Spring has sprung in the Australian housing market, at least in Sydney and Melbourne. Why have house prices started rising again? There are a few candidate explanations.
The first theory is that the Coalition’s surprise victory in the May 18 federal election boosted prices. Labor’s policies to reform negative gearing and halve the capital gains tax discount, it’s said, would have dampened prices; Scott Morrison’s win should have taken the handbrake off.
Another candidate is the post-election interest rate cuts.
But our analysis, using daily house price data compiled by Corelogic, suggests that the bigger driver may be the prudential regulator’s post-election decision to loosen the lending restrictions it imposes on the banks.
House prices didn’t rebound immediately after the election
Across the five biggest Australian cities, house prices jumped 0.14 per cent immediately after the election – but then remained stagnant for a further three months. If the election result had a big effect on prices, it certainly took its time to show up in the data.
And the post-election price jump is a Sydney and Melbourne story. In each of the other big Australian cities, prices continued to fall after the election and remain below their pre-election levels even now, months on.
Rate cuts should boost prices but only over time
Nor did prices rebound immediately after interest rate cuts in June and July. But the Reserve Bank has signalled that rates could go lower still in the coming months, and the combination of all these cuts should boost prices over time.
Recent Reserve Bank research suggests reducing interest rates by one percentage point would be expected to lead to house prices rising by 8 per cent over the following two years.1 This suggests that the 50 basis points of cash rate cuts to date should see house prices 4 per cent higher than they otherwise would have been over the next two years. If the Reserve Bank cuts rates by a further 50 basis points in the coming months, as markets expect, prices could be 8 per cent higher than otherwise.
The prudential regulator has put the spring back into the property market
Prices took off with a bang, however, after rules banks implemented new rules governing how banks assess loan applications.
Since December 2014, the Australian Prudential Regulatory Authority (APRA) has required banks to assess borrowers’ ability to repay loans assuming a minimum interest rate of 7 per cent. In changes flagged soon after the May election, and finalised in July, banks will instead be able to assess loan applications using current interest rates plus a 2.5 per cent buffer. 2 Analysts have suggested the rule change has increased borrowing capacity by 10 to 15 per cent. Banks began applying the new rules to loan applications over late July and early August, which means the first buyers would have received pre-approval and found a property to purchase by mid-August.3
And house prices have since rocketed in Sydney and Melbourne. Property prices in both cities are now over 2 per cent higher than they were at the start of August. If sustained, the pace of current increases would see double-digit annual house price growth in Sydney and Melbourne over the next year.4
Past tightening in borrowing capacity had the biggest impact on prices in Sydney and Melbourne, where price-to-income ratios are highest and mortgages are typically larger. So it’s no surprise that it’s in those markets that house prices are accelerating again.
The rebound also coincides with the Federal Court’s ruling in favour of Westpac over ASIC on August 13 over the question of what constitutes responsible lending.
The decision made clear that banks should judge consumers’ ability to repay loans by looking primarily at their income – not their expenditure. Justice Perram found in favour of Westpac, famously stating that “I may eat wagyu beef every day washed down with the finest shiraz but, if I really want my new home, I can make do on much more modest fare.”
But that ruling is unlikely to have driven the recent price rises because it has not yet been translated into lending policies.
Where to from here?
House prices are clearly on the rise again, and that means policy debates about housing affordability will return to centre-stage. Reforms to negative gearing and the capital gains tax discount were always going to be a harder political sell while house prices were falling. But if prices keep rising, there’s a good chance they’ll be back on the political agenda.
Co Authors :
- The researchers model the scenario where the cut in interest rates is temporary, and is expected to last for three years. Under a similar permanent fall in interest rates, due to structural factors such as population ageing that reduce the real interest rate, house prices would rise by 28 per cent.
- The change came after regulators, including the Reserve Bank, became concerned that banks were becoming too risk-adverse in their lending practices. And APRA was concerned that that the gap between the 7 per cent floor and the actual rate of interest paid had become unnecessarily wide.
- Based on a sample of guidance to mortgage brokers from 14 banks, including the four majors.
- The Corelogic daily data tells a similar story to other housing market data: the market is taking off again, at least in Sydney and Melbourne. Data from Domain shows that fewer rental properties are vacant. Auction clearance rates are up. Other forward-looking indicators of the housing market – like the number of people showing up at home opens – are also pointing up.