FYI | Jan 25 2011
By Chris Shaw
Australia continues to have a favourable medium-term economic growth outlook thanks to its exposure to the fast growing Asian region, but the outlook for housing prices is somewhat more mixed in the view of ANZ Banking Group.
Ange Montalti, the bank's senior economist for property and financial system research, expects Australian housing prices will take a breather in coming months following a solid run-up through 2009. This reflects expectations of further increases in interest rates later this year, which will impact on activity in the housing sector, affordability levels and investor sentiment.
According to Montalti, rising mortgage rates will cause builders to remain cautious, as margins will be vulnerable to sluggish house prices. This suggests dwelling starts will decline from an expected 149,000 in 2010/11 to 131,000 in 2011/12. This is well short of the 180,000 plus starts required to stabilise the current housing shortage.
Montalti expects this market imbalance will at some points cause an acceleration in rentals growth and a tightening in rental vacancies, so setting the stage for a recovery in prices through 2012. This expected acceleration in rental growth will play the key role in signaling renewed support for housing prices in Montalti's view.
At present the market is somewhat vulnerable to weaker economic momentum becoming more entrenched, but Montalti takes the view there will be good support from solid economic growth and a further tightening in rental markets moving into 2011/12.
Prior to this recovery he doesn't see the basis for a significant correction in housing prices, as while a number of market supports were removed in 2010 and potentially higher interest rates will impact on sentiment, the economy growing at trend rates and a potential tightening in rental markets will establish pre-conditions for a renewed house price recovery in 2012.
As Montalti notes, it is easy to suggest Australian housing prices are overvalued, but such an argument often ignores or discounts other forces at play in the market and tends to focus on single-dimensional metrics using long-run averages.
House prices are driven by a complex set of influences at play on both the supply and demand sides, with the relative importance of these drivers shifting over time. So any attempts to determine overvaluation in the market must attempt to quantify these drivers and influences.
Taking a structural view, household incomes have risen over time, which Montalti notes offers a solid basis for house price growth. House prices have risen by more than incomes, creating a distortion, but falls in inflation and interest rates over the past decade or so have helped offset this.
Deregulation in the Australian financial sector has impacted on the demand side of the Australian housing market by changing the operating environment , especially with respect to the average threshold of debt servicing.
This also supports higher house prices, while Montalti notes the persistence of very low housing loan delinquency rates adds weight to the argument debt levels and house prices in Australia are sustainable. Also supportive is the emergence in recent years of a chronic shortage of dwellings, which has coincided with a period of solid population growth.
Putting all this together, Montalti argues there are a number of structural elements in the Australian housing market at present that validate observed price outcomes. This means there are no real grounds for any significant correction in house prices in the foreseeable future.
Looking at the market across the various states, in New South Wales Montalti notes fundamental conditions remain tight as dwelling completions continue to run at well below underlying requirements. This should drive rental vacancies below 1% in the second half of this year, pushing rental growth up by close to double digits by the end of 2011.
Montalti expects this will support the market medium-term, but near-term he expects a cyclical upswing in interest rates will put a cap on house prices. Growth of a modest 2% is forecast for 2011.
The Melbourne real estate market fared better than other Australian capital cities in 2010, thanks to healthy employment growth and sustained strength in underlying market fundamentals. An ongoing tight market has delivered strong growth in Melbourne house prices and Montalti expects prices will remain elevated through the coming year.
The floods in Queensland mean up to 28,000 homes will need to be rebuilt, Montalti noting this compares to a total of only 33,700 homes being built during 2009/10. While reconstruction will boost activity levels, there remains significant spare capacity in the Queensland building sector.
The floods are also expected to exert additional downward pressure on house prices, which follows a decline of 0.8% for the year to November 2010. But Montalti expects the reduction in the housing stock and a number of displaced owners will tighten the rental market. Vacancies are forecast to fall below 3.0% this year, so supporting moderate rental growth.
Adelaide's market delivered the lowest rental vacancy rate across Australian capital cities in 2010, while annual house price growth was marginally lower than the national average. Montalti sees it as a matter of time before investors start to chase stronger rental yields, but modest population growth and balanced housing market fundamentals should maintain annual house price growth at around 2% this year.
Underlying market fundamentals should tighten in Western Australia in 2011 in Montalti's view, this reflecting the state's economy enjoying the rewards of the current boom in commodity markets. But given poor affordability levels following strong house price gains between 2004 and 2007, Montalti expects market conditions in Perth will remain favourable for both home buyers and renters as price growth and housing stock additions weaken in the coming year.
In Tasmania the economy remains in the doldrums and this is impacting on housing as both investors and owner occupiers have withdrawn from the market. The market remains affordable and this should limit any price declines, so Montalti sees prices moving sideways in 2011. Rental yields are expected to remain in the range of 3.5-4.5%.
The Northern Territory has seen a moderation in economic conditions over the past year and as interest rates have moved higher house price growth has slowed. A decline in net migration in the state has also weakened the rental market but Montalti expects the Darwin housing market's imbalance will continue to worsen.
This suggests while prices could soften near-term, the tightness of the market should place further upward pressure on prices and rents over the medium-term.
Canberra was a solid property market in 2010 thanks to a shortage of housing stock and solid economic and employment growth in the region. Montalti expects moderate house price growth this year, along with some further upward pressure on rent growth. This suggests housing purchase affordability in Canberra will remain well below the national capital city average through 2011.