In light of the recent surge in Australian capital city house prices, particularly in Melbourne and Sydney, the residential housing agenda has again entered the forefront of economic and political discussions. At the heart of the issue is whether price rises are a sound reflection of economic fundamentals, or are indicative of an investor-fuelled property bubble. Admittedly, doomsday forecasts about the state of Australia’s property market are not new at all, with forecasters having predicted numerous imminent collapses which have never eventuated. To complicate things further, there is little consensus on what a ‘bubble’ or ‘economic fundamentals’ are. Circumstances seem to only appear clear when the bubble pops, which occurred spectacularly in the US property market leading to the GFC. However, there are tell-tale signs that current anxieties may be justified. Financial regulators are usually known for taking a conservative approach to forecasting future economic events. There’s no such hesitance this time around, with the ASIC chairman, Greg Medcraft, as well as the head of the Australian financial systems inquiry, David Murray, explicitly warning that further action should be done about Australia’s property bubble and the housing affordability issue.
What do the numbers say?
CoreLogic data has indicated house prices in Sydney have soared 18.4% in the past year, followed by rises in Melbourne and Canberra prices of 11.7%. This looks particularly disturbing when contrasted to the average Australian income growth of 2.2% in 2016. It’s clear that investors have contributed significantly to the price rise, with ABS data showing that new investor lending grew 27.5% over the past year. Buyer FOMO (Fear of missing out) seems to have contributed significantly to this price rise. As Greg Medcraft has noted, the danger is that many buyers have been rushing into the market for fear of missing out on a perceived property boom. Foreign capital flows are also a large contributor, with China accounting for 80% of foreign demand for Australian properties.
The fact that rent has fallen significantly across Australia’s capital cities has meant rental yields (yield = rent/house prices) have decreased in light of price increases. As such, many investors are increasingly reliant on capital gains as the source of their return, rendering them particularly susceptible to any stagnation or potential downturn in property prices.
What are Australia’s regulators doing about it?
Of the three bodies that are responsible for the macroprudential oversight of Australia’s economy, the RBA and APRA are the two best positioned to tackle the issues associated with the property market. Unfortunately, the RBA has its hands tied, with inflation and the state of the labour market too weak to justify a tightening of monetary policy. Instead, the onus lies largely with APRA, which has attempted to circumvent the limitations of monetary policy by placing pressure on bank capital reserves and setting stricter benchmarks for bank lending standards.
The politics – An issue of supply or demand?
There is ongoing debate as to whether the property market price phenomenon can be justified in terms of supply or demand, with AMP Capital suggesting that both elements are problematic. It is helpful to understand the typical supply and demand dynamics in the residential real estate market with the help of a graph. The property supply and demand curve looks quite similar from your traditional graph, with one primary modification. Because of the significant time required for residential construction projects to be constructed, including all regulatory approvals, the short-run supply of houses is relatively fixed, as depicted in the graph below (SRAS). In the long-run, supply is free to adjust to house prices, as seen by the LRAS. Of course, this is a relatively simplified example, which does not factor into consideration matters such as regulatory issues.
So what are the views of the two major political parties?
The Liberal Party has taken the position that rapidly rising property prices are primarily attributable to a lack of housing supply, suggesting the prices are due to ‘real’ factors and therefore are not economically problematic. As such, they have pledged to improve infrastructure to support housing development in key areas of Sydney and Melbourne, as well as across the other states.
In contrast, the Labor Party’s policies have been largely targeting the demand side of the equation, stating that policies such as negative gearing (where rental property losses can be used to offset a home owner’s taxable income) and the capital gains tax discount of 50% must be revised to cool investment property demand.
Some closing thoughts
Predictions about the state of Australia’s housing market should be taken with a grain of salt. Goldman Sachs had it wrong back in 2015. The Economist got it wrong in 2016. All that seems to be certain for now is that if house prices continue at their current trends, the related issues of housing affordability and the stability of the housing market will intensify concerns about the economy. It will be interesting to observe the Government’s course of action in the upcoming May Budget.
Image courtesy of: IPRG
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