Property Market Continues to Thrive Against the Odds

The Australian property market is experiencing an unusual recovery, defying expectations of a slowdown despite restrictive interest rates and high levels of household debt. CoreLogic's May property data is anticipated to reveal a third consecutive monthly rise in national house prices, contrary to the usual factors that drive rebounds, such as interest rate cuts or government policies. The supply of properties is constrained due to a temporary drop in sales and a long-standing failure of housing construction to keep up with population growth. This shortage has resulted in a tight rental market, with rental vacancies in capital cities at just 1%, leading to significant rent hikes. Both tenants and landlords are feeling the pressure. However, there is a possibility of rent pressures easing as Australians seek more spacious accommodations in the post-pandemic era, which may result in larger average household sizes.

The tight rental market in Australia is pushing more buyers into the property market, exacerbating the demand for homes in a market with low turnover. Interestingly, higher-end properties appear to be immune to interest rate increases, as evidenced by the mortgage book of National Australia Bank's private bank growing while the retail bank's book remains stagnant. Housing markets in other countries, such as the US, UK, Canada, Sweden, and Germany, are also stabilizing, driven by limited supply, a robust job market, and accumulated household savings. Nevertheless, the current pace of house price growth is deemed unsustainable due to affordability and serviceability constraints. The future path of interest rates will be a crucial determinant of the housing market's trajectory. Money markets suggest an implied peak rate of 4% in September, and Reserve Bank governor Phil Lowe is reportedly indicating that interest rates may need to rise further, particularly if wages increase. Achieving a soft landing for the economy, as desired by Lowe, is becoming increasingly challenging due to the surge in immigration, which fuels housing demand and supports consumption through the wealth effect. Rising rents and borrowing costs are starting to impact household behaviour and economic activity, potentially signaling the early stages of a slowdown. Pimco suggests that when the cash rate reaches 3.5% to 4%, households will start to feel significant financial pressure.

The current fixed-rate mortgage cliff is a cause for concern, as interest rates are at their highest level since 2012, while household debt levels have risen significantly. Mortgage rates have increased by approximately 1 percentage point relative to the cash rate, resulting in the current rate being equivalent to nearly 5% in 2012. This has created the most restrictive environment for Australian households, with interest payments as a proportion of income expected to surpass the peak seen in 2006. The impact of high interest rates on consumption is becoming evident as a significant number of low fixed-rate home loans are set to switch to higher floating rates. By the end of the year, around 50% of these loans will be refinanced, representing approximately 17% of all mortgages. This mortgage cliff represents a critical moment for the housing market and the Reserve Bank, which is grappling with uncertainty and conflicting forces. While it has never been wise to bet against Australian house prices, it is risky to solely rely on the Reserve Bank to mitigate the situation, as expectations of interest rates quickly decreasing may prove unfounded.

Source: https://www.afr.com/property/residential/brace-for-impact-borrowers-face-their-biggest-test-ever-20230525-p5dbax