Australian housing, cooling not crashing: HSBC's Paul Bloxham
Australia’s housing boom is coming to its end, with national housing price growth set to run at low single-digit rates in 2018.
Housing construction has peaked and is set to be a drag on GDP growth in H2 2018 and 2019.
Continued strong population growth and low interest rates are expected to prevent a sharp decline in housing prices.
Expect a soft landing, unless there’s a global shock
After five years of strong house price gains in Sydney and Melbourne, the market is cooling. In both cities, housing price growth has run at low double-digit annual rates over the past five years. However, over the past six months, Sydney house prices have fallen 1% and Melbourne price growth has slowed to a 7% annual rate. The rest of the country has had low single-digit house price growth over the whole period.
The slowdown in Sydney and Melbourne has been driven by a number of factors. First, housing supply has ramped up, as an apartment building boom has delivered new dwellings to market. Second, prudential settings have been tightened, which has also included an increase in lending rates for investors. Third, foreign demand has pulled back, reflecting restrictions on Chinese capital outflows, constraints on lending to foreign buyers by domestic banks and increased local taxes on foreign buyers.
We expect these factors to continue to weigh on housing price growth in the coming quarters and retain our forecast that national housing price growth will slow from the double-digit rates of recent years to 3-6% in 2018. We expect housing construction to remain at a high level over the next 6-9 months – given a large pipeline of apartment construction that is already underway – and expect it to be a modest drag on GDP growth from H2 2018 and in 2019.
However, we do not expect a sharp decline in housing prices and expect only a modest decline in construction activity, as both are likely to be supported by strong population growth and low interest rates. Although we see the RBA beginning to lift its policy rate in 2018, we expect only a slow pace of cash rate tightening and some relaxation of current tight prudential settings as the housing market cools.
A hard landing is possible, but we believe this would require a negative shock from abroad and a sharp rise in unemployment rate. In short, we do not see a significant local housing imbalance and view Australia as having had a housing boom rather than having a housing bubble (Downunder Digest: More boom than bubble, 6 July 2017). The ramp up in Sydney and Melbourne house prices has reset the relativities amongst the capital cities, for example, with Sydney back to twice Perth prices.
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Housing price growth has slowed in Sydney and Melbourne
Australia has many housing markets and there has been considerable divergence across these markets in recent years. Sydney and Melbourne have had housing price booms, while conditions in the other cities have been quite subdued (Chart 1). Since mid-2012, Sydney prices are up 71% and Melbourne’s are 58% higher (Chart 2 and 3). By comparison, Brisbane and Adelaide have had price gains of only 20% and 17%, respectively, and Perth prices have been flat (Charts 4, 5 and 6).
Even within individual cities there has been considerable divergence across detached houses and units (apartments and townhouses) markets, largely reflecting differing supply dynamics. Across the country there has been a large ramp up in unit construction in recent years, which has weighed on apartment prices in the cities where that boost has been strongest. In Melbourne and Brisbane, where the addition to the stock of apartments has been largest relative to the existing stock, unit price growth has been weak relative to detached dwellings.
However, the housing booms in Sydney and Melbourne are now cooling, with Sydney leading the way. Over the past six months, Sydney house prices have declined 1% and Melbourne price growth has slowed to a 7% annual rate. In addition to increased apartment supply, tighter prudential settings and reduced foreign demand have also weighed on housing price growth. These effects appear to have had a larger impact on Sydney and Melbourne than elsewhere.
Australia has many housing markets and there has been considerable divergence across these markets in recent years. Sydney and Melbourne have had housing price booms, while conditions in the other cities have been quite subdued (Chart 1). Since mid-2012, Sydney prices are up 71% and Melbourne’s are 58% higher (Chart 2 and 3). By comparison, Brisbane and Adelaide have had price gains of only 20% and 17%, respectively, and Perth prices have been flat (Charts 4, 5 and 6).
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Even within individual cities there has been considerable divergence across detached houses and units (apartments and townhouses) markets, largely reflecting differing supply dynamics. Across the country there has been a large ramp up in unit construction in recent years, which has weighed on apartment prices in the cities where that boost has been strongest. In Melbourne and Brisbane, where the addition to the stock of apartments has been largest relative to the existing stock, unit price growth has been weak relative to detached dwellings.
However, the housing booms in Sydney and Melbourne are now cooling, with Sydney leading the way. Over the past six months, Sydney house prices have declined 1% and Melbourne price growth has slowed to a 7% annual rate. In addition to increased apartment supply, tighter prudential settings and reduced foreign demand have also weighed on housing price growth. These effects appear to have had a larger impact on Sydney and Melbourne than elsewhere.
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As prudential tightening has been heavily targeted to property investors, the markets where these types of buyers had been the dominant participants have seen the biggest effects. In particular, the prudential focus on investors has put more downward pressure on housing prices in Sydney and Melbourne and on apartments, which tend to attract investors.
The pullback in foreign demand is also likely to have affected some markets more than others (Chart 7). Again, Sydney and Melbourne, as well as the apartment markets in general, are likely to have seen the biggest effects of weaker foreign demand. Tighter restrictions on Chinese capital outflows, constraints on lending to foreign buyers by domestic banks and increased local taxes on foreign buyers have contributed to a pullback in foreign demand for housing.
Across the country, the standout market remains the detached dwelling market in Melbourne, where strong population growth, only slow growth in supply and better affordability than Sydney have all contributed to support house price growth which is still running at double-digit rates.
More boom than bubble
As described above, many of the recent trends in Australia’s housing markets can be explained by fundamental factors. In regions where demand has been strong and supply has been insufficient, housing prices have risen significantly. In contrast, in areas where demand has been weak or supply has been strong enough, housing price growth has been weak. As a result, we remain of the view that the recent episode is more ‘boom’ than ‘bubble’
(see Downunder Digest: Australian housing: More boom than bubble, 6 July 2017).
To argue that Australia has a housing bubble, there needs to be evidence of significant misalignment from fundamentals. This could involve a misallocation of lending, which was the key cause of the sub-prime crisis in the US, or an oversupply of housing, which was a key factor that exacerbated the impact of the financial crisis in the US (and was a big factor in Spain).
On our reading, neither of these factors appear to be a significant concern in Australia.
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No national oversupply yet, although the supply/demand gap is closing
First up, the overall housing market does not appear to be oversupplied. Although housing completions have run ahead of population growth in the past couple of years, this followed an 8-year stretch when population growth exceeded housing supply (on average), which drove an accumulated undersupply (Chart 8). Our national estimates, which account for previous supply shortfalls, suggest the housing market is close to balance at the national level, but there is not yet a significant oversupply (Chart 9).
Of course, these estimates are highly dependent on the assumptions made in their calculation, such as the number of unoccupied dwellings, the household formation rate, and the rate of demolitions. As a result, there is considerable debate about the extent of housing undersupply, but we find it hard to substantiate claims of a national oversupply of dwellings based on the aggregate numbers. Even prominent studies that conclude that there is an oversupply note that the market is close to balance if unoccupied dwellings are properly accounted for.1 In particular, it is hard to see significant oversupply in Sydney and Melbourne housing markets, given strong population growth relative to dwelling completions in Victoria, and the accumulated undersupply in New South Wales (Chart 10).
However, there are some regions with housing oversupply. Estimates for both Western Australia and Queensland show that dwelling construction has run well ahead of population growth in recent years (Chart 11).
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A particular area of oversupply is the Brisbane apartment market, where there has been a substantial boost to supply relative to the existing stock of apartments. In this case, there has already been a fall in prices and we expect to see further Brisbane apartment price declines in 2018. However, at this stage, although there is evidence of settlement times on purchases having risen, there have been few reports of loan defaults in the Brisbane apartment market. Likewise, weak demand and strong supply in the Perth market have seen housing prices fall in recent years.
Another area of concern had been the Melbourne apartment market, where there has been a significant boost to supply. However, the recent step up in population growth in Melbourne appears to have helped absorb this supply. As a result, although apartment price growth in Melbourne has slowed, prices continue to rise.
Given the ramp up in housing construction and the closing gap between demand and supply, new building approvals have fallen back from their 2016 peak levels (Chart 12). As a result, dwelling investment has levelled out in recent quarters, albeit at a high level of around 5.75% of GDP. We expect housing construction to remain at a high level over the next 6-9 months, given the large pipeline of apartment construction that is already underway, and then expect it to be a modest drag on GDP growth from H2 2018 and in 2019. The housing construction outlook should continue to be supported by the detached housing market where there has been less of a ramp up in building in recent years but continued solid demand.
Tightened prudential settings have reduced the risk of misallocated debt
Another concern would be if the households that have taken on housing debt in recent years become unable to service that debt at some point. As we have noted previously, in our view, it is not the aggregate level of debt that matters most, but who holds it (see Downunder Digest: How worrisome is Australia’s high household debt?, 16 May 2017).
A particular concern has been that the pick-up in housing prices has been fuelled by a rise in housing credit growth and that much of this has been borrowing by investors. Over the past five years, housing credit has increased by 35%, led by 39% growth in lending to investors and 34% growth in lending to owner-occupiers. As a result of these concerns, the authorities have progressively tightened up prudential settings over recent years, with a particular focus on investors and borrowers that were taking interest-only loans. These tightened settings have helped to reduce the proportion of loans issued at high loan-to-valuation ratios and on an interest-only basis, particularly to investors (Chart 14).
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In its most recent financial stability review, the RBA deemed that, given the tightened lending standards, the key risk from rising household debt is to the macroeconomic cycle rather than financial stability. The central banks’ own granular assessment is that any build-up of risks that could see rising mortgage defaults in a downturn is not large enough to be a financial-system-wide risk.
Housing price relativities have been reset
The housing price booms in Sydney and Melbourne over recent years have also seen the relativities across Australia’s housing markets reset, following the large impact that the mining cycle has had on various markets.
In particular, the mining boom drove strong growth in housing prices in Perth and Brisbane, while growth in Sydney and Melbourne was more modest. Between 2003 and 2007, Perth housing prices went from less than half the value of Sydney prices to almost be on par with Sydney and rose from around three-quarters of Melbourne prices to well over Melbourne prices (Chart 15). Brisbane saw similar trends over the same period (Chart 16).
However, over the past five years, these relativities have been reset. The recent gains in Sydney and Melbourne housing prices, and the weaker performance in Perth and Brisbane, have seen these ratios return to approximately the pre-mining boom levels. Sydney house prices are now back to around twice the value of Perth house prices, which is around the ratio that prevailed through the 1990s and early 2000s (before the mining boom). Likewise, the ratios between Brisbane and Sydney house prices are back to around pre-mining boom levels.
Single-digit housing price growth is expected in 2018
Our forecasts for national housing price growth in 2018 are unchanged since July, with growth still expected to slow from 9% in 2017 to 3-6% in 2018 (Downunder Digest: More boom than bubble, 6 July 2017). However, we have revised down our forecasts for Sydney and revised up our 2018 estimates for Melbourne, given recent trends and changes in the population growth estimates. We expect housing price growth of 2-4% in Sydney and 7-9% in Melbourne in 2018. For the other cities, our 2018 housing prices forecasts are largely unchanged, with low single- digit rates of housing price growth expected to continue.
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What the cooling could mean for consumption
As the housing boom comes to its end, it is possible that this could weigh on household consumption growth. Two key channels would be at work. First, there could be a negative wealth effect. Second, a fall in housing construction could weigh on demand for household goods, such as furniture and white goods.
However, in our view, both these effects are likely to be quite weak. We see little evidence of a positive wealth effect in recent years, so we doubt that there will be a large negative wealth effect from the housing market cooling. The various household cash flow measures show that consumers have been injecting equity into their homes, rather than borrowing to consume as they did in the early 2000s credit boom. This suggests that rising household debt has not driven a lift in consumption. In addition, although the national household savings rate has fallen in recent years, savings have only fallen significantly in Western Australia and Queensland where the mining cycle was largest. This appears to reflect income smoothing. Savings have not fallen in New South Wales and Victoria, which are the states that had the largest house price gains (for more on this topic see Downunder Digest: Australia’s shifting consumer, 27 June 2017).
At the same time, although a slowdown in housing construction is likely to weigh on household goods purchases, this effect is already running its course. The retail survey shows that household goods sales have been broadly flat over the year to the past three months, down from annual growth rates of 10% in 2015. Although high and rising levels of household debt remain a risk to the consumer outlook, our central case of a housing market soft landing is unlikely to deliver a significant weakening in household spending (Chart 19).
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A pick-up in household income is needed
To get a soft landing in the housing market, the economy will need to continue to grow and, in particular, there will need to be a pick-up in household income growth, which has been sluggish recently. On the overall economy, we are forecasting GDP growth to pick-up from 2.4% in 2017 to 3.2% in 2018. We expect mining investment to stabilise, after five years of decline, and expect a further pick-up in non-mining investment, supported by a large pipeline of urban infrastructure investment as well as a recent significant improvement in local surveyed business conditions. Growth is also expected to be supported by continued inward migration which is underpinning strong population growth.
Better business conditions are supporting strong jobs growth which, in turn, is set to support a pick-up in household incomes. We expect the tightening labour market to also drive a pick-up in wages growth, which should also help lift household income growth (see Downunder Digest: An Australian Phillips curve, 14 November 2017). A risk to the outlook is that this pick-up in wages growth takes longer to arrive than we are currently factoring in. The lift in household income growth that is expected over the next couple of years should support growth in consumption. It should also see a broad levelling out in the household debt to income ratio.
Paul Bloxham is the chief economist for Australia and New Zealand for HSBC.
