House prices – too strong for too long?
The Sydney housing market was recently described by Reserve Bank Governor, Glenn Stevens, as “crazy” and “acutely concerning”, while Treasury secretary John Fraser proclaimed that Sydney, and to a lesser extent Melbourne, was showing “unequivocal” signs of a housing bubble.
These comments shouldn’t come as a surprise considering Sydney dwelling values have shifted 15% higher over the past year and are up nearly 40% over the past three years. This level of growth comes at a time when rental rates are hardly moving (up 3.1% last year and 10% over the past three years), rental yields are compressed (the typical Sydney house is attracting a gross rental yield of just 3.4%) and affordability is a challenge for many segments of the market (the median house price in Sydney is now $880,000).
The exception that proves the rule
Sydney’s housing market growth comes at a time when household incomes are hardly moving. Wages across New South Wales have only risen by 8.3% cumulatively over the past three years and national GDP data shows real disposable income levels are only 1.9% higher over the past three years.
Add to this the fact that households are highly leveraged (the household debt to income ratio is at a record high of 153.8%, most of which is housing debt) and the risk scenario becomes more apparent.
Current market conditions in Sydney are very different from any other capital city housing market where growth conditions are much more moderate. Outside of Sydney and Melbourne, every other capital city has seen dwelling values rise by less than 3.5% over the past year.
It’s useful to examine what happened the last time Sydney’s housing market showed such exceptional growth conditions. Cast your mind back to the year 2000, when Sydney’s housing market was showing even stronger growth conditions than now. Between January 2000 and March 2004, Sydney home values increased by 72%. The post-boom period saw local dwelling values fall by 8.2% and the market didn’t experience any nominal value recovery until four years after the 2004 market peak.
Many economic factors were different back then, so comparisons to the current cycle are difficult. Interest rates were rising from mid-2002, unemployment was trending lower and the resources boom was kicking off as the housing market slowed.
Despite the differences in the economy, it would be surprising if post-boom we saw the Sydney housing market implode due to the fact that lending standards have been consistently responsible and are actually tighter than what was evident pre-GFC. New mortgages with a loan to valuation ratio (LVR) of 90% or higher are diminishing as a proportion of all new mortgages (measured at 11.1% in March this year) and new loans with an LVR of 80-90% are holding relatively firm, at just over 21% of all new mortgages. Additionally, 90 day+ arrears rates remain well below 1% of all mortgages, at just 0.5%.
As well, households continue to save a large proportion of their income which provides some protection against a housing market downturn. According to the ABS, the household savings ratio in March was 8.3%, suggesting households remain somewhat conservative. It should be noted that the savings ratio is now at its lowest level since March 2008 and trending lower. In its latest Financial Stability Review, the RBA points out that the average mortgage buffer, based on funds held in offset accounts and redraw facilities, has grown to be 16% of outstanding balances, which is more than two years’ worth of scheduled repayments.
Overall, the risk of a substantial correction in dwelling values across the Australian housing market is most concentrated in Sydney and (to a lesser extent) Melbourne, where dwelling values have increased substantially post GFC. The longer dwelling values continue to outpace income growth and rental prices, the greater the risk. These risks are somewhat offset by other factors such as a high rate of savings, responsible lending standards and organic population growth. However, the longer this growth cycle runs in Sydney, the more the market is at risk of a more substantial correction.