Is Now The Time To Buy?

March 28th 2014

House prices are moving into very dangerous territory.

They are rising so fast and are moving to a point where there is a very real risk of a situation that spills over to poor borrowing decisions, relaxed lending standards and financial market malaise that would threaten to end Australia’s multi-decade economic expansion.

Up until the end of last year, there was little to fear about rising house prices. There were even many positives about the effect of the rise in house prices on the economy especially in terms of wealth creation for home owners, which spilt over to stronger growth in consumer spending. Also positive was the fact that higher house prices started to encourage new construction as developers built dwellings in full knowledge of a profitable sale. Bank balance sheets are also enhanced as house prices rise.

Also important to note is the fact that house prices fell 7 per cent slump between late 2009 and early 2011, which means that the 11 per cent rebound to the end of 2013 was not a big deal. In other words, house prices at the end of 2013 were in net terms only about 4 per cent higher than four years earlier.

But now, with prices rising at an annualised pace of close to 15 per cent, there are difference pressures emerging.

Potential home buyers are rushing to purchase, having missed out on lower prices just a few months ago. While difficult to quantify, there is a risk these buyers are biting off more than they can chew with high levels of debt. The problem would be in a case of either interest rates rising or if their employment situation deteriorates. 

Investors, who are seemingly still non-plused with the low interest rate on term deposits and nervous about where the stock market might be going, are piling into residential property. Around a third of new housing loans in the past year have been for investment purposes.

Throw in some strong demand from demographic factors, especially strong population growth, and the cocktail for a house price problem is real.

There is also a risk that strong growth in house prices spills over to broader inflation, as it is prone to do if left unchecked. This is something the Reserve Bank would be keen to avoid.

The simplest solution to the house price problem in simple – higher interest rates.

For the moment, the Reserve Bank seems reluctant to increase interest rates due to its assessment that the economy is only just approaching trend growth. If it maintains this view for too long, house price gains will, of course likely rise further making the problem even larger in the months and years ahead. In other words, it would seem to be prudent for the RBA to start to hike interest rates soon, to head off the pending price problem.

What could also happen, although the time frame for it impacting on prices is very long, perhaps several years, is a dwelling construction boom. The more houses and other dwellings that are built, the more likely demand can be satisfied without resort to buyers bidding up prices.

Over the past year or so, there has been a very welcome increase in building approvals which will add to housing supply once those approvals become finished houses. 

But that can take a long time and further increases in building approvals are needed over the next few years of demand to be satisfied.

In all, the favourable impact of rising house prices is now turning into a potential problem for the economy and stability of the financial system. Double digit annual increases in house prices are not sustainable.

This is why a move to higher interest rates is likely over the course of the next 12 months and why we may be near the end of the robust house price growth of the past year or so. New supply, sparking by the building boom, is also likely to dampen price pressures, especially if it coincides with the expected interest rate rises.

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Is Now The Time To Buy?
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