Sure property prices are rising sharply, particularly in the Sydney and Melbourne housing markets, but there's a forgotten factor at play that will continue to put upward pressure on prices.
According to a research report by the ANZ Bank, the ongoing weakness in building approvals is creating a looming housing shortage, particularly in the apartment market.
The ANZ report sates:
The lags between interest rate cuts and building approvals are lengthening as apartments (which take longer to approve and longer to build) become more significant in the housing mix.
There are signs of a pick-up in some of construction’s other leading indicators, which suggest a turn in approvals is imminent.
The decline in approvals to date suggests that construction will fall for some months yet, not picking up until mid-2020.
That fall will feed through to housing supply, and vacancy rates are set to decline over 2020 and 2021.
Across the two major capital cities, the shortage of housing looks likely to be more marked in Melbourne than Sydney.
The housing market has turned around sharply.
Established home prices are rising in nearly all capital cities, and Sydney posted the strongest monthly gain in November since the late-1980s.
If prices continue to rise at the current pace, Melbourne prices will be back to the 2017 peak by February 2020 and Sydney by March.
But so far, there’s little sign that higher prices for established homes are driving a pick-up in construction.
RBA Deputy Governor Debelle noted in a recent speech that:
While the increase in supply has finally met the earlier increase in demand, demand will continue to grow given population growth but supply is going to decline.
So there is quite likely to be a shortfall again in the foreseeable future.
While there has been a wide range of outcomes over the rate cut cycles of the past 30 years or so, prices and housing finance are rising in a very typical fashion.
ANZ found, however, that in this cycle the response from approvals has been at the low end of the range (Figure 3).
While the response of building approvals to the most recent rate cuts has been relatively muted, so far, it’s not outside the range of experience.
Given that apartment approvals account for a much larger share of overall approvals than has historically been the case, it makes sense that more recent cycles will be more lagged than was the case in the 1990s and early 2000s.
Concerns about the quality of newly constructed apartments, particularly in NSW, may be weighing on approvals.
Developers report that while sales of the existing stock of apartments have picked up strongly, pre-sales remain weak.
With a large amount of stock still coming on stream over the next few years, particularly in Sydney, investors seem to be keen to snap up these (often discounted) properties, where they have the opportunity to assess quality rather than take the risk on an off-the-plan purchase.
While this may prove to be a special factor damping the pick-up in apartment approvals, with approvals for detached homes also yet to turn up, we have no evidence in the data to support this theory, as yet.
There are tentative signs of a pick-up in some other leading indicators that point to a recovery in construction in 2020.
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The ANZ-Property Council survey shows a sharp improvement in residential activity, including forward orders and construction (Figure 4).
Similarly, Ai Group construction indexes show a pick-up in sales and new orders for apartments.
And housing finance data are showing signs of a turnaround in lending for housing construction to both households and businesses (Figure 5).
While these indicators point to a pick-up in approvals in the coming months, the lags between approval and construction suggest that housing supply will tighten over the next couple of years.
Given the increased share of apartments in the housing mix and the longer lead-times associated with apartments, the lags are likely to be longer than past cycles might suggest.
This could mean that housing cycles become more pronounced over time, with higher highs and lower lows (for both construction and prices).
In the current cycle, the fall in approvals to date suggests that construction will fall until mid-2020.
This tightening needs to be viewed in the context of a large amount of new apartments coming on stream, particularly in Sydney (Figure 7). Sydney is, in fact, having some difficultly digesting the large number of apartment completions and the vacancy rate is now at a 15-year high.
The Melbourne vacancy rate is close to its long-run average, while Brisbane (where many were concerned about a looming oversupply of apartments just a few years ago) has the lowest vacancy rate of the three eastern capital cities (Figure 8).
Notwithstanding the issues in Sydney, it’s clear that strong population growth is absorbing new housing supply quite quickly.
ANZ analysis suggests the decline in housing supply will drive the national vacancy rate further below its long-run average.
Adjusting the expected change in the housing stock for the increase in the population, we can derive a measure for the “housing supply balance”.
Not surprisingly, this indicator has a good relationship with the vacancy rate.
ANZ forecasts for activity suggest there will be a net deficit of new supply and the vacancy rate will tighten over the next couple of years (Figure 9).
This measured shortage of housing at the national level reflects different performances across the two major capital cities.
In Sydney, where there is currently oversupply, our forecasts suggest that the excess supply will be eroded over 2020 and 2021, but the market will not move into undersupply if approvals pick up through 2020 as we expect.
In Melbourne, however, we expect the vacancy rate to tighten further, with this putting upward pressure on rents and eventually prompting a bigger price and supply response.
The behaviour of approvals over the next few months will be key to informing our view on the housing shortage further out.
Source of graphs and commentary ANZ Bank who warn that this is not investment advice