Australia's housing slowdown may be sowing the seeds for the next upswing in prices

  • Annual house price growth in Australia has been slowing recently, led by Sydney
  • Economists at Bank of America Merrill Lynch suggest this could see housing construction slow, potentially laying the platform for a reacceleration in price growth from 2020 should population growth remain strong
  • It expects modest supply shortages to reemerge in Australia’s eastern states within a couple of years

Sydney and Melbourne home prices are starting to soften after years of rollicking gains, capped by a record-breaking increase in new housing supply, affordability constraints and tighter lending restrictions introduced by Australia’s banking regulator, APRA, in early 2017.

Just have a look at the chart below from Bank of America Merrill Lynch (BAML) for evidence of the sharp deceleration in annual price growth in both those cities recently, particularly in Sydney.

Source: BAML

And, partially contributing to that slowdown, this next chart from BAML shows the huge lift in apartment supply expected to arrive over the next couple of years.

Again, the increase is most acute in Sydney.

Source: BAML

To Alexandra Veroude and Tony Morriss, Economists at BAML, this has raised concern among some analysts as to how these apartments will be absorbed into the market, fanning fears of a potential oversupply at a time when price growth is already slowing.

“The price moderation has arrived just as the supply of newly constructed apartments is expected to hit record highs, the lagged effect of building approvals peaking late 2015,” they say.

“There are currently 150,000 apartments under construction, with 90% of activity concentrated in New South Wales (NSW), Victoria (VIC) and Queensland (QLD), and follows a 10% uplift to the dwelling stock over the past five years.”

While that could potentially weigh on apartment values in the near-term, especially should the RBA begin to lift interest rates later this year, Veroude and Morriss, pointing to historic relationships between price movements and new housing supply, say that new dwelling starts could fall sharply over the next couple of years, potentially laying the foundation for a reaccleration in price growth from 2020.

“Key determinants behind dwelling investment all point toward housing commencements heading lower from 2018, which will flow through to the housing supply in 2-3 years’ time,” they say.

“Sydney houses prices have the strongest correlation, at 0.75, when leading dwelling starts by three quarters.

“Dwelling price growth in Sydney has eased to 2% year-on-year, and our expectations of the RBA lifting interest rates from Q4 this year and two further hikes in 2019, suggest price growth is unlikely to quickly rebound.

“Based on previous periods of modest price growth, annualised dwelling starts [for both] detached houses and apartments would be expected to fall to around 2013 levels, at 150,000, by the end of 2018/early 2019.”

This chart shows the relationship between annual house price growth in Sydney and national dwelling starts on a rolling annual basis.

Source: BAML

Should dwelling starts fall back to around 150,000 per annum as BAML currently expects, Veroude and Morriss says that could start to lead to supply shortages reemerging should population growth remain strong.

“Assuming population growth remains at 1.6% year-on-year and household formation holds constant at 2.6 persons per household, additional demand for housing, purely from population growth, will be approximately 150,000 dwellings per year. If dwelling starts fall to 150,000, this suggests supply and underlying demand would be in balance in 2020,” they say.

“True demand is typically greater than that solely based on population growth due to the demand for vacant/second dwellings such as holiday homes and replacement demand.”

While Veroude and Morriss acknowledge that any acceleration in price growth may be slower than in the past given the likelihood of higher official interest rates, the continuation of tighter macroprudential lending restrictions and uncertainty over the outlook for negative gearing ahead of the 2019 federal election, if prices are to accelerate, it’ll likely occur in the eastern states.

“We assume population growth in New South Wales steps slightly lower from its current pace, Victoria eases after such strong outperformance, and Queensland picks up to more normal levels,” they say.

“Based on these assumptions, underlying demand is expected to outpace supply in each of these markets.

“Our analysis expects the imbalance to be greatest in Queensland, with a shortfall of around 5,500 dwellings. New South Wales and Victoria are each expected to see shortfalls of around 4,000 dwellings by this time.”

Veroude and Morriss also suggest an increased focus on housing affordability constraints from state governments could provide another upside risk for prices.

“The risk is that policy measures providing grants or concessions for first home buyers simply increases demand and prices that this end of the market,” they say.

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