Housing price recovery: just eggs not chickens

Yet you could be forgiven for thinking a strong housing upswing is already emerging.

" The improvement in purchase affordability has been only modest, and unevenly spread.”

ANZ Research argued in April that signs of an end to the housing downturn were emerging. Since then a number of favourable developments have followed. The Reserve Bank of Australia (RBA) cut interest rates, wholesale market funding conditions have improved, the prudential regulator has proposed easing the mortgage interest rate floor, the Australian dollar has fallen and tax cuts will be delivered through the second half of the year.

But the critical question for the future of the housing cycle is whether it is restricted credit supply or subdued credit demand that have been more important in driving the downturn.

If it's primarily credit demand then signs of market stabilisation, coming after the largest Australian house price decline in modern history, should encourage a V-shaped housing recovery as demand for credit returns.

But if it has been primarily credit supply - as we believe - then the housing cycle will be much more subdued.

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While The Australian Prudential Regulation Authority’s (APRA) relaxation of the interest rate floor will provide a modest easing, it is only small compared with the range of other measures that have been tightened in recent years and which, in some banks, will be ongoing.

Consider the banks' increased focus on debt-to-income ratios across their mortgage portfolios. For some borrowers that will constrain the increase in their maximum borrowing limits to be no greater than the growth in their expense-adjusted income.

Modest growth

It has simply become more difficult for house prices to rise more quickly than income for sustained periods. And income growth itself is, of course, only modest anyway.

There are also two important top-down constraints likely to operate over the medium term.

The first is leverage. Many are treating the slowdown in housing credit growth to a four-decade low of 3.8 per cent as temporary.

But the rate of household income growth is still very modest at about 3 per cent. Tax cuts will see that pick up closer to 4 per cent over the second half of the year. But in order to stabilise the household debt to income ratio over the medium term, barring a surprising pick-up in household income, credit growth can’t grow more quickly than it is at present.

The second is affordability. The recently released ANZ-CoreLogic Housing Affordability report shows various measures of housing affordability have improved over the past year or so. But the improvement in purchase affordability has been only modest and unevenly spread.

On a dwelling price to income basis, for instance, affordability in Canberra and Tasmania has continued to deteriorate, Adelaide has seen no meaningful improvement, and Brisbane has only become more affordable very recently.

Affordability also needs to improve just to keep pace with the tightening in lending standards. In this sense, a given level of affordability today implies less borrower activity than it might have historically.

That means continuing to pull first home buyers into the market may be challenging. State government initiatives saw the number of first home buyers rise sharply in 2017, but they have since declined.

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Remaining rental

In fact, the most persistent trend in improving affordability is for renters. The national rent to income ratio has declined consistently since 2012 and has returned to 2007 levels as growth in rents dipped to recession levels.

The improvement in rental affordability also suggests some potential first home buyers may prefer to remain as renters. We tend to presume more people buying and owning a home is desirable - even though Australia has a very high home ownership rate. As tastes and demographics change, renting is likely to become an option preferred by more, and not just those unable to afford to buy.

ANZ Research doesn’t expect a V-shaped rebound in house prices and neither do they expect a material and sustained improvement in the flow of credit.

Much of what has driven the housing adjustment over the past two years is permanent, affecting both supply and demand. Modest improvements in affordability, therefore, are likely to be insufficient to reduce the affordability overhang and drive a material increase in housing demand.

Richard Yetsenga is Chief Economist and Felicity Emmett is Senior Economist at ANZ