House prices: some short-term bounce but longer-term stagnation

With an upturn in housing finance for the first time in two years and improved auction clearance rates in recent weeks property owners and investors may be tempted to think the slump is finished. They shouldn’t be.

Housing prices may bounce a little but will remain around a stagnant trend for several years, according to Shane Oliver, AMP Capital Investors head of investment strategy and chief economist. Prices remain about 18 per cent above the long-term trend because of the big upswing between 1997-2003. Since the 1920s, house prices have risen on average, 3 per cent a year over the inflation rate. And while there is recent evidence of a tightening in the rental market, the yield from residential housing is even further below the long-term average. AMP estimates that house prices would need to fall 29 per cent (or rents rise by a commensurate figure) for yields to return to long-term averages. In its international comparison for 2004, the OECD rated Australia as having the most overvalued housing market in the developed world. The organisation estimated Australian prices were 51.8 per cent above fair value. The next highest was the UK with 32.8 per cent. Consequently, housing affordability is low, and, according to Oliver, unable to support a strong rebound in house prices. “The key drivers of affordability are house prices, interest rates and household income… While affordability has moved up over the last two years (thanks to stagnant house prices and rising household incomes) it remains very low,” Oliver says. “The housing boom of the 1990s occurred after several years of strongly improving affordability as incomes rose and mortgage rates fell. So far we are yet to see this and as a result it is hard to see owner occupiers come into the market in a big way.” He says housing rental yields remain extremely low, making them unattractive to investors. The average gross rental yield is just 3.2 per cent for houses and 4.1 per cent for units. This compares to a 5 per cent grossed up (for franking credits) dividend yield on shares and a 6.5 per cent or so yield available on non-residential property. Even if low vacancy rates were to result in a 10 per cent rise in average rents this would only push up the average housing rental yield to 3.5 per cent (assuming flat house prices), which is still low. As a result of the low yield it is hard to see investors rushing back into housing. Oliver also believes that any whiff of a return to boom time conditions in the housing market would most likely be met by higher interest rates by the Reserve Bank. The last housing boom was associated with surging household debt and upwards pressure on inflation (partly as homeowners borrowed against their rising wealth levels to finance consumer spending). The Reserve Bank would be keen to avoid a rerun of this. “As we have seen over the last two years, Australians’ very high debt levels mean they are now very vulnerable to even talk of higher interest rates so it would be easy for the RBA to snuff out any emerging recovery,” Oliver says.