Why do residential property prices continue to surge despite an ongoing financial crisis? Aren't property investors scared?
The Sydney property market has continued to grow substantially over 2020 and into 2021, increasing 24% year-on-year to the June quarter. Despite the ongoing effects of the COVID-19 pandemic and the further potential impact of current lockdowns and economic pressures, in Domain’s recent Domain House Price Report for June 2021, it was highlighted that the median price for houses and units was $1,410,133 and $786,175 respectively.
But how and why has this occurred, you would assume, that in a time of significant health and economic uncertainty, that consumers would be more conservative and spend less on discretionary items?
Let us first consider the supply and demand of the Sydney residential market. Strong population growth in recent years, as a result of overseas migration, has positively contributed to population changes in Sydney, experiencing an increase of 42% in migration between 2010 and 2019. Furthermore, in 2019, 60.2% of annual population growth was due to net migration. However, following the beginning of the global COVID-19 pandemic, there has been a sharp decline in overseas net migration of 98.7%, on the previous year, as at December 2020, which should contribute to reduced demand for residential housing.
Over the past decade, housing construction has risen, reaching a high of 30,797 private dwelling new builds under construction in March 2018. Despite a slowdown in new building construction from 2018 to 2020, new housing construction has increased by 40.2% over the past year as at March 2021, leading to a significant increase in supply in the residential market.
Generally, a reduction in demand and increased supply would lead to an oversupply in the housing market and a reduction in prices. However, median house prices continue to rise increasing 8.2% since the March 2021 quarter. So why is this the case?
A low cash rate set by the Reserve Bank of Australia (RBA) means that interest rates, and subsequently the cost of borrowing, is low. The current cash rate has been 0.10% since November 2020. A low cost of borrowing has contributed to the ability for consumers to purchase property at a higher price as they can afford to borrow more. A low cash rate ultimately drives inflation, noting the Consumer Price Index (CPI) increased 3.8% as at June 2021 on the previous year, partly due to a rebound from recessionary conditions in the June 2020 quarter. These levels of inflation have been driven mostly by demand-pull inflation, where aggregate demand has increased in the health sector, and in goods and services such as alcohol and tobacco, clothing and furnishings and household equipment over the previous year. A level above the inflationary target of 2-3% indicates that the cost of borrowing may ultimately be too low and could be a key contributor to surging house prices in Sydney. Additionally, the Residential Property Price Index, measuring inflation in the property market, rose 8.0% in the last 12 months.
A significant driver of strong house prices is the low level of interest on variable and fixed-rate housing loans. Noting the low rate of 3-year fixed-rate home loans at circa 2.28%, as at 2nd August, which allows consumers to maintain the same cost of borrowing for the next 3 years. If any changes to the cash rate were to occur, a reduced impact would be felt in the residential market following this period.
There is also high household debt, above 175% of household disposable income. In comparison to other OECD countries, as at 2020, Australia ranked 5th highest for household debt to net disposable income ratio. High levels of debt may restrict the domestic economy and economic growth prospects in the future as consumers are less willing to spend on discretionary items.
Moreover, increased levels of household savings, reaching a high of 22% of household income in the June 2020 quarter, may have been a key contributor to rising property prices. High levels of savings can allow consumers to spend more on domestic properties, especially when other discretionary items such as airline flights and interstate and overseas holidays are extremely limited or not possible. Additional savings increase the potential deposit and allow higher borrowings, as well as make it easier for consumers to service their debt. Spending more time at home and with many continuing to work from home has increased consumer demand for houses with particular features such as a study, pool, outdoor areas and waterfront high on housing search lists.
Cheap debt, increased savings and with people spending more time at home, the high demand for residential housing continues to drive house price growth. The end of COVID-19 will increase migration, savings will begin to fall and health restrictions removed, the expectation is for house price growth to plateau or reduce marginally. New entrants will need to be creative to enter the Sydney housing market as while debt remains cheap there will unlikely be the significant price correction many people are craving.
By Sophie Doherty - First Year Bachelor of Economics (Econometrics and Mathematics)