Latest NewsWhy Housing is very affordableWednesday, 14 April 2021

It has never been cheaper to buy a house, which is why prices are rationally rising.

Australian Financial Review   (Christopher Joye)

Contrary to popular myth, there is no housing affordability crisis. Quite the opposite, in fact: housing has not been this affordable in a very long time. Indeed, Aussie house prices are surging precisely because residential property has suddenly become much cheaper than it used to be.

Our purchasing power has improved dramatically because of several key influences. First, the federal government’s unprecedented fiscal stimulus prevented a large number of Australians from losing their jobs while contributing to a substantial increase in overall household incomes.

When purchasing power changes, property prices have to adjust in lockstep.

Second, the RBA’s record monetary policy stimulus, which slashed its overnight cash rate to a never-before-seen 0.1 per cent, bailed out droves of borrowers by driving down variable-rate loan costs. (The banks’ very generous repayment holidays also helped.)

Third, the RBA’s novel term funding facility furnished lenders with access to $180 billion of three-year money at a price of just 0.1 per cent, which in turn allowed banks to offer current and prospective home owners the cheapest fixed-rate mortgages in history.

As you might know, it has been possible to get a three-year home loan for less than 2 per cent. (The practical cost of the term funding facility is higher than 0.1 per cent because banks have to back these borrowings by posting high-grade assets, or eligible collateral, with the RBA, which carries additional expenses.)

When purchasing power changes, asset prices have to adjust in lockstep. This is the same logic equity junkies have been rolling out to rationalise uber-expensive price/earnings multiples: it’s the discount rate, stupid.

And as the RBA has been diligent in explaining to anyone who listens, the sharp compression in borrowing costs since the COVID-19 shock is likely to be a semi-permanent feature of our environment for years to come.

For the avoidance of doubt, the RBA is really referring to variable-rate loans, which price off its overnight cash rate. It is not necessarily talking about longer-term, fixed-rate borrowing costs. As the global economy heals, there are good reasons why, say, five-year to 10-year fixed-rate borrowing expenses will trend higher, as they have done since late 2020.

Another big myth about the local housing boom is that this is a uniquely Australian affair.

The unavoidable reality is that at some future date the RBA will be minded to start the gradual process of normalising its overnight cash rate back up to a level commensurate with a “neutral”, or neither stimulatory nor contractionary, risk-free cost of capital (or monetary policy stance). And that neutral cash rate is probably around the 2 per cent threshold, give or take 0.5 percentage points.

That’s why our 10-year government bond yield has jumped up towards 2 per cent: markets are rationally starting to price in a return to some sort of new-normal over the next decade.

Another big myth about the local housing boom is that this is a uniquely Australian affair.

I regularly come across the claim that Aussies are unusually obsessed about residential real estate despite the evidence that our circa 66 per cent home ownership rate is lower than that in China, Norway, Mexico, Spain, Greece, Portugal, Brazil, Italy, Belgium, Finland, Ireland, the Netherlands, Israel and Canada. And it is only slightly higher than the ownership rates in the US, France, Sweden, New Zealand, the UK, Japan and Denmark.

Folks are also fond of alleging that this entirely predictable housing boom (which we projected in the midst of the March 2020 crisis) is idiosyncratic to the sunburnt country. The truth is that even stronger price action is playing out globally as ultra-aggressive monetary policy around the world transmits into cheaper money and more affordable homes.

According to CoreLogic, Australian dwelling values have increased by only 6.2 per cent over the year to March 2021. Yet in New Zealand prices have leapt by more than 16 per cent over the same period. Along similar lines, US house prices are up 11 per cent in the year to February while UK house prices have appreciated 7.5 per cent over the 12 months to January.

Possibly because the RBA has provided less monetary stimulus than its peers overseas, the capital gains experienced here have been relatively subdued. Of course, there is a great deal of runway left!

One curiosity of our contrarian position on Aussie housing during the COVID-19 crisis was that it apparently prompted nontrivial action. I have been surprised how many random strangers have approached me relaying that they bought a house last year, or early this year, on the back of the analysis rendered by this column. I have also noticed that there has been a striking spike in the number of home owners among my 26-person executive team over the past 12 months (I am surprised they listened)!

We continue to confidently forecast total house price growth of 20 per cent to 30 per cent over the next few years from the recent peak in April 2020 purely as a function of the change in affordability. Obviously, risks to this outlook include irresponsible lending necessitating regulatory-induced credit rationing, the spectre of war over Taiwan, and/or a leap in inflation requiring a faster-than-expected hike in interest rates.

Back in March 2020, we forecast that the jobless rate would quickly settle at 6 per cent to 7 per cent, as it did, and were extremely bullish on the immediate economic recovery. The RBA will, however, be mindful that the jobs data will probably overstate the strength of the labour market, and wages growth, while our borders remain closed and population growth is suppressed by the absence of immigration.

This will be a relatively short-term dynamic. We are predicting very material rises in skilled migration over the next five years, which will significantly expand labour supply, keeping downward pressure on wages growth.

Australia is one of the most attractive destinations on the planet for top talent, and the federal government has made it clear that it intends to intelligently capitalise on this once-in-a-century opportunity to capture the best brains in the world (and the meaningful amounts of financial capital that is likely to accompany them).

Over the medium term, the RBA is therefore likely to find it challenging getting wages growth to the circa 4 per cent annual pace required to normalise consumer price inflation back into its target band. And it knows this, which is why Martin Place remains dovish.

Christopher Joye is a contributing AFR editor who has previously worked at Goldman Sachs and the RBA.  He is a portfolio manager with Coolabah Capital, which invests in fixed-income securities including those discussed in his column