The future of house prices in Australia

Australia’s house prices are high. All kinds of global comparisons will confirm this. But why are they high? It’s complicated.

Behind Australia’s rapid price growth over recent decades is our economic growth, financial deregulation and supply-side constraints as well as our urban structure, tax incentives and, undoubtedly, our love affair with property ownership. 

My colleague Yad Haidari and I recently undertook research to compare Australian house prices globally, investigate why prices are so high and, by extension, determine the risk of the current correction turning into a deeper price collapse.  

We examined real inflation-adjusted house prices across 23 countries and found Australia has the biggest increase in price-to-income ratio since 1975.

Real house prices grew by 301 per cent between March 1975 and June 2018, compared with 68 per cent in real income. 

Australia’s strong long-term economic performance and population growth have been important drivers in house price growth over recent decades.

Unsurprisingly, the highest long-term house price growth was in countries that also recorded the strongest income and population growth — Australia among them. 

Australia’s population is also concentrated in a few urbanised coastal cities, and this has contributed to higher prices. Inland cities have fewer physical land constraints and are generally flatter, which is reflected in lower prices. Over the past five years, more than 75 per cent of our population growth has been in three cities — Sydney, Melbourne and Brisbane. 

In addition to these physical constraints, we have created artificial supply constraints via a slow, often inefficient planning system. This has stifled residential construction levels, especially in Sydney, and has meant long periods where construction has fallen short of demand.

The slow response of construction to population growth contributed significantly to the recent surge in Sydney and Melbourne prices. While supply eventually responded, tight bank lending conditions have already curtailed large-scale apartment development, and supply levels will fall sharply over the next few years.

On the demand side, important structural changes such as more women in the workforce and financial deregulation have boosted households’ income and borrowing capacity, helping fuel real house price growth globally.

Culturally, the Great Australian Dream has always been strong, reinforced by a tax system that encourages investment in residential property.

The bias towards property has prompted Australians to put a higher proportion of wealth into their own and/or investment properties, essentially capitalising the income growth into house prices.

In other countries, more income has been invested in other asset classes or into consumption.

So what could precipitate a collapse in Australian prices?

House price corrections generally come after a debt-fuelled binge, where easy finance artificially inflates demand and, combined with rapid price growth, causes oversupply. Then, rising interest rates or unemployment affect households’ ability to meet mortgage obligations. 

Against this backdrop Australia’s current housing downturn is unusual, occurring when economic growth is around trend, interest rates and unemployment are low and population growth still supports housing demand.

The phenomenon has been concentrated in Sydney and Melbourne. Other major capital city markets and regional Australia have seen little growth in real prices over recent years and are not experiencing the same downturn. 

This suggests it was domestic and overseas investor demand fuelling the boom and that regulators were quite right to pull the punch from the party early and restrict credit growth to investors.

There can be no arguing the policies have both cooled demand and lowered the risk of major oversupply

So, with the debt tap firmly turned down, all that would cause a sharp collapse in house prices is a demand shock that lifts unemployment. And the probability of such a shock is relatively low.

Australian house prices are high and this won’t change. 

In the longer term, we will not have the tailwinds that once boosted borrowing capacity. However, population concentration and strong growth will keep prices high.

The chances of a price collapse will remain low but over the next few decades, price growth is likely to be much slower than we have become accustomed to.

With continued tight credit conditions, prices are likely to continue falling moderately in the coming months but stabilise later in 2019. 

Sydney and Melbourne are likely to see little growth for an extended period while incomes catch up. But other capital cities like Brisbane and Perth, and some regional areas, are better placed for solid real price growth from 2020 onwards. 

• This article first appeared in The Australian newspaper. Leigh Warner is JLL’s Head of Residential Research
  — Australia, based in Brisbane.

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