Australia’s housing sector has turned sharply as a deep economic shock from the COVID–19 pandemic has upended the market.
The housing market is driven by owner-occupiers, where affordability and expected affordability are key, and by investors where conﬁdence dominates.
How this will play out moving forward was the subject of recent commentary by Westpac in their latest housing market update.
Westpac's economists said:
Westpac's Investor Housing Sentiment Index and our analysis of affordability are the key inputs to our house price forecasts.
Our preferred measure of affordability includes interest rates, current house prices and incomes while expected affordability captures the impact of changes in the labour market (highlighting employment and income uncertainty) and house price expectations.
On affordability, one of the factors noted as a positive – the absence of a material monetary tightening prior to the recession – is also a negative.
Interest rates may not be coming from a high starting point but they also have no scope to move lower.
Monetary policy has been the primary tool for cyclical demand management, but is no longer able to stimulate in the same way.
The RBA's March easing has taken its cash rate target to 0.25%, the effective ‘lower bound’.
The RBA remains of the view that moving the policy rate into negative territory brings more costs and risks than beneﬁ ts.
And while the Bank still has some ways to generate further stimulus, these are unlikely to move mortgage interest rates much lower.
This has important implications for how the current correction will play out.
Firstly, it means most of the affordability improvement must come from lower prices rather than lower interest rates or higher incomes.
Chart 19 below shows our preferred measure of affordability – the proportion of income required to ﬁ nance the purchase of a median priced dwelling (regular readers will be familiar with this metric and the close links it has to our survey’s ‘time to buy a dwelling’ index).
While affordability is not overly stretched on this measure – below recent peaks in 2017, 2010 and 2008 – it is still well above its long run average, implying we need to see a material improvement before it starts to provide support to demand.
We estimate that an affordability improvement of 3-3.5ppts will be needed.
While that is less than the adjustment seen during the GFC, ﬂ at interest rates and weak income growth mean the bulk of the adjustment will have to come from prices.
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Our estimates suggest a 10% fall in prices should provide enough of an affordability improvement to start supporting demand (noting that the correction and the extent of support will vary state to state – table 17 shows our forecasts in more detail).
Nationally, a 10% decline is comparable to the correction seen during the GFC.
The second question is how this may play out in terms of dynamics.
Clearly the level of interest rates, prices and affordability are important – but interest rate changes also provide a critical catalyst for housing markets to turn.
Housing-related consumer sentiment shows a very clear response to rate cuts that is usually a precursor to a pick up in activity (a link we rely on heavily for this publication).
Without rate cuts it may take longer for improving affordability to see a recovery take shape.
Investors will tend to exacerbate this weakness.
As set out on p10, conﬁdence in this sentiment-driven segment is poor and is likely to remain weak while-ever prices are adjusting.
That will reinforce price weakness which could easily extend well into 2021 as a result.
Source: Westpac Housing Pulse 2020. This material contains general commentary only and is not intended to constitute or be relied upon as personal financial advice.
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