House prices are rising — why? And what will happen now?
At 6%, Australian house prices didn’t dip nearly as far as those in the USA and UK (32% and 19%, respectively) and already prices are rising again. So what happens now? And how does housing compare with other investments?
Despite fears of the big declines we’ve seen in the USA and UK, Australian house prices did not plunge dramatically - indeed the average drop remained well in single figures.
Yet, after “only” falling 6% from their early 2008 peak to the March quarter (a big enough drop for those trying to sell), house prices have begun to recovering, with Australian Bureau of Statistics’ data showing average gains of 4.2% in the June quarter, confirming rises already seen in private-sector surveys.
So what happens now? Why has the Australian housing market been so resilient in the face of far larger slumps elsewhere? Or will we still see that 30-40% dive some commentators tipped? Should you put your money into bricks and mortar or another investment?
Why the resilience?
Dr Shane Oliver, head of Investment Strategy and the Chief Economist at AMP Capital Investors, says despite Australian house prices having had a stronger run up than those in the USA and UK, they have fared remarkably well by comparison over the past couple of years. From their peaks, US house prices have fallen 32% and those in the UK by 19%.
Several factors explain the Australian housing market’s relative resilience, including Australia’s housing shortage as well as the fact lending standards were far higher in Australia than in the USA. The debt surge focused on older wealthier Australians and full-recourse loans in Australia, providing a powerful incentive to keep servicing a mortgage - even when the debt value exceeds the home value.
Tim Lawless, National Research Director at RP Data-Rismark, says Australia’s low mortgage default rate (just 0.6% against 5% in the USA and 3% in the UK) also helps to support the market.
Dr Oliver says the factors above, along with the view that Australia was not going to have US-style recession, led a handful of economists - including himself - to reject the 30-40% house price plummet proffered by some. However, he says, even the 10% fall he anticipated seems too pessimistic.
“The big surprise has been that Australia’s economic downturn has turned out to be even more modest than earlier thought.
“The economy is yet to have a technical recession and the rise in unemployment has been mild. As such, the generational lows in mortgage rates and the increase in first-home owner grants have dominated the housing market.”
Outlook
However, says Dr Oliver, while house prices seem to have turned the corner, it’s hard to see a return to boom conditions. The positives are:
- that affordability is much improved
- Australia is still suffering a housing shortage, and
- the upswing in most housing-related indicators (such as auction clearance rates and housing finance) suggest confidence has returned to home buyers – both owner occupiers and investors and at top and bottom ends of the market
Australian housing is expensive
Against this, three factors are likely to constrain the upswing in house prices. Firstly, despite the correction over the past 18 months, Australian housing remains expensive.
In real terms, Australian house prices remain well above their long-term trend. Over the past 80 years, the trend rate of growth in real house prices has been 3% per annum (which is consistent with long-term, real GDP growth). But since the mid 1990s, house-price gains have been well above trend growth.
The historical experience has been that after a run up in house prices to well above trend, they then spend many years working of the excess (such as in the 1930s or from the early 1970s). This has in fact been occurring in Sydney with average prices having been stagnant for the past 5.5 years now.
Australian housing remains expensive by global standards, with a ratio of house prices to median household income roughly double that in the US.
Low rental yields
Despite strong growth in rents, rental yields remain low. Gross rental yields of around 5% are well below the 7%-plus net rental yields available on directly held commercial property, the 10% distribution yields on listed property trusts and a grossed-up dividend yield of 7% from Australian shares.
Affordability and unemployment
Lower mortgage rates have mainly driven the improvement in affordability, which could vanish pretty quickly if interest rates go back up again, leaving many somewhat vulnerable if they got in recently.
This contrasts with the US and UK, where the housing prices collapse has mainly driven the affordability surge.
While less of a threat than feared, unemployment is still trending up and poses a constraint on house prices. Historically, rising unemployment has been associated with falls in real house prices.
FHOG
Dr Oliver says the ending of the first home owners boost from December will be a dampener on the housing market’s lower end. However, Tim Lawless says the fact house prices are increasing across the market - including in Australia’s most expensive suburbs - lays bare the “popular myth” that the recovery has been driven by first home owners at the market’s lower end.
Bubble-free horizon?
Dr Oliver says while all these considerations suggest that a US-style collapse has been averted, house prices are just as unlikely to just go back into boom territory. He believes the more probable scenario is for house prices to grow, but at a rate below that of nominal incomes, so the ratio of house prices to incomes gradually continues declining.
That said, given Australia’s history with house-price bubbles and that much of this can be traced to restrictive land-release policies, the risk of another unsustainable surge cannot be ignored. The downside though is that, having dodged a bullet this time, given Australia’s very high household debt to income ratio, it would leave Australia very vulnerable to the next global economic downturn.
Is housing a good investment?
History suggests that once proper allowance is made for costs, residential investment property and shares generate a similar long-term return.
Analysing data from the ABS, REIA, Global Financial Data and AMP Capital Investors, the total return from housing versus other assets of $100 invested in 1926 until 2006, was
- 11.5% pa for both residential property and Australian shares
- 7% pa invested in Australian bonds and
- 5.4% pa for Australian cash
Over the long term, returns from housing and shares tend to cycle around each other at similar levels. While housing is less volatile than shares – and for many seems safer - it offers lower levels of liquidity and diversification.
The bottom line is that once the similar returns of housing and shares are allowed for, and these characteristics are traded off, there is a case for both in investors’ long-term portfolios. Right now after the second-worst bear market in the Australia’s share market history, and with the yield on shares running well above the yield on housing property, shares are arguably a better short-term bet.
While housing prices now appear to be on the way up again, a return to boom conditions seems unlikely. Over the very long term, residential investment and shares have provided similar returns and so there is a role for both in an investment portfolio.
And just a note of warning: there are articles around talking up house prices, indeed predicting big rises over the next few years. As with any information, it is very important to understand the source; inherent biases can skew data and the intended inference readers are meant to take. If you have any questions about your investments, please contact us.
Sources: “Australian house prices on the up again – is it sustainable?” by Dr Shane Oliver head of Investment Strategy and Chief Economist AMP Capital Investors; SmartCompany; “Australian residential markets continue to record solid gains in July” by RP Data; “Australian house prices to rise by up to 20%” by APS Growth News.
Tags: house prices, Investment strategy