), an increasing share of lending at high loan to valuation ratios and a rising share of interest only loans albeit from a low base. The first thing to do would be to increase interest rate buffers but limits on high loan to valuation ratio lending and high debt to income ratio lending may make sense too.

Fourth, it’s likely that the 30 year tailwind for the property market of falling interest rates has now run its course. While variable rate hikes are probably two years away at least, four year plus fixed mortgage rates have started to move up with the rise in bond yields and shorter dated fixed mortgage rates may also start to move up over the next year. Longer term the RBA is more determined than ever to see inflation sustained in its target range which will ultimately put an end to the long term downtrend in interest rates and mean higher variable rates.

Fifth, the hit to immigration and a likely only gradual recovery in it once international borders are reopened combined with continued strong home building is likely to lead to an oversupply of property in the next few years.

Finally, the “escape from the city” phenomenon unleased by the pandemic and made possible by technology enabling more working from home compared to prior to the pandemic is likely to take some further pressure off capital city property prices – albeit this will drive a further catch up in regional prices.