RBA Forecast “Large increase in prices… unlikely”

The RBA looked at underlying demand for housing (population growth and household formation) and supply (housing investment & construction) to consider future housing construction activity in Australia. It is a significant driver of economic activity. As it may potentially cushion/replace the fall in mining related capex and associated unemployment currently forecast to occur in the resource states in 2015/16 (thanks to declining commodity prices), it is worth spending some time to digest the RBA’s conclusions.

The state of housing construction activity

The number of dwellings constructed and renovated in Australia has stagnated since around 2003 and builders and associated industries have endured a sustained period of below trend activity.

Housing stock has grown at approximately 1.5% versus 2-3% in prior decades, not keeping up with population growth. This can be seen in our dwelling approvals / population growth chart we track in our Australian Property Market Dashboard.

While housing construction volumes are down, the aggregate dwelling investment, as a percentage of GDP, has broadly remained within a steady range, as properties have increased in size and people are spending relatively more on fixtures and fittings.

What has happened to housing demand?

While population growth has outstripped housing construction, the average household size has leveled off from approximately 2000 onwards. This effectively reduce the growing demand for housing, as the number of people per household now remains at approximately 2.6, versus the trend where an increasing number of people have been seeking their own residences, since the 1960s when there were 3.5 people per household.

In summary the RBA concludes the recent slow down in demand and the new construction levels are “broadly in balance, to there being a shortfall of up to 50,000 dwellings per year”.

What is causing this potential supply shortfall

The RBA looked into this extensively a few months back (see here). In short they level it on: increasingly complex regulations levied on developers, often administered by different agencies, a shift towards private funding and delivery of infrastructure and funding, and additional burdens such as greater environmental legislation. This should improve slowly, as Governments currently seek to expedite and simplify the planning processes.

Conclusion

The RBA concludes “it looks likely that dwelling investment will pick up at a relatively moderate rate in the medium term”. They state this will be driven by continued population growth, continued tightness in the rental market, reduced interest rates and continued income growth.

Offsetting factors such as households not showing any “inclination to take on debt at the same rate they did in the 1990s and early 2000s” and the “ratio of prices to income remaining relatively high to its history” lead the RBA to conclude “it is unlikely that a large increase in prices is in prospect”.

This is aligned with our current hypothesis that house price growth will remain stagnant, in real terms, for several years to come, housing construction will gradually respond to underlying supply side pressures, and we should not see the a return to the highly cyclical, speculative construction activity of the past, for quite some time.

Refer to our collection of Australian property market reports for the RBA article and other articles from respected publications, and to our Australian Property Market Dashboard for trends on property price movements and important leading indicators, updated monthly.