Bubble Trouble

Soaring House Prices

When the Reserve Bank of Australia’s board meets, a key topic of conversation will be the reaction of our unusually interest rate elastic housing market to recent reductions in local borrowing costs.

The bottom line is that Australia’s housing boom is racing away. So-called “macroprudential” constraints on bank lending, which place a soft limit on credit growth at four times current wages growth, have had zero impact to date.

And contrary to new Treasury Secretary John Fraser’s claim, the soaring house prices are not a “global phenomenon”. They are exclusively an artefact of the RBA’s decision to slash borrowing rates to the lowest levels in history.

People forget that Sydney prices fell by a record margin between late 2010 and mid 2012. It was only after the RBA cut its cash rate from 4.75 per cent in October 2011 to a “crisis-level” 2.5 per cent in August 2014 that the great east coast housing boom was truly ignited.

Cash Rate Effects

In contrast to America and Britain where fixed-rate mortgages are much more popular, the vast bulk of local borrowers have their loan costs determined by the overnight cash rate. This makes their investment decisions extremely sensitive to monetary policy movements.

From Boom to Boom

In 2014 many dismissed The Australian Financial Review’s forecast that the RBA’s cuts would fuel double-digit house price appreciation and force regulators to introduce macroprudential regulations on new lending.

Back then the conventional wisdom was that because Australian households had already leveraged up before the global financial crisis, we could not possibly get another debt-led boom.

Yet since 2012, home values across the five biggest capital cities have leapt 23 per cent with Sydney prices jumping 35 per cent.

Since 2014, Sydney property prices have inflated at a 14.4 per cent annualised pace, and 10.5 per cent in Melbourne. National price growth has not been far behind at 9.3 per cent.

Some argue that this boom is nothing to lose sleep over because it is limited to these two cities. Yet New South Wales and Victoria represent almost 60 per cent of Australia’s total population, and if you add in Queensland (where property values are rising at 2.3 times the rate of wages), the east coast accounts for 78 per cent of all residents.

When the RBA’s board members congregate, they will confront a new challenge. The housing boom that looked like it was cooling in the final quarter of 2014 appears to be heating up again.

This is the predictable result of the RBA’s February rate cut, which has shaved the discounted variable mortgage costs to just 4.29 per cent, combined with the related currency depreciation that has made our bricks and mortar even more attractive to overseas buyers.

In the final six months of 2014, Australia’s volume-weighted auction clearance rate averaged a robust 68 per cent according to RP Data. The highest weekly clearance rate in 2013 and 2014 was 76.2 per cent.

Comparable conditions

To find comparable conditions you have to go all the way back to September 2009, when Australian real estate was surging on the back of massive stimulus provided by the Rudd government’s first time buyer “bonus” and a record low (at that time) 3 per cent cash rate. The current house price action is even more disconcerting.

Over the three months to 27 February, 2015, national prices climbed 2.5 per cent, which represents annualised capital gains of 10.5 per cent. That’s more than four times wages growth, which is running at 2.5 per cent.

Dwelling values in Sydney and Melbourne have appreciated at a 12 per cent and 18.4 per cent annualised rate, respectively, over the last quarter (and by 13.7 per cent and 7.3 per cent, respectively, over the past 12 months). According to the RBA’s data, housing credit growth is also rising at 2.8 times the rate of wages, which is pushing Australia’s housing debt-to-income ratio, which was already at an all-time peak of 139 per cent in September, further into uncharted territory.

And finally....

One of the RBA’s preferred valuation benchmarks, the national house price-to-income ratio is now above its preceding high watermark touched in 2007 and again in 2010. After both these episodes, home values fell by 6 per cent to 8 per cent.

There are two silver linings to this leveraged asset price inflation.

  1. capital is pouring into new construction, which will give a much-needed boost to historically inert housing supply that has not been keeping up with underlying demand.
  2. Australia’s housing debt-to-assets ratio has been declining as prices outpace credit growth. This means the value of the collateral protecting bank balance sheets has been improving.