In a post-COVID-19 world, the Australian housing market is entering unique and unprecedented times. This has left many individuals wondering what the future of the Australian housing market will look like and whether this really is the best time to invest in property. In the following article, Willy Matuschek, a Finance and Mortgage Broker Brisbane at Borro, gives his professional opinion:
Touching on last year briefly, COVID-19 impacted all of us in one way or another. Throughout most of Australia, life has largely remained unchanged, with low restrictions and returning economic growth. However, COVID-19 did change some aspects of our lives permanently.
In 2020, central banks around the world loosened credit at a rate previously unseen in recent history. The US was forced to provide liquidity swap lines to its trading partners and buy corporate debt to keep credit spreads from blowing out. It also had to support household income through Universal Basic Income (UBI) type payments. Likewise, the Reserve Bank of Australia (RBA) loosened credit conditions, making borrowing easier for many home buyers. The most drastic action taken by the RBA was expanding its balance sheet and suppressing short-dated bonds (more on this later).
Coming out the other side of COVID-19, we can see an extraordinary acceleration in technological infrastructure that companies have built to become more capital efficient. Chief among these is the decentralisation of a workforce and the work from home lifestyle.
“Rock bottom rates. Booming market. Housing Bubble. FOMO. Inflation.”
We’ve probably all become familiar with these concepts over the past 12 months, either through media outlets or day-to-day conversation. Such statements grab your attention and pressure you to take advantage of the current “opportunity” or else risk “missing out”.
It is important to understand that humans are great at telling narratives. A strong narrative can spread, leading some to act. Their actions will then drive certain economic outcomes. Most people will hold opinions on a narrative (sometimes unintentionally) so, we need to look at this topic objectively with all the facts clearly in front of us.
Australia’s Love for Housing
Australians love the housing market. Owning your own home has long been part of the “Great Australian Dream”. To be clear, real estate is a great asset to own because it performs well despite the debasement of the currency, inflationary pressures and growth in society. Not only is real estate a financial asset, but it also serves another important function. The pleasure derived from making your home your own is sometimes of more perceived value than the actual financial gain.
Holding some of your wealth in such an asset is a financially prudent decision. However, the price you pay for the initial purchase will dictate your future returns. The idea that housing prices will only go up has been generally true in the past, but we must also look at what forces drive price appreciation and ask: Is this trend sustainable?
Over the last 40 years, our economy has had lowering interest rates, which has spurred lending and created debt-fuelled productivity. This pursuit of a never-ending business cycle via the use of monetary controls causes distortions in our society.
Debt is borrowing from one’s future productivity. Initially, this is inflationary, as additional purchasing power (money) is created. However, while a loan is being paid down, the additional purchase power (or asset that was created from the transaction) is being destroyed, which is deflationary. Debt should be used to increase productivity via goods and services that, in turn, produces growth and therefore raises incomes. More income naturally results in more spending. Since one person’s spending is another person’s income, it should theoretically create more jobs and productivity within society.
But we have this wrong.
Today, a lot of debt is used to buy assets that do not increase productivity. Rather, it’s used to participate in price appreciation.
Interest rates (which determine the price of money) are a monetary lever the Reserve Bank of Australia uses to contract and expand the monetary policy of the country. Lower rates incentivise people to take on debt and spend now instead of in the future. The longer interest rates are held at lower levels, the more indebted we become (as money is cheap). This adds more and more leverage to the system, making the economy more sensitive to higher rates. The RBA shifts this monetary lever to satisfy its mandates of price stability (targeting inflation above 2%) and full employment before considering raising interest rates.
Australian Interest rates 1970-2021
Inflation achieved through large fiscal policies jolts the financial system, which causes investors and large funds to balance their positions relative to the underlying economic outcomes. This recent rise in interest rates is from exactly that – an expansion of the global economy.
Some economists forecast a paradigm shift in long-term inflation. Higher rates would be a substantial headwind for housing prices, which rely on the momentum of credit to continue to appreciate.
In reaction to COVID-19, the Australian government responded with rapid intent. They began handing out paycheques to support household incomes while banks started allowing borrowers to defer mortgage payments. The RBA also expanded credit in 3 ways:
- They cut rates to new lows, trying to encourage borrowing despite the economic slowdown.
- They established the Term Funding Facility, which provides banks with cheap funding for 3 years after draw.
- They started Yield Curve Control. Essentially, this means that the RBA will hold rates at a set price along the yield curve (regardless of market forces). This is done through Quantitative Easing (QE), which is the government creating an accounting entry (printing money) that allows them to purchase government bonds from large banks’ balance sheets. This gives banks extra cash reserves to loan against.
All this accompanied the government incentivising banks to lend at low fixed rates, while also rolling out policies such as the First Home Buyers Scheme. This made it cheaper for borrowers to get into the market and less risky for banks to lend. We have seen the result for these policies recently reflected in the Australian housing market.
This money will continue to be pumped directly into the Australian housing market.
Governments want people to spend, so the idea of “rock bottom rates” or rates that can’t go negative is false. In a society being choked by its debt load, it needs savers to start spending. And a simple way for governments to encourage this is by having deeper negative real rates, which pushes people further out on the risk curve (e.g., buying investment homes instead of holding government bonds) and introduces spend into the economy.
What seems to be a housing boom due to credit expansion has led to housing prices that are well above “normal” valuation metrics. This does not mean housing prices have to revert to mean valuations in nominal terms – they could just deflate in real terms in the future. This would inflate away the debt obligation while keeping the illusion that prices are still rising (or at least not falling).
In extreme circumstances, heavily indebted governments have two options: Deflate through credit contraction, destroying wealth by letting the asset fall in value. Or inflate, expanding stimulus, destroying wealth by letting the denominator fall in value. It’s a balancing act that policymakers must maintain to avoid bad outcomes.
The Wealth Effect
Sentiment for Australian housing market is particularly important because real estate is the preferred store of wealth for Australians (compared to the US, where stocks are favoured). When an asset appreciates, the owner feels richer. When people feel richer, they spend more, making businesses more money. When businesses make more money, they expand, adding staff and producing more goods. All of this combines to make the country wealthier. This is called the Wealth Effect.
In our economy, this spending is reliant on ever-increasing property prices, which sets the stage for the trend of higher house prices to continue. Any fall in property values may have a similar effect as credit contracting, reducing the amount that people can draw on their equity and making them feel less wealthy. This makes you wonder, can housing prices even fall…?
Australian Housing Index 2000-2021
Australian Consumer Confidence 2000-2021
Everyone wants to be a part of this. Some people enter into the property market with no intention of paying off their loan but purely to speculate on property prices.
This article has so far probably left you with more questions than answers. I will now summarise a likely pathway that I believe we are heading towards.
Government Playing Robin Hood
We are headed towards more capital controls, government stimulus and higher house prices. Australian housing prices will remain dependent on credit growth, the economy will stay hooked on forever appreciating home prices (therefore, accommodating interest rates remain likely) and young couples will continue to feel priced out of the market. This means the government must implement policies to tax the ones who are already benefiting and give money to those who are not.
The First Home Builders grant, First Home Buyers grant and First Home Deposit grant all have one thing in common: they are aimed at new entrants into the Australian housing market. These grants also incentivise people to buy brand new homes, which encourages building and boosts production. We have already started to see this, with more regional planning and more houses being built that are similar in size, shape and price, with no rarity or competitiveness. This trend of “Metricon Cities” will continue and people will be less inclined to buy established homes.
Of course, there will still be some demand for established houses in advantageous locations or pockets of “undervalued” properties. But this market may potentially see reduced liquidity, as there will be fewer buyers who can afford to invest in this kind of property.
Investment has been steadily decreasing since 2016, although we have seen a slight uptick more recently. This could be a combination of existing homeowner’s drawing equity and using it to buy an investment property and established households getting pushed further on the risk curve out of treasuries and into homes (something that has a better risk-to-reward ratio and that is believed to be safe).
However, with capital controls, these trends are unlikely to last as rental yields deplete due to inflation, taxes and fees associated with holding the asset. Capital controls aim to re-distribute wealth, decrease speculation and encourage owners to hold onto their land instead of selling it for capital gains.
Additionally, since all assets compete with one another and with bond yields (interest rates) so low, rental yields will fall in line with interest rates (meaning house prices will rise until their yield is similar to that of bonds).
Here are some recent capital control examples:
- New Zealand is tackling the same problem of young couples getting priced out of the market. To deal with this they’re increased the amount of time a property needs to be held as a primary residence (from 5 years to 10 years) to avoid paying CGT. And they’re removing tax deductibility from interest-only loans for investors.
- Victoria has been the leading state for new capital controls coming out of COVID-19, in an effort to raise funds for its newly proposed budget. They’re looking at increasing land tax on holdings worth over $1.8 million and implementing windfall tax (targeting developers and landowners who reap windfall gains when their property is rezoned). Higher stamp duty will also increase transactional costs, making the market less liquid and incentivising owners to hold onto their property rather than selling.
- Germany previously implemented rental caps in Berlin. While these were eventually overturned, this doesn’t mean governments won’t opt to go down the same path again in the future.
All these controls will make the property market less attractive for investors. As a result, capital will likely move into other assets.
The Bright Side
To end on a positive note, Australia is a country of strength and resilience in tough times. It is rich in resources and diversity. And it has strong political ties to world power, which is important considering the global economy is so intertwined. Lately, we’re even starting to see some disruptive tech companies emerge, which is essential for the digital era we’re entering into. Australian employment data is looking very strong, rising higher than it was pre-COVID-19. This has allowed some families to get out of the rent trap and into their own homes. Now, we just need this positive momentum to continue.
To break the secular trend of lower rates, productivity will have to outpace debt growth in the future.
“My dad told me always stay in 80% debt as housing always goes up” – Australian worker
Humans are built to have a memory bias towards recent events – that’s one of the reasons we usually only learn from what we’ve lived through. Yet the future is unknown, so we must educate ourselves on what could happen and how we can position ourselves to become more financially resilient.
Thank you for reading.
Please note: The views expressed in this article are the personal opinions of the author and should not be viewed as representative of the views or opinions of Borro.