Will the Royal Commission change Australia’s housing market?
For those of you looking to set up a mortgage, it is worth knowing that credit conditions have changed. The Royal Commission’s recent inquiry into banking misconduct has resulted in more stringent lending policies and lower credit availability. A bigger question, however, is what effect that this may have on house prices? From an economic perspective, a lower availability of credit correlates to a reduction in house prices. However, given Australia’s housing supply-demand relationship, it is likely that the drop in prices would be modest at worst.
Background – Australia’s Housing Market
It could be said that the major property boom over the last two decades has been a result of ineffective and at times, questionable banking practices. Banks have been continually giving out loans on the basis of flawed assumptions that hugely underestimate the living expenses of the applicants. For example, one of the assumptions is that the living expenses would be the same at $32,400 for households earning a basic income of $80,000 and households earning $500,000 or more. The ease of finance has resulted not only in the overvaluation of the Australian housing market but more importantly, it has created a huge household debt to GDP ratio of 100% that places the economy in a precarious position. Thus, the International Monetary Fund (IMF) has warned that such a high level of indebtedness is a source of vulnerability which could lead to prolonged recessions.
Effects of Tightened Policy
So let’s explore the two main implications of the policy reforms: less credit availability and drop in house prices.
Less credit availability
The new lending policies have made adjustments to the House Expenditure Measure to encapsulate higher living expense assumptions for a given income. For example, households making $80,000 their assumed expenses are now $50,000 as opposed to $32,400. Based on the average of the four major bank’s calculators this means that the amount they could borrow decreases from $337,985 (4.2x income) to $195,912 (2.4x income).
Furthermore, the new policies have decreased the number of eligible borrowers. Data from Digital Finance Analytics have shown an increase in the number of loan rejections this year. From January to July 2018, loan rejections for first home buyers rocketed from 353 to 3,828. For investors, this was more staggering – from 1,564 to 16,076.
Drop in Property Prices
With less credit available, buyers would have less ammunition to bid up house prices and thus house prices would fall. However, it is unlikely that the drop would be substantial. This is due to two factors (among others) unique to the Australian housing market: 1) High consumer demand 2) Low supply of houses.
- High Consumer Demand
The high demand for houses is driven primarily by Australia’s increasing population. Australia’s natural population has dramatically risen from the mid 2000s as a result of immigration, with the peak growth rate of 2.2% occurring in 2007.
Smaller Household Size
The amount of individuals per household would also directly affect housing demand for a given population. A smaller household size average corresponds to higher demand for houses. Data from the Australian Bureau of Statistics have indicated that household size has fallen from an average of 3.5 in 1960 to 2.5 in 2011.
- Low Supply of Houses
In comparison to the high population growth and property demand, the supply of houses have only grown at a modest rate of 145,000 additions per year. This has generated an excess demand which is a relevant driver in high property prices
As such, it is unlikely that the Royal Commission’s recent inquiry would have catastrophic implications on the Australian housing market. In fact, economists predict that the declines would be no greater than 5-10%. Nonetheless, it is best to remain vigilant for future events whether as a current or as an aspiring homeowner.
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