- What has led to the increase in housing prices?
- Where to from here?
- Unemployment & Wage Growth
- The RBA have lost control and are now resorting to crisis era tools
- Quantitative Easing
- Key indicators are showing households under the strain of record debt in a slowing economy
- Supply of Housing
- Auction Clearance Rates
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The Australian housing market has been overheating since the early 2000’s, but the rise post-2012 has been alarming. Since 2012, the housing market has been driven by the loosest debt availability conditions in Australia’s history as the RBA aggressively cut the cash rate to levels far lower than those seen during the Global Financial Crisis in 2008.
Since 2012, the largest factor driving the housing market is rising debt, and this debt is not backed by any improvement in Australia’s financial health – income growth is stagnant, rental income hasn’t changed, key household financial health indicators like retail spending and car sales are flat to negative, and the amount of debt relative to income in Australia is at record highs historically and relative to other countries. The increase in debt is solely a result of the RBA keeping debt cheap and the banking regulator (APRA) loosening lending standards to allow banks to lend more than ever.
Despite the RBA’s efforts, inflation is stubbornly low and unemployment is now rising putting pressure on wage growth to fall further. It isn’t surprising that all these indicators are now under pressure after a record 30 consecutive years of economic growth in Australia – the concerning part is that the cash rate is already at record lows (0.75%) so there is little the RBA can do to push the economy on in case of further economic deterioration without resorting to crisis era tools like quantitative easing and negative interest rates.
After a 10-15% drop in the housing market in 2018, the market has rebounded in 3Q 2019 driven by a flurry of positives – a 50% reduction in the cash rate (1.50% to 0.75% since June 2019), a shock Liberal election win (Labor planned to scrap negative gearing and reduce capital gains discounts) and a material change from APRA that has allowed banks to more easily lend.
To buy a house at the current price level and economic situation requires some research to be comfortable that the record mortgage you are taking on is backed by some value check. Believing in catchy slogans carries little risk when houses are 3 times your wage, but at 8 times, the consequences of being wrong are much higher. In the current economic climate property may no longer be a low-risk investment, as it once was.
What has led to the increase in housing prices?
House prices rise as debt increases, an obvious relationship considering up to 80% of the purchase price is a mortgage. Mortgages are issued based on an ability to repay the principal and interest in monthly instalments. Banks assess repayment ability by considering factors like wages and net assets.
In Fig 1, we can see this relationship between debt and housing prices, with an increasing gap between ability to pay (post tax income and rent) and the average mortgage size and house price. This gap can be attributed to the fall in the amount of interest charged on the average mortgage. The RBA cash rate plus roughly 2.0% (the banks margin) reflects the interest rate that banks charge customers. The current cash rate is 0.75% – the lowest in history, 2.25% lower than at the peak of the GFC and never has the cash rate been cut so many times consecutively.
The fall in interest rates have increased an individual’s ability to repay off a given mortgage amount. The data suggests that rising house prices have been driven not by any increase in an individual’s wage or investment income, but by lower interest repayments. This has allowed banks to issue more mortgage and personal debt than ever before in Australian history. Fig 17 shows that this level of debt is the highest of our peers. Sellers require buyers to access more debt each year in order for their house price to increase. If economic factors such as income and inflation have not moved in-line with the growth in house prices, and the supply of housing isn’t showing any strain due to population growth (Fig 23), this suggests that debt, particularly growth in debt, is the biggest factor currently driving the market. This is not the sign of a healthy market.
As well as record low interest rates, the banking regulator (APRA) has made it easier for more Australian’s to access debt. Changes to lending practices in July 2019 meant banks no longer have to assess if applicants could pay their mortgage if interest rates rise to 7.25%. Now banks only need to add 2.5% on the mortgage’s current interest rate. With interest rates currently below 3%, banks only are now only required to assess an applicant’s ability to repay their mortgage at an interest rate of around 5%. This means that applicants who were previously classed as high risk or rejected, are now passing this test and able to borrow. Prior to 2013, interest rates have never dropped below 5% in recorded history, so this is either APRA taking the view that interest rates won’t increase again or they are relaxing their regulations so that debt growth won’t slow.
“In a letter to ADIs issued today, APRA confirmed its updated guidance on residential mortgage lending will no longer expect them to assess home loan applications using a minimum interest rate of at least 7 per cent. Common industry practice has been to use a rate of 7.25 per cent.
Instead, ADIs will be able to review and set their own minimum interest rate floor for use in serviceability assessments and utilise a revised interest rate buffer of at least 2.5 per cent over the loan’s interest rate.”
Above we can see the total amount of mortgage debt and the annual change in debt split between owner occupiers and investors. Owner-occupiers are still growing at a decent clip (albeit at 30-year lows), while investor growth has turned negative for the first time in data collection history. After the negative gearing fuelled property binge of the 90’s and early 00s, when investor debt growth was +20-30%, investor growth has been falling since 2016. Another way to visualise the current situation is to compare the growth in prices between houses (where owner-occupiers dominate) and apartments (where investors dominate) (Fig 6)
In most cities from the mid 2010’s, apartment price growth has dropped off compared to house price growth, after showing a strong correlation previously (see Melbourne as an example). Clearly investors see little value in real estate as an investment at current price levels.
Monthly lending data is good indicator for future moves in the housing market. People are issued a loan first and they then use this to buy a property at a later date. In Fig 7, you can see as the growth in lending changes (red line), housing prices (blue line) follows with a delay.
We can separate this data into owner-occupiers and investors to see who has most recently been issued a loan. Investor demand for loans has been negative since late 2017 and is currently sitting below -10%. Owner occupier demand has rebounded sharply from the lows in early 2019 to be positive again.
Since 2016, even as interest rates continued to fall, investors have not come back into the market. The only segment driving the housing market has been owner-occupiers, and monthly lending data indicates this will be the case into the near future.
Where to from here?
Everything discussed so far shows that changes in the growth of debt will determine the future of the housing market. Besides technical changes in lending standards by APRA, the ability to lend will depend on income growth, housing supply and demand, interest rates and savings/deposit. Currently none of these indicators bode well for house prices.
Unemployment & Wage Growth
Wage growth depends on the supply and demand of workers. When the unemployment rate is high, there are more unemployed people (a higher supply of labour) and wages fall. When the unemployment rate is low, more people are employed (lower supply of labour) and wages move up.
The RBA are hoping that the three rate cuts since June 2019 would help push the unemployment rate down to 4.5%, and this would stimulate wage growth, but the opposite is happening – the unemployment rate is rising and this a big issue for the RBA. A low unemployment rate correlates to higher wage growth as we can see in the chart below.
The unemployment rate is an imperfect indicator. It only counts a person as unemployed if they are actively looking for a job. If a person stops looking for a job because they can’t find one, they are excluded from the statistic. Another measure of employment is the percentage of workers per working age population (employment ratio). This statistic takes into account every working age person and is a more representative figure of employment in our opinion.
In Figure 10 we can visualise the employment ratio and wage growth by country and state:
This paints a bleak picture for future wage growth. Nationally, the employment ratio is at record highs but wage growth is not moving from the lows. The same dynamic can be seen in the state level data – the employment ratio is either at record highs, or has accelerated higher since 2016, but wage growth is not moving up.
Considering the current low rate of unemployment has not had the expected positive impact on wage growth, how will wages fare in a time of rising unemployment?
Another interesting way to split employment data is to measure the proportion of males and females in the labour force over time. This data shows that females have always been a large proportion of the workforce. In 1990 females made up 41% of the labour force, and now they make up 45%. This would suggest that the ‘duel income’ factor is not a driver of house price moves.
The RBA have lost control and are now resorting to crisis era tools
The RBA is Australia’s central bank and is in charge of the country’s monetary policy. It operates independently to the government so as to remove any political influence. The RBA sets the cash rate and this is what interest rates are based on. In simple terms, when the RBA decides it wants interest rates in the economy to rise, it reduces the supply of money and when it wants interest rates to fall, it increases the supply of money.
For instance, a country with low economic growth, low inflation and high unemployment would see cuts to the cash rate.
Inflation (price of goods and services increasing) of 2-3% per year is the objective of the RBA. When inflation is above this range, the cash rate is increased and vice versa. Deflation (price of goods and services falling) is like the plague to central bankers – it encourages us to delay spending as we will get more for our dollar next year.
Besides the recession of the late 80s/early 90’s, in times of high inflation, the cash rate trends up and vice versa. Historically, when inflation moves outside of the target range, the RBA have been able to manage inflation back into their range via cash rate changes quickly and successfully. Since 2012 the cuts in the cash rate have not had the desired impact and inflation has trended lower. Inflation has been outside the RBA’s target range for almost 4 straight years – the longest streak in 30 years. This is with the cash rate at record lows (0.75%), and is the reason the RBA are considering QE – their conventional tools have failed and they now need to resort to more drastic measures.
Quantitative easing (QE) is the expansion of a country’s money supply, or more simply printing money. The power to do this lies only with the country’s central bank and the government have no say. The current head of the RBA, Philip Lowe, has said that QE could commence once the cash rate hits 0.25%.
The RBA equivalents in the USA, UK, the EU and Japan have all attempted QE, but only in response to a major crisis. For the USA it was in response to the Global Financial Crisis, when American house prices dropped 40% and the entire banking system needed to be saved. For Japan, it was in response to their property bubble popping and property prices dropping 50%. In Europe, Greece was blowing up.
The point of QE is to keep interest rates in the economy low. As discussed above, interest rates depend on the supply and demand of money. When supply is high, interest rates fall and vice versa. In times of economic crisis, debt issuance (the supply of money) dries up as banks and individuals scramble to reduce risk to an economy in recession. If they do lend, interest rates will rise to reflect the increased risk. By printing money, the central bank ensures that supply of money is high and this keeps pressure on rates to stay low.
As we have seen, an increase in interest rates or a slowdown in debt issuance will be a major issue for the housing market (indeed the entire economy) which is now overly reliant on debt. The RBA will be desperate to keep interest rates low and the flow of debt high. In the country’s where QE has been performed, we can see the impact on house prices has been mixed.
In Japan, prior to the housing bubble popping, house prices rose over 5 times in the preceding 30-year period. The housing bubble burst and the Bank of Japan aggressively cut interest rates to 0%, then in 2001, began QE. As we can see in Fig 13 Japan’s housing market continued to crater, eventually settling down -45% from the peak. In the USA, QE started in early 2009, and house prices continued to fall. It wasn’t until 2012, 3 years later, that house prices began to rise. The fall in USA house prices was over 40% in the 4 years post the GFC.
In the examples above, QE was not a saviour to an over-valued, debt fuelled housing market.
Additionally, the RBA must be worried by the moves in the cost of funding for the banks. Banks loan out more money than they have in deposits, and to bridge this gap they must borrow money. The rate that they borrow money at is called the Bank Bill Swap Rate (BBSW) and this is anchored to the cash rate.
The BBSW is why banks may not pass on the full RBA rate cut, or increase rates out of sync with the RBA. We can see this dynamic play out in late 2018 (red dot), the RBA had cut the cash rates to record lows, but the BBSW started to increase and banks were forced to up their mortgage rates to protect margins. In Fig 15, we can see that banks have been targeting a 2% margin.
During the last dislocation between the cash rate and the BBSW between June 2017 to May 2019, mortgage rates on average rose 0.1%, which coincided with the 10% drop in house prices and may highlight how sensitive the market is to interest rates changes (or future expectations of interest rate moves). Since May 2019, the funding market has been rescued by another round of cash rate reductions, sharply moving mortgage rates lower.
Key indicators are showing households under the strain of record debt in a slowing economy
We can assess the ability of households to take on additional debt by taking a view on household health indicators such as retail spend, household savings and debt levels and real wage growth (wage growth less inflation).
After 30 straight years of economic growth, Australian’s have not paid down debt in preparation for a downturn and have instead leveraged up almost every year along the way. Australian’s are more in debt than ever and saving a declining percentage of their income each year. For every $1 in post-tax income earned, there is $2 of outstanding debt and the average Australian saves just over 2% of their post-tax income each year.
Compared to the rest of the world, Australia’s level of debt is very high and the gap between the average and Australia has been growing since the early 2000’s.
In addition to a record debt burden, Australian’s are seeing any wage growth eroded by inflation. From 2000 to 2014, wages were growing at a much higher rate than inflation – meaning Australian’s had more money each year to spend or invest. Since 2014, any extra money from wage increases has been cancelled out by the effect of inflation
A key indicator of household financial health and confidence is spending on retail items. Adjusted for population growth, the trend in retail spend has been declining since 2014. Clearly interest rate cuts have done little to stimulate spending in the economy.
When we drill down into the detail of retail growth numbers and split it into segments, we can see that the only segments in the retail industry that are growing are necessities like clothing and food (Fig 20). Growth in spending at cafes and restaurants are hovering around 0%, while spending on household goods and at department stores are shrinking. This shows that households are unwilling, or unable, to spend on items that aren’t a necessity.
The data for car sales is even worse. Total vehicle sales are down 10% this year, with the decline being led by the passenger vehicle segment. This segment has been declining since 2014, but the rate of decline has accelerated since 2018.
Looking at employment by industry, the trend of weak spending is a worry for an economy that is overly dependent on services. Service based employment makes up 80% of all jobs in Australia, with the second largest industry being construction at 9%.
Supply of Housing
A common argument in favour of future house price increases is that the supply of properties is declining as population growth and migration rises. This logic makes sense, but isn’t reflected in the numbers.
To gauge the supply of properties we look at rental vacancy rates (number of vacant properties divided by total rental properties), the number of vacant rental properties and the number of permits for housing that has been issued in each state. Rental properties are a good indicator for supply of housing as contracts are up to a year, so the data should be more reflective of market conditions than houses being bought and sold which have no contract length.
If supply was an issue, we would see vacancy rates drop as less properties are available for rent, but this hasn’t happened. The vacancy rate nationally has been quite stable since the data series starts in 2005. If anything, the trend has been for an increase in vacancies and the answer for why can be found in the city level data.
In the charts on the right-hand side, the number of permits issued are overlaid on the number of vacant properties. The number of vacant properties has been lagged by 12 months to better match the permitting, building, renting timeline. In some states, like Melbourne, the amount of new properties were evenly matched to demand and we can see that over time the vacancy rate and number of vacant properties remain stable, even as the number of permits rise. The opposite is true in Darwin Perth and Sydney, where the number of permits issued rose sharply and the demand was not there for these new properties. This caused the vacancy rates to rise. We can see that the amount of permits issued in these cities has plummeted as there is a lot of over supply to work through.
The only city that appears to have a supply shortage is Hobart and this is reflected by the amount of permits being issued there.
Auction Clearance Rates
Clearance rates have rebounded strong during the second half of 2019 after dropping to 7 year lows at the end of 2018. The clearance rate nationally has rebounded back to historical highs aided by the rush of owner-occupiers back into the market after the 50% cut in the cash rate, Liberal victory and relaxation in lending standard.
Looking at the state by state data (which only exists back to April 2018) we can see that the total amount of auctions is down in 2019 vs 2018 helping the clearance rate improve. Before the aggressive moves by the RBA and APRA in the middle of the year the clearance rates were still in the 50% range.
ABS – https://www.abs.gov.au/
RBA – https://www.rba.gov.au/
SQM Research – https://sqmresearch.com.au/
Domain – https://www.domain.com.au/