Why I was wrong on house prices in 2016 – and why I might still be proved right

5 January 2017

by Stephen Koukoulas

ustralian house prices rose at a solid pace in 2016, defying many expectations for moderate price falls – including mine.

It seems the error of my forecast was to misread the policy approach to regulatory restrictions on investor lending which, as it turned out, was limp and ineffectual.

For years, smart people have been arguing for a tightening in prudential controls on lending to cool the housing market. The people who regulate the mortgage market have, however, taken only baby steps to address the issue and have failed to cool it. Investor loans have been roaring along since the middle of 2016.

Another important factor behind the resilience in house price growth was the shock interest rate cuts from the Reserve Bank of Australia during 2016 as it reacted to the surprising slump in inflation and wages growth. These low interest rates fuelled extra borrowing capacity, some of which fed into house prices.

Oversupply from the apartment construction boom, which I also thought would start to bite in 2016, looks to be more of an issue for 2017 even though apartment prices fell in most major cities in the latter part of 2016. Prices for freestanding houses were particularly strong.

No sensible observer of the Australian housing market believes the regulators have it “right” when it comes to conditions attached to investor lending. Just about anyone with a few assets and a half decent income can get a loan for investment purposes despite the pretence of “tighter” lending conditions. The negative gearing rules only add to such demand.

While that remains the case and while there is strong demand relative to the growth in housing supply, price pressures will be skewed to the upside.

With 2016 behind us, there are grounds to think that 2017 could be the year of the great house price moderation. While the Reserve Bank appears to have official interest rates on hold, the sharp jump in bond yields over the past few months is feeding into bank funding costs. This higher cost of funds has already filtered through to higher fixed-mortgage interest rates which, unchecked, will erode housing demand.

Also acting as a likely dampener for demand is the sponginess in the labour market, with wages growth hovering at record lows, full-time employment sluggish and the unemployment rate high. Potential purchasers of dwellings, already constrained by high levels of debt, have only limited ability to add to their leverage, at least in the near term.

And then there is dwelling supply. Building approvals reached record levels in 2016 and, once those approvals turn into finished dwellings ready for owner-occupiers or renters to move into, there is likely to be excess supply in several major cities. This will, at least in the short to medium term, undermine prices.

While supply and demand remain the dominant long-run drivers of house prices, interest rate changes, macroeconomic conditions and prudential changes can all have a short-term impact.

The supply and demand dynamics are pointing to a moderation in house prices, as are changes to interest rates and what looks to be a soft economy with a weak labour market. 2017 is set to be the year of weaker house price growth, perhaps even price falls.

If the moderation is orderly, without much in the way of forced selling, it will actually be good news for the economy. Some prudential risks will ease, affordability will further improve and the housing market will move towards balance.

The government and regulators could help to lock this in if they are bold enough to tighten lending and tax rules to reduce some of the investor demand which has, in recent times at least, distorted the market.


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