AFR Article 3-4 July 2021 Page 28
Economic forecast A key government report warns that the biggest drivers of residential real estate growth could be starting to weaken, writes Duncan Hughes.
Property buyers will be caught in “machine gun alley” if predictions by an influential government study into future economic growth that flag sharply rising interest rates and falling population growth turn out to be true.
The new Intergenerational Report calls time on the 25-year property boom – fuelled by falling interest rates and undersupply – which has driven up prices and made it increasingly difficult for first-home buyers to enter the market.
Chris Richardson, a partner with Deloitte Access Economics, warns property developers will be under pressure as population growth slows and the risk of oversupply rises, particularly in traditional hubs such as Melbourne and Sydney.
“At face value, it is not a pretty document for developers and buyers,” said Richardson about the federal government’s latest Intergenerational Report on the big-picture economic issues of the future.
Key issues affecting property buyers and developers include slower population growth and lower levels of migration because of restrictions on travel caused by COVID-19. The report assumes 10-year bond yields will increase over time back to levels consistent with nominal gross domestic product growth of about 5 per cent. Bond yields are currently about 1.5 per cent.
“That would be machine gun alley for property buyers and should have them quaking in their boots,” Richardson said of a trend that could more than double average 30-year variable mortgage rates to about 7 per cent.
The accompanying chart shows the relationship between the benchmark 10-year Australian government bond yield and home loan rates.
“If the long-term expectation for the benchmark is 5 per cent – or about 3.5 per cent higher than today’s yield – it is a reasonable expectation that loan rates for owner-occupiers and investors would also be around 3.5 per cent higher over the long term than today’s low rates,” Canstar financial commentator Steve Mickenbecker said.
That would result in the average variable rate of owner-occupier loans doubling from 3.59 per cent to 7.09 per cent, or adding another $2000 to the monthly repayments on a $1 million, 30-year principal and interest loan.
“A 5 per cent, 10-year bond yield will also mean that inflation has taken off so that salaries will have increased. But with today’s escalated loan amounts, there will be stress attached to the higher repayment,” Mr Mickenbecker added.
Interest rates are already beginning to creep up, particularly for four- and five-year fixed rates as funding costs rise.
Shane Oliver, AMP Capital’s chief economist, said the convergence of economic growth and bond yields is a reasonable assumption consistent with “long-run historical relationships”.
“If migration levels only get back to pre-pandemic levels by 2024-25 and don’t make up for lost ground through the pandemic, then the population in five years will be nearly 1 million smaller than previously assumed, and this will mean a net loss in demand for homes of around 350,000 over five years compared to what might have been expected pre-pandemic,” Oliver said.
“If dwelling construction continues around its current pace, this will see the property market move into oversupply in the years ahead.”
Two key drivers of the long-term property boom that began in the mid-1990s – low interest rates and undersupply of property – will come to an end, he says.
“It would be good – or at least better – news for new home buyers,” Oliver said. “But it may not be so good for property developers – particularly those in cities like Sydney and Melbourne – who have become dependent on rapid property price appreciation.”
Borrowing commitments by investors are at an 18-year high, having increased by nearly 13 per cent to nearly $8 billion in the three months to the end of May, according to government statistics.
The nation’s home-building pipeline is full, with demand for supplies and labour exceeding availability even as the sugar hit of the government’s HomeBuilder stimulus drops out of the system, according to economists.
Critics of the Intergenerational Report contest some of the underlying assumptions about the size of any rate rises and suggest strategic responses for property investors and developers.
Deloitte’s Richardson argues weakness in the economy, weak wages growth, low inflation and structural changes will keep a lid on rates.
Andrew Wilson, the chief economist at My Housing Market, adds: “We are continuing to find factors hampering any return to long-term normal, particularly income growth.”
Wilson said the types of property investors were seeking had also changed, with demand for fringe developments and high-rise being replaced by more competition for bigger townhouses. Circumstances were changing, he said, and the past may not be an accurate guide to future events.
Simon Pressley, a buyers’ agent and head of research for Propertyology, said population growth was “way down the list of influences on property prices” after interest rates, jobs and economic confidence.
“Given that all overseas migrants rent property, it is the rental market – as opposed to property values – that is likely to be more affected by border closures,” Pressley said. “Also, regions have very little reliance on overseas migration. Further, an increasing number of people are relocating from capital cities, especially Melbourne and Sydney.”
Mickenbecker said the prospect of higher rates meant buyers should start paying off their loans while rates remain low.
“There is time now to build a buffer through making extra repayments while interest rates are low. But as rates rise whether two or three years away, that will get tougher,” he said.
