Digging A Bigger Hole In The Australian Property

Owning Australian property is an honorable and admirable pursuit. We work and save eventually to own a piece of Australia that we call home. But for Gen Y and younger, it might remain just a dream.

Baby boomers, born between 1946 and 1964, have the highest home ownership rates in Australia. During their time, house prices were more affordable and often manageable on a single income.

This affordability allowed baby boomers to benefit from significant appreciation in their property’s value over the decades.

It is no secret that housing affordability has been a major topic for some time. Especially more now as interest rates have risen rapidly in the past year.

Historically, interest rates would be considered low if we compare it to 1980’s when interest rates peaked above 17%. How did baby boomers afford housing when interest rates were so much higher compared to now?

Loan values were typically five times a family’s annual income, whereas now, we often service loans at 15 times or more our annual income.

A recent article predicts that Brisbane and Adelaide will reach median house prices of $1 million by December, raising the question: have we financialized housing so deeply that there’s no turning back?

Australian Property Values Only Goes Up

There’s a growing belief that Australian property will only increase in value. Over the past 20 years, this idea has seemed credible, with property values doubling every seven years.

This translates to a 10% compounded annual return, and with leverage, the returns can be even higher. However, the longer term average works out to be a 3-4% increase annually. Which begs the thought: how much longer can property values increase at this pace?

During the pandemic, many borrowers struggled to make repayments due to job losses, but they were given some leniency. Mortgage default rates began to rise, prompting banks to set aside provisions.

However, the government managed to prevent disaster with much-needed stimulus checks as we emerged from lockdowns.

The reality is that the government is unlikely to let Australian property values crash, as such a scenario would be devastating for the economy.

The majority of property purchases are financed through bank loans. If a large number of borrowers were to default and fail to repay these loans, the consequences would be catastrophic.

We saw the effects of the 2008 financial crisis, where the financial system collapsed, and bailouts were needed to save the global economy.

It’s crucial to understand that financial institutions borrow and lend to various individuals and companies. Our economy is globally interconnected, so a major bank failure wouldn’t be an isolated incident.

Not to mention, it would be very unpopular for the sitting government to be in this predicament. When the majority of Australian’s net worth is tied to property there is only so much a person would do to take that away.

Rising Interest Slows Down Australian Property

Rising interest rates primarily reduce the borrowing capacity of individuals and corporations, which in turn diminishes their purchasing power. For Australian property, this typically means that buyers can afford to offer less.

However, the dynamics of supply and demand can complicate this picture. When there are fewer houses for sale and more buyers, demand for limited stock increases.

From 2002 to 2023, Australia experienced a net annual gain of 518,000 people due to overseas migration. While many of these arrivals were temporary visa holders, the country still saw a net population growth of roughly 2%.

This growing population has outpaced the availability of housing, creating a scenario where, despite higher interest rates limiting borrowing, more people are competing for the same number of properties.

In 2024, the construction industry faced significant challenges, with a record number of insolvencies, including the notable collapse of Porter Davis. This industry turmoil adds pressure to the housing market, as the capacity to build new homes struggles to keep pace with demand.

As a result, Australian property prices may either increase at a slower rate or continue to rise due to the high demand, despite the challenges of rising interest rates and affordability issues.

Property Last Line Of Defense

To combat rising inflation, central banks around the world, including the Reserve Bank of Australia (RBA), increase interest rates. This strategy aims to slow down economic activity by reducing the amount of money circulating in the system.

This approach contrasts with measures taken during economic downturns, like the recent pandemic, when stimulus efforts were necessary to boost spending.

Unlike the United States, where home loans often have fixed rates for 30 years, Australian homeowners experience a significant impact on their finances when interest rates rise. This is because loan serviceability changes with the RBA’s rate adjustments.

The purpose of raising rates is to curb excessive spending, but the burden often falls hardest on new homeowners with large mortgages. These individuals aren’t necessarily the ones driving inflation through excessive spending.

As home loan rates increase, monthly repayments rise accordingly. Given the large size of these loans, even a small rate increase, like 0.5%, can dramatically raise monthly payment obligations.

Wages don’t increase quickly enough to keep pace with these rising costs, so households are forced to cut spending elsewhere.

Typically, this means reducing retail and discretionary spending. Recent reports indicate that after construction company insolvencies, the retail and hospitality sectors had the next highest insolvency rates in FY2024.

The result is a decrease in overall economic spending, as Australian property owners prioritize keeping their homes over other expenditures. Australians will cut back on non-essential expenses, like coffee, and find other ways to make ends meet.

Unfortunately, businesses unable to generate sufficient revenue may close, leading to job losses. However, this reduction in spending and economic activity is considered necessary to bring inflation under control. It’s a challenging but necessary adjustment for the long-term health of the economy.

Key Takeaways

• The government is unlikely to let property values crash, as such a scenario would have severe economic consequences.
• Rising interest rates reduce borrowing capacity, but high demand from a growing population and limited housing supply can still drive up Australian property prices.
• To combat rising inflation, central banks, including the RBA, increase interest rates. This reduces spending power, impacting new homeowners and leading to reduced discretionary spending, business closures, and job losses.

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