Australia | Mar 23 2017
By Craig Swanger, FIIG Securities
Australian residential property – 15 years of undersupply comes to an end
Australia’s housing market has defied every doomsayer’s forecast for the past 20 years, avoiding the massive housing market shakeup that hit most other western economies between 2007 and 2011. Can it last?
Australia’s housing market has outperformed almost every other residential market in the world over the past twenty years. Doomsayers from The Economist to local lobbyists like LK Economics have called it a “bubble”, yet the party continues. Residential property is a source of income for many investors, not to mention that their home is typically their largest single asset by value. In this article we look at some of the drivers for the past two decades plus the status of those drivers now, as a sign of what the near future might hold.
Outlook for the Australian residential property
There is no outlook for the Australian residential property market as there is no Australian property market. Other than tax, all the major drivers of property prices are state specific. For example, if there is an overall population growth in Australia, but no one wants to move to South Australia, the South Australian property market will suffer, but cities with increasing population will benefit.
So, you need to assess each of the states individually – more on that later.
Ten years of inadequate supply is coming to an end
In the late 1980s when the CGT tax system was introduced and negative gearing was reintroduced, rents and capital prices rose dramatically causing a boom in construction, ending with an oversupply that combined with the early 1990s economic slowdown to curb both prices and rents.
A significant shortfall in supply of dwellings over the last 10 years:
Figure 1
Source: RBA
By 1995, excess dwellings had been taken up, and rents started to rise again. Prices rose shortly after, kicking off the longest bull market in Australian residential property history. Then, in 2006, the impact of the Howard Government’s increased legal migration programmes supported by the Rudd and Abbott governments – started to impact population growth. Rents rose steeply as the shortage in dwellings across Australia reached record highs, and the 2009 recession only served to slow construction further, leading to more price increases. By 2012 construction had picked up and rapidly reduced shortages. By 2015, construction exceeded demand for that year for the first time since 1999.
Supply has risen, demand from migrants has fallen, and rents are slowing
Supply has now picked up to meet demand, with a net surplus expected for the next three years at least. Population growth has also slowed dramatically since the end of the mining investment boom in 2011 and 2012, exacerbating over supply. Western Australia, South Australia and Queensland have experienced 60%, 40% and 35% declines in their net overseas migration respectively, contributing to a national drop in net migration of around 32%. New South Wales and Victoria are still experiencing near record high overseas migration.
This increase in supply, coupled with lower population growth, needs to be carefully monitored by investors as it will lead to more price volatility in local areas where this imbalance is more acute. At the moment, inner city Brisbane is the most vulnerable as supply is expected to remain high for the next two to three years, and population growth has slowed. However, rental data is providing a strong lead indicator that excess demand has already dropped far enough to push prices down.
Figure 2 shows the medium term rental and capital (price) growth rates for the Australian market as a whole. The shaded areas highlight periods of oversupply (red shading) and undersupply (blue shading), relative to population growth (demand). The chart data uses rolling three year periods to remove short term noise, but the change over the past year is just 0.6%pa; ie there are signs of an even faster slowdown.
Rental and capital growth rates for the Australian market (rolling three year):
Source: ABS
Note: Green line is rental income growth, blue line is price growth
Sensitivity to population growth and density
As mentioned, population growth is a key driver of property price movements. For Australia, net immigration is particularly important as it is far more volatile than changes in the birth and death rates. When Australia’s economy slid into recession in the 1990s, net immigration halved, putting further pressure on the economy and property prices in particular.
This sensitivity is exacerbated by the same point that has created such great performance to date – too many people wanting to live close to the cities, particularly Sydney and Melbourne. The most crowded city in the Western world is London at 5,100 people per square metre (sqm), followed by Athens, Barcelona, Berlin, Paris, Dublin, Rome, Los Angeles, Toronto and then Sydney at 2,200 people per sqm, remarkably ahead of New York and Chicago. Melbourne is 40% less dense than Sydney.
What’s more, Sydney’s density is growing three times faster than London’s – driven by population growth, in turn driven by net immigration, which in turn is driving very steep rises in land values around our CBDs. Sydney’s inner eastern and inner western suburbs have a population density of 8,800 people per sqm.
Quick word on “fake news”
The real estate and banking sectors point to the total shortfall in housing over several years. They claim the cumulative shortfall over the past 15 years justifies current prices. Markets simply don’t work that way. For any year in which there is more supply than demand, excess demand shrinks and the pressure on prices subsides. If there are 120 properties for sale in an area and 100 buyers, it is a buyers’ market and the desperate seller will need to sell at a lower price than the current market. Housing is no different than any other supply and demand market in the world, no matter how much property spruikers might wish it otherwise.
Conclusion
Residential property is an income producing asset, just like other types of property, bonds, equities and real assets. However, residential property captures far more of the headlines due to the enormous profit pools available when markets are strong – for example property developer margins, banking margins, mortgage brokers, and the media themselves. It is also one of the least regulated parts of financial services, so the potential for overzealous research is high. Forecasting property prices is challenging because of this zeal and the love of property as an asset class, particularly in Australia.
While Australia remains a residential address of choice for families in particular, there will be a natural floor under property prices. But from time to time, prices can and will fall particularly when they step too far from fundamentals, like the level of rent earned. Rent is not just about investment income, but the lower it gets relative to value, the more it encourages owners to sell and rent instead.
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