The Australian Housing Market Cycle – What’s next? (Part Two) Part One of the Australian Housing Market Cycle – What’s next?, can be found here.
A key point made in last month’s e-news was that we needed to look at individual markets when looking at cycles. During the GFC, one less well-known fact is that some US cities comfortably missed the sharp falls experienced in most markets -- there were very divergent experiences across its housing markets. And that has also be the case fairly consistently with Australian cities – in the Table below, the stories for Sydney, Melbourne and Perth are very different.
Housing and property broadly, is one of the more cyclical elements of any economy and it is useful to understand the elements which underpin its natural cyclicality.
On cycles, the RBA has referred to housing as being described by the ‘hog cycle’ in farming. The hog cycle says that:
when demand increases with supply fixed in the short-run, prices rise. The high prices lead to more investment (farmers lift their stock of hogs, cattle, etc). The impact of that investment, however, is delayed due to the breeding time (construction time with housing). When the supply does hit the market, there is ‘oversupply’ which leads to a decline in prices. In response, farmers cut their investment….
In addition, in the property market, there is a tendency for momentum to develop as price rises fuel expectations and this can lead to some over-shooting.
If we look at the current cycle in the Sydney market, we can see the ‘hog cycle’ has been at work.
Two demand factors (a rise in the population growth rate, a decline in interest rates) shifted demand for housing higher. This led to a surge in approvals/investment but there was a lag, made longer by the mix of high rise units, before this translated into completions and an increase in the growth rate of housing stock. In 2017 and 2018, we now find stock growth running ahead of population growth and the pipeline of new houses under construction means it will take some time for the rate of stock growth to slow. It should be no surprise that this is placing downward pressure on rents and prices.
What is happening to the demand factors. The population growth rate actually lifted in 2017 due to higher net overseas migration (NOM), but due to much larger lift in supply, it did not stop prices falling. In the 2018/19 Budget lower NOM and marginally lower population is projected for Australia in the next four years (from 2017’s 1.6% to 1.5%, then toward 1.4%), which will translate to marginally lower population growth in the Sydney market in 2018-21. Not a big negative in itself but with stock growth locked in at 2%, the hog cycle says prices will stay under pressure for a while longer. The recent fall in approvals will take about two years to materially slow stock growth.
The other demand factor is interest rates which have been steady for close to two years and seem set to stay steady for at least another year. The earlier interest falls were fully factored into prices by first half of 2017. Steady rates says not a factor either way BUT, actions by APRA, plus populist bank bashing at the Royal Commission etc means that banks have become more conservative. Tighter lending is similar to a rate rise. It weakens demand. Then add in the foreign investor
So, add in touch of over-shoot, and all factors point to a period of cyclical weakness in prices. Prices in nominal terms are down about 5% since mid-2017 and given prices tend to grind (up and) down over 2-3 years – i.e. no instantaneous adjustment – there is no reason why prices would not fall 10%. That would translate to a 15% fall in real terms by mid-2019 which would make it a sharper fall than recent cycles. Hardly catastrophic but enough to cool enthusiasm for property.
In the case of the Perth market, we can see an example of market hit by a much more pronounced hog cycle, leading to 15% fall in real terms 2014-18. Lower interest rates cushioned the fall. But note that Perth’s peak was in 2007, and 2018 prices are 17.5% below that level. If the 1970s slide in Perth prices is any guide, in real terms at least, Perth prices still have some way to fall.
Why not a sharper fall for Sydney given the preceding 63.5% rise? Because, part of the fall in interest rates, which explains a big part of the rise, is ‘semi-permanent’ - it is highly unlikely that the Reserve Bank will be lifting rates by 1-2% anytime soon. The economy would need to really take-off for that to happen – interest rates go up for a reason. Mind you, the fact that at some point, interest rates will edge higher makes it likely that the next upswing in the cycle will be very modest and may be some way off.
But what of pent-up demand? Will that not support prices? No. The shortfall in supply in earlier years led to higher prices, which balanced supply and demand. At 2017 prices, there was no pent-up demand. It requires lower prices for that demand to re-emerge.
Table: Housing Price Cycles Since the 1960s
|Sydney Cycles||Melbourne Cycles||Perth Cycles|
Source: Stapledon (2018)
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MacroPlan regularly conduct research assignments on housing demand and supply and employ this understanding when delivering market assessments, economic impact reports and business case recommendations. Contact Dr Nigel Stapledon (one of Australia’s leading macro-economist and housing experts) to discuss your next research requirement, 02 9221 5211 or via email.