A strong growth cycle, but RBA won’t raise rates yet

8th Oct 2014By: Tim Lawless

The housing market has been increasingly in the spotlight since the current growth cycle kicked off back in June 2012. Since then we have seen capital city dwelling values rise by 18.8% through to the end of September 2014. While the growth cycle has been strong, the rate of capital gains hasn’t been as high as previous cycles.

The 2009/10 cycle saw dwelling values rise by 21.8% across twenty two months. The previous 2006/07 cycle saw values rise by 23.6% between the beginning of 2006 and March 2008, when the market hit a GFC-related peak. The cycle before that was the ‘boom’, which lasted from late 2000 through to the end of 2003, and saw capital city dwelling values rise by an astounding 63.3%.

Of course, these growth cycles have also been balanced by some reductions in values. Most recently, we saw dwelling values fall by 7.4% between October 2010 and the end of May 2012 and prior to that, values were down by 6.1% between March 2008 and January 2009.

There are two important factors in the housing market that are making the Reserve Bank of Australia (RBA) concerned. Firstly, recent capital gains have been very much concentrated across the two capital cities of Sydney and Melbourne since the beginning of 2009. Since then, Sydney values have increased by almost 52% and Melbourne values are up by approximately 47%. The next best performance across the state capitals has been Perth, where values are up by a comparatively low 14.5%. Australia’s third largest capital city, Brisbane, has seen values rise by just 6.0%, Adelaide values are up 10.9% and Hobart values are only 2.4% higher.

Having the vast majority of capital gains so focussed within our two largest capital cities does present some concentration risk. These two cities account for just over 40% of the nation’s dwellings. Historically, a strong run up in dwelling values has been followed by either a fall in dwelling values, as the market moves into the correction phase, or at the very least, a period of value stability – in inflation-adjusted terms this too is typically a fall. A fall in dwelling values equates to deterioration in household wealth, which in turn leads to less household consumption and this has implications for the broader economy.

The other factor that is likely to be concerning the RBA is the growing proportion of home lending being attributed to investment. Over the year to July investor housing finance commitments comprised 38.8% of all commitments, is a record high. Across New South Wales, investors now comprise close to 50% of all commitments, highlighting the popularity of the Sydney market to investors. Based on RP Data logic, the highest investment concentrations appear to be within the inner city apartment markets of both Sydney and Melbourne.

Investments in the housing market are gathering pace at a time when the growth cycle is very mature and rental yields have been substantially compressed across the Sydney and Melbourne markets. This highlights how most investors are purchasing speculatively for capital gains. It is rare for a growth cycle to continue as long as the current cycle has. Chances are that many investors targeting Sydney and Melbourne markets are committing late in the game, when the potential for future capital gain appears limited, and rental income is short due to the low-yield environment (Sydney houses are averaging a gross yield of just 3.6% while Melbourne houses are averaging a 3.3% gross yield).

With a heightened risk profile in both Sydney and Melbourne housing markets, it will be important to monitor the responses from the Reserve Bank and APRA. If investor interests in these markets does not moderate, there is growing expectation that the RBA (in conjunction with APRA) will intervene via prudential regulation of the banking sector in an attempt to slow the level of investment lending activity. As foreshadowed in remarks by the RBA to a recent Senate Economics Committee Inquiry into Affordable Housing, such an intervention is likely to take the form of higher risk weightings (or capital) for investment loans, although this is unclear at this stage. In any event, the goal would be to slow the level of speculative investment across the housing market, particularly in Sydney and Melbourne, alleviating the pressure on the RBA to raise interest rates in order to dampen housing market conditions.

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