House prices keep on booming, but for how long?

The extraordinary surge in house prices continues to roll along. This is despite there being no population growth and a strong rise in the construction which is adding significantly to the number of new dwellings.

For the moment, it seems that low interest rates, a strong recovery in the labour market and demographic changes as a flood of first home buyers leave their rental properties or their parents houses are behind the price surge which has been evident since September 2020.

According to Corelogic, house prices rose 2.2 per cent in May. Since the end of September 2020, just eight months ago, prices have risen 13.9 per cent in Sydney, 12.3 per cent in Brisbane, 11.0 per cent in Adelaide, 10.0 per cent in Perth and 9.7 per cent in Melbourne.

The price gains in Canberra, Hobart and Darwin, and in regional cities and towns, have been similarly strong since the latter part of 2020.

It is a tremendous boom no one saw coming.

That said, gains of this magnitude never last long and there are signs of a cooling already in what has been a super-strong market.

When will the property price boom end?

Any long run view of house prices boils down to relatively straight forward supply and demand dynamics.

Demand comes from population growth and supply in this instance is simply the addition to the number of dwellings due to construction.

Think of it this way: In a place with zero population growth that has 1,000 new dwellings built, will see an oversupply. No one is around to live in those 1,000 extra dwellings.

Owner occupiers may move to a better, newer place, but there will always be 1,000 dwellings too many for the population.

In this instance, it would be certain that prices would fall.

In Australia right now, with international borders closed and likely to stay that way for at least the next year, population growth is very low. In the September quarter 2020 (latest data), population actually fell by 4,200 compared to a rise in the same quarter of 2019 of 106,800.

The building approvals data point to around 175,000 additional dwellings being completed during 2021 with a similar number hitting the market over 2022.

With population growth stalled, who will buy these dwellings when they come on to the market?

Research from Westpac shows that even with a reopening of the borders in the middle of 2022, as assumed in the recent budget, there will be a small surplus (oversupply) of dwellings during 2021 which will build to a large oversupply of around 120,000 dwellings in 2022 and 150,000 in 2023.

If the border reopening is postponed or involves small numbers of new immigrants when the borders reopen, the oversupply would be larger.

While there is huge uncertainty as to when the borders will open to immigration and when it does, how many people will be allowed to enter, the surplus of housing is with us now.

Picking the timing of turning points in the massive Australian housing market is impossible, but in coming months, there should be a material cooling in house price growth as the supply surge crashes into the demand drought.

By years' end, there should be clear weakness in house prices.

But wait, there is more negative news

There are other signs demand for housing is turning lower.

Westpac, in its monthly consumer sentiment survey asks respondents, “is it a good time to buy a dwelling”?

The long run history of this series shows that changes in interest rates, unemployment and house prices themselves have a strong influence on the answer.

In the most recent survey, there is a clear trend lower in housing optimism.

Indeed, in April, it fell to a level well below the long run average and is now only a little above some of the low points of the past decade or so.

In other words, fewer and fewer people reckon it is a good time to buy.

At the same time, auction clearance rates are easing in both Sydney and Melbourne which points to some buyer fatigue starting to emerge and / or unrealistic price expectations from sellers.

Either way, the turning point for house prices is about now.

The big question is whether prices merely stabilise or start to head lower.

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