Market comment: DON'T WORRY .... BE HAPPYTue, 16 Aug 2022
Rates rise again, Reserve Bank isn’t worried
At its August meeting the Reserve Bank increased the cash rate by 50 basis points, to 1.85 per cent. This will further reduce the amount the average family can borrow to purchase a home, and some analysts have forecast the RBA will raise the cash rate by another two full percentage points before December.
The Sydney Morning Herald calculated what the latest rate rise means for borrowers: “On an $800,000 mortgage, the cumulative increase in monthly repayments since the RBA started tightening monetary policy is now $770. Analysts expect the big four to pass on the full 0.5 percentage point rise to home loan customers.”
Modelling by RateCity calculates that the average Australian family of four has already seen their maximum borrowing power reduced by $106,600 after the first three consecutive rate hikes. This reduced the amount they can borrow from $871,400 to $764,800, which is a 12.2 per cent drop.
More rate rises are on the way. RBA governor Philip Lowe said the latest rate rise was unlikely to be the last this year: "The board expects to take further steps in the process of normalising monetary conditions over the months ahead, but it is not on a pre-set path," he said.
"The board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time."
It must be noted that the speed of any house price falls caused by interest rate increases isn’t seen as a problem by the Reserve Bank. It shows their strategy to reduce inflation is working and delivering the economic outcomes the RBA desires: “Employment is growing strongly, consumer spending has been resilient and an upswing in business investment is under way,” the RBA said while announcing the latest rate rise.
The Herald’s Elizabeth Knight explains: “In previous rising interest rate cycles or when introducing changes to macroprudential measures, the RBA was alive to the desire to manage the impact on house prices. But this time around, it is more prepared to risk housing price deflation.”
The RBA’s deputy governor, Michelle Bullock says that Australian households are in a “fairly good position” to cope with further rate hikes. The Bank’s analysis, based on a realistic assumption interest rates will rise by 3 per cent, found that just under 30 per cent of owners might find it hard to make repayments and could face increases of more than 40 per cent of their current amount.
“Borrowers with fixed-rate loans that are due to expire by the end of 2023 would experience a median increase of around $650 (or 45 per cent) in their monthly repayments,” Ms Bullock said, adding that half of owner-occupier mortgage holders on variable contracts were two years ahead on repayments.
The RBA’s forecast that 30 per cent of mortgage holders could find it hard to meet repayments was echoed in the results of a NAB Australian wellbeing survey covering three months to June this year that found about three in ten respondents said they would experience “high stress levels” over their home loan.
Those most affected by the RBA’s rate increases yet to come will be borrowers seeking a home loan. “Borrowers need to brace for more rate pain with several substantial rises still to come,” Rate City research director Sally Tindall told The Guardian.
“If [the 3.35 per cent cash rate] happens, the average existing variable rate customer could be paying 6.11 per cent on their mortgage by early next year. Borrowers need to prepare for this new norm, rather than see it as an anomaly,” she said.
Borrowers stress tested
The Australian Prudential Regulation Authority (APRA) has already required banks from last November to stress test people applying for new loans by adding 3 per cent to the current interest rate when evaluating their ability to make repayments. However, rates above 6 per cent would be well above the test for millions who had taken out a mortgage when rates were abnormally low.
Sydney mortgage broker Anthony Landahl, managing director of Equilibria Finance, said the increased cost of living is also affecting how much money home buyers could borrow: “We’re seeing an increase in the cost of living, and we’re seeing that flow through to some of the serviceability calculators of the providers,” he said.
“The impression we’re getting from conversations with assessors … is there’s a keener eye on making sure expenses all make sense and reflect cost-of-living pressures – particularly around some of those inflationary pressure areas like transport, food and groceries.”
The Guardian’s Pete Hannam says that commercial lending rates have been increasing for almost a year as the economy began to emerge from its Covid-induced depression: “An additional drag on the market could come when many of those who took out fixed-rate loans when rates were low have to refinance; these peaked at almost half of new mortgages in July and August , with borrowers facing much higher repayment rates when they refinance after two years or so.”
Both NAB and Westpac have said they expect the RBA to raise the official cash rate to its highest level in nine years by December. Westpac chief economist Bill Evans said he now believes the cash rate will reach 3.1 per cent by December, then rise to 3.35 per cent by February 2023. The last time official interest rates were at 3 per cent or more was a decade ago in 2013, a year of rapid growth in Sydney property prices that followed several rate cuts in 2012.
Swiss investment bank UBS has done its own calculations, saying that if interest rates were to rise to 3.5 per cent – its prediction for March 2023, it would see the average variable mortgage rate hit 6 per cent: “Interest payments across the economy next year for the household sector will [be] close to double from now,” George Tharenou, chief economist at UBS said. “We have never seen such a sharp increase in repayments. That really crushes household cashflow next year when you have cost-of-living issues,” he added.
Mr Tharenou believes the RBA will cut interest rates in the second half of 2023 to prevent Australia falling into recession: “The house price outlook is at least 10 per cent down over the next year, but to stop a larger fall will require the RBA to shift their policy direction and start cutting next year,” he said.
The Australian Financial Review’s annual survey of 31 economists produced a median forecast for the official cash rate of 2.85 per cent by the middle of next year. If this happens, Australia’s official cash rate would rise another 1.5 per cent from its current level.
Leith van Onselen, chief economist at the MB Fund and MB Super, says that this could cause a peak-to-trough fall of house prices in the vicinity of 20 per cent: “Mortgage-holders in our two largest cities better hope neither the economists nor the market is correct, and that the RBA stops well short in its monetary tightening.”
It’s generally accepted by financial analysts that the current transition from a rising housing market to a falling one is mostly due to rising interest rates. The resulting higher costs of borrowing money as well as tighter lending conditions have significantly dampened buyers’ enthusiasm. The high rate of inflation – now just above six per cent, is another negative factor.
Centre for Independent Studies chief economist Peter Tulip has researched the relationship between cash rate changes and property prices. He says faster changes in interest rates lead to a faster response in prices, but he does not expect it to make a noticeable difference to overall declines.
“As a rough rule of thumb, a 1 per cent increase in the cash rate means an 8 per cent decline in house prices,” he said, noting it could take about two years for the impact of rates to flow through the market, and part of the price weaknesses now is a response to fixed mortgage rates that started to increase a year or more ago.
Sydney property prices have had their biggest fall in three years after the median house price declined 2.7 per cent to $1,552,015 in the June quarter. Sydney house prices fell 1.9 per cent just over the month of June, the market’s fastest rate of decline in 40 years, then the median price fell again in July by 2.2 per cent.
At least the median Sydney house price is still higher than the median price of a year ago as the 28.6 per cent gains from mid-2020 to April 2022 to their peak in early 2022 are still a factor in the calculations.
The current downturn has so far been felt hardest in Sydney’s pricier suburbs, but it’s now radiating outwards into Sutherland, Parramatta and Blacktown. Data from Domain shows that house prices have now pulled back by more than $100,000 in Sydney’s inner west, northern beaches and north shore.
The downturn’s rate of decline is faster than the fall in prices during the Global Financial Crisis (GFC) of 2008, and it’s expected to accelerate even more as interest rates increase.
CoreLogic data shows that Sydney’s house prices fell more than four times faster than unit prices in the June quarter, although unit prices had their second quarterly decline, dropping 0.6 per cent to a new median of $790,983.
Sydney’s eastern suburbs and the Baulkham Hills and Hawkesbury region led unit declines in dollar terms, down $90,000 and $55,000 respectively. Units have been protected to some degree by their lower price points compared to houses, but their annual rate of growth nationally is now a meagre 0.4 per cent.
New Sydney house and unit listings in the month of June fell 8.4 per cent from May and were down 2 per cent year-on-year, although total listings were up 13.1 per cent as unsold homes were staying on the market longer. “The latest results continue to highlight tougher selling conditions as interest rates rise and consumer sentiment remains low,” CoreLogic research director Tim Lawless said.
Taken nationally the story told by sales figures is much the same. Australia’s median house price has fallen for the first time in two years. The median house price across Australia is now $1.065 million; this is around $10,000 less than it was in March this year, but still $100,000 above the median house price this time last year.
CoreLogic analysed 3085 property markets across Australia and found that home values declined in 41.9 per cent of all house and unit markets over the June quarter, compared to declines across 23.6 per cent of markets in the March quarter.
Looking closer at the numbers, these figures result primarily from housing price falls in Sydney and Melbourne. The latest data on home values showed prices in the two biggest Australian cities are now close to where they were a year earlier.
Before the end of June, housing in the rest of Australia, including the other capital cities, was still increasing in price, although at a much slower rate than twelve months before when the boom was gathering strength. This June, Brisbane and Adelaide reached record highs in both house and unit prices.
History shows us that housing prices are cyclical. Until the interest rate increases began, Sydney houses had experienced a substantial increase in prices, but now they’re contracting. History also shows us that there will be a recovery in housing prices and that the eventual result will be a higher pricing level than in the previous upturn. It just doesn’t tell us when the next upturn will begin.
This doesn’t stop members of the property industry from making predictions about the duration and the degree of the present fall in prices. AMP Capital chief economist Dr Shane Oliver has predicted that house prices will drop by 15 to 20 per cent nationally peak to trough, with prices in Sydney falling closer to 20 per cent: “The main driver of the weakness is the rise in interest rates, and we do have further to go,” he said.
Mr Oliver did, however, acknowledge that the fall in prices was still within the bounds of the usual cyclical nature of the housing market, “albeit a bit more rapid”.
Domain’s chief of research and economics, Dr Nicola Powell thinks that Sydney will experience the worst of the downturns: “I’m certainly of the view that Sydney will see the strongest declines of anywhere,” she said. “It may feel like this has happened quite quickly but it hasn’t at all. We already had issues with affordability during those escalating prices, then we had a build-up of listings … add into that aggressive interest rate rises and here we are.”
The PropTrack Property Market Outlook July 2022 Report forecasts housing prices to shrink between seven and 10 per cent in 2023, with the report noting this would “potentially bring prices down 15 per cent from current levels”.
John McGrath, founder of McGrath Real Estate and a veteran of the Sydney market’s fluctuations, says prices have pulled back 10 to 15 per cent but quality properties were holding their value well. He expects the correction to last another 12 to 18 months with prices declining another 5 per cent, then plateauing for “a few years”.
The Commonwealth Bank announced in June that house prices in Sydney were set to fall by 18 per cent by the end of 2023 as a result of interest rate rises. The bank also forecast an 11 per cent house price drop in Sydney by the end of 2022.
David Plank, the head of Australian economics at ANZ, says that the faster move to a restrictive rate setting will bring forward the slowing of the domestic economy: "It also suggests house prices will fall by more than the 15 per cent, or so, we currently anticipate to the end of 2023.
"But it doesn't necessarily mean a hard landing for the economy. A cash rate of 3.35 per cent implies that household interest payments as a percentage of household income peak below the level reached in 2008," he told ABC News.
Barrenjoey senior economist Johnathan McMenamin said the price falls would be sharpest in the coming months and were unlikely to halt until early 2024 – following an expected cash rate cut in late 2023. He also said that the top quarter of the market should have sharper declines, although a pick-up in investor activity combined with a pull-back in sellers amid lower prices could moderate declines.
The consequences of buyers’ reduction in borrowing power have been demonstrated in the outcomes of Australia’s property auctions. Although the number of properties offered in Australia-wide auctions totalled 31,439, the second highest June quarter on record, the clearance rate fell from the previous year to 60.8 per cent which was about 20 per cent lower than the June quarter in 2021. It was also the lowest success rate since the September quarter in 2020.
Sydney auctioneer Jesse Davidson, the director of AuctionWorks, said that consecutive cash rate rises by the Reserve Bank had affected buyer borrowing power and sentiment. This and a fear of overpaying were leading some buyers to ditch plans of purchasing at the last minute: “The most common feedback is that their finance conditions have changed,” Davidson said. “The banks are calling clients and saying that the approval we gave you is no longer valid, and they have to redo the process again. The second thing is the fear of overpaying that has entered the market.”
Sydney sellers this year were more likely to pull their properties off market before auctions than a year ago with the withdrawal rate rising from 12.9 per cent in the March quarter to 19.4 per cent in the June quarter while the success rate of Sydney auctions fell to 57.2 per cent. The clearance rate in July has stabilised in the mid-50s where it’s likely to stay as vendors accept the need to set realistic prices for their properties.
About 25 per cent of scheduled auctions were withdrawn in May and June, Domain data shows.
This is the highest monthly withdrawal rate since the start of the pandemic, when more than half of auctions were pulled after a ban on public auctions. The proportion of withdrawn auctions peaked at almost 30 per cent in December 2018 during the last market downturn.
There are some pockets of Sydney where cooling buyer demand has once again seen up to half of all properties offered at auction failing to sell. In the Sutherland Shire, Baulkham Hills, Hawkesbury, Blue Mountains and outer west regions there have been weeks where clearance rates were below 50 per cent.
Building costs rising
In these inflationary times it will come as no surprise that the costs of building a home are rising. Every element of a home’s construction, from the glass in the windows to the timber in the frames has increased in cost and contributes to the overall price of a new house or unit. Steel products are up in cost by 42 per cent compared to last year, and timber’s up in cost by at least 20 per cent with similar hikes in the price of things like plumbing fixtures and kitchen appliances all making an expensive contribution to the cost structure.
The Housing Industry Association’s chief economist Tim Reardon told Domain the rise of construction costs is the result of an increase in the demand for houses in speed and volume, as well as constraints on supply and labour that failed to meet the unprecedented demand.
HIA figures show that pre-covid the construction of freestanding houses was slowing, with about 105,000 being built before the pandemic struck. However, by the end of 2021, that had increased by almost 50 per cent, and there are now 80 per cent more homes under construction than before the pandemic
“We have seen a 19 per cent increase in the value of the average home approved in Australia over the past 12 months to May,” Reardon says.
There could be some relief in sight, according to a new forecast from global construction and property consultancy firm Rider Levett Bucknall (RLB). They say Australia’s construction industry is “in a positive phase” based on the current volumes of work in 2022 and increasing values of work yet to be done and commencements in the majority of states.
RLB’s Oceania Director, Research and Development, Domenic Schiafone writes, “RLB is seeing significant construction activity in road, rail, health, and social and affordable housing projects, aided by significant investment by all state governments,” and forecasts a slowing of cost inflation in Sydney from 6.9 per cent to 3.9 per cent in 2023.
All this is in contrast to the current fall in the prices of Sydney housing. In part, it’s the result of homeowners deciding to renovate their properties after they’d spent so much time in them during lockdowns and other covid-inspired restrictions on movement.
Australians typically spend $55 billion each year travelling overseas. Covid kept them in Australia so they tapped into their savings and spent up big on their homes. There was also government support for income and jobs that helped to pay for some of the renovation expenses.
“It’s been a rollercoaster … two years ago, contracts were being terminated because everybody thought they would lose their job. All of a sudden, JobKeeper and HomeBuilder came along and people weren’t travelling, the building industry went from no work to too much work,” says Denita Wawn, chief executive of Master Builders Australia.
Ms Wawn says that ‘resolving the people shortage’ in the construction industry is the main concern at the moment. ‘We need to resolve those skills shortages.’
Jon Stoddart who is managing director of Stoddart group, Australia’s leading supplier and installer of residential building products said the sector has been impacted at every stage of the building process: “It’s not just one thing that’s occurred, it’s a multitude of things that have occurred.
“First there was the home stimulus grant. We sold a bucketload of houses then freight got dearer, then worldwide timber took off. To top that off, a lot of the timber that comes out of Russia was banned, that limited that supply. I don’t think anybody has done well out of this, whether it’s the builder, homeowner, supplier or the contractor,” Stoddart said.
In our last article we covered the surprising outcome of the 2021 census that showed just over a million dwellings were vacant on census night. This revelation has stimulated much discussion in the press about why and how so many properties could be standing empty at a time when there’s a shortage of rental accommodation across the country.
Some of these unoccupied dwellings are genuine ‘holiday homes’ that have been acquired solely for the purpose of allowing city dwellers to escape to the country on weekends or whenever they have some free time from their jobs. It may seem hard to believe now, but fifty years ago this wasn’t at all uncommon, and many of these properties are still in the same baby boomers’ hands as they were in the 1970s and ‘80s.
Other vacant properties are the result of a taxation system that favours investments in property and that have been acquired primarily for the purpose of generating capital gains. They might be available for short-term holiday rentals but not for longer periods as the owners wish to retain flexibility about a time when they might want to sell them.
There are empty homes in country towns whose populations are shrinking and there’s literally no demand for property in those areas, either for rental or for acquisition. There are also properties that are empty in agricultural areas at times of the year when there’s no activity needing accommodation for seasonal labour. The 2021 census night was in August which is midwinter and there’s no harvesting.
And finally, Covid too may have played a small part in the numbers gathered on census night. The statistics showed a slight increase in the population of coastal towns, especially in southern Victoria. It’s thought that these increases are the result of a census having been conducted at a time of lockdowns, showing that people had moved from their homes in the major cities into their holiday homes along the coast to escape lockdowns and other restrictions that had been applied in metropolitan areas.
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