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The looming excess of housing and why prices will fall

In an apparent suspension of collective logic, it appears few people have asked what happens when you provide massive incentives to bring forward an unprecedented spike in house construction while simultaneously choking off future demand by halting net migration.

Away from the fog of COVID, unless the starting position was a massive undersupply of housing, then this combination of policy settings would soon generate a large excess of housing. In this note we summarise how large this excess in housing is likely to be and the investment conclusions.

What happens when a Government programme is too successful in inducing supply?

The Homebuilder programme, in concert with generous incentives from state governments and mortgage rate reductions, has proven successful in bringing forward construction. But have they been too successful?

Recall that upon the introduction of the Homebuilder scheme, the Treasury estimated that COVID-19 would see cancellations of housing projects of ~30%, compared with ~17% during the GFC. This reduced the Treasury’s pre-COVID housing starts estimate of 171,000 to just 111,000. The HomeBuilder scheme was explicitly designed to offset half of the expected decline in starts, with the aim of backfilling 30,000 starts in 2020-21. That is, the Treasury was hoping to achieve ~140,000 housing starts once HomeBuilder was fully implemented.

Instead, approvals for houses have exploded to the upside.

By the March quarter of 2021 dwelling approvals were annualising at 278,000 (refer Chart 1), and even though approvals have declined from that peak, by the end of the 2020-21 financial year some 200,400 dwelling were approved. Single home approvals were even more spectacular, with a record 136,600 approved during the year, to be 31% above the prior financial year. Of course, this also excludes the surge in approvals for renovations over the same period.

In the end, 99,300 Homebuilder applications were received by the Government to build a new home and a further 22,100 applications were received for a ‘substantial renovation’. Which means the HomeBuilder program exceeded Treasury’s objectives for new dwelling construction by 330%.

The clear lesson being never stand between an Australian household and an uncapped government program! Taxpayers have effectively handed out almost $3bn in ‘free money’ to people to build or renovate their home.

Such Federal government largess was obviously well received. However, what is less well understood is that state governments were also busily providing their own incentives, especially via stamp duty exemptions for first home buyers. 

To put the incentives in context, we have created separate housing affordability indices for established and first home buyers. This captures all the incentives and taxes by state and Federally in addition to all the standard factors that influence affordability – house prices, mortgage rates, loan to deposit ratio and household income.

Chart 2 shows the enormous boost to housing affordability for first home buyers that was provided principally by shifting government incentives. The subsequent decline in affordability is mostly due to the lapsing of the Homebuilder incentive, although 15%yoy growth in house prices by mid-2021 has also weighed heavily on affordability.

These seismic shifts, however, do not create new demand for housing. Rather they merely bring forward housing construction that would otherwise have been demanded at a later stage. The bigger the pull forward, the bigger the decline once affordability declines back to its pre-incentive levels.

What happens when a pandemic eradicates future demand?

Housing can only be demanded by those who have placed themselves in a situation to form a household. The demographic structure of the population and future housing demand incorporates factors as diverse as; the relationship type and number of dependents of each household, the type of structural dwelling, the vacancy rate of established dwellings, demolitions, and trends towards second or lifestyle homes.

The census data is an important input for the historical analysis, however, the forward projections rely heavily upon the accuracy of the ABS’s population projections. Although the ABS provides three main scenarios for future population growth, their projections have been rendered useless by the de facto ban on net migration from travel restrictions.

We have recast the population projections by looking at the age characteristics of migrants and assumed that net migration doesn’t return to pre-COVID type levels until 2023.

By modelling the future supply of new housing as a function of the change in affordability and comparing that demographic demand for housing adjusted for the unprecedented reduction in net migration, we can solve for the likely future oversupply of Australian houses.

We define ‘market balance’ for housing as the most recent year that demographic demand and completions were equal in number. As such the accumulation of the difference between demographic demand for housing and completions of housing from the year of market balance determines the excess or undersupply of housing through time.

We estimate that by the end of 2023 Australia will have 150,000 dwellings in excess of demographic demand (refer Chart 3). This would be the largest excess of housing since 2008, and this rather sombre forecast embeds as a base case of a 30% decline in dwelling approvals by the end of 2022.

What happens to the excess of established homes if the immigration recovery is delayed or if building approvals remain elevated?

What if housing approvals don’t fall as sharply as our base case? Demand for housing is ultimately determined by demographic demand, but participants in the housing market typically operate with a more limited information set. And what happens if Australians become so enamoured with recent house price gains that Australia continues to build at an excess rate?

If we assume only a 10% decline in approvals is recorded by the end of 2022, then the excess of housing will equal the peak excess of 2006 (refer Chart 4) which on our calculations was greatest excess of housing since our calculations commenced in 1976.

Alternatively, what happens if net migration doesn’t bounce back to 200,000 by 2023? How would that affect the base case? If we assume net migration of +20,000 in 2021 and +75,000 in 2022 (instead of +200,000 under our base case) the oversupply of housing will increase from 150,000 to some 200,000 by the end of 2023 (refer Chart 5).

What are the investment conclusions?

Just under 70% of all households either own their own home outright or are in the process of paying off a mortgage. Housing remains the largest financial asset that most households own and we estimate that by mid-2021 the value of the housing stock is $11.6 trillion. For context, that’s 4.8 times the market capitalisation of the ASX200 and 5.8 times the size of the Australian economy. 

Moving into a large oversupply of housing does not necessarily mean that house prices are at risk of significant decline. The prime example is that the peak excess of housing in 2006 did not unleash a sharp fall in prices. Price growth did slow significantly during the 2003-06 period, but two important things happened that avoided the housing excess translate into falling prices.

Firstly, the combination of stronger household formation rates of the local population and a mining-related boom in immigration transformed the demographic demand for housing. In the 10 years to 1996, we estimate the demand for housing averaged 140,000 per year. In the 10 years to 2006, housing demand had slipped to just 118,000 per year. However, in the period since 2007 Australia’s annual housing demand has averaged 199,000, with a large step change occurring in 2006 due to more Australians moving into key household formation age brackets and the surge in net migration associated with the mining boom. This step change was crucial in gradually absorbing the excess of housing that had previously accumulated.

Secondly, the GFC and the subsequent slow economic recovery saw the RBA cash rate decline from 7.25% in August 2008 to 0.75% pre-COVID and just 0.10% post-COVID. Capitalising low interest rates into house prices has become something of a national sport ever since.

The problem facing Australia today is two-fold: (i) interest rates are today at the lower bound, and (ii) housing demand is now hostage to the evolution of the pandemic and how fast we choose to ramp up immigration in the post-vaccination phase. 

In our view, repeating the good fortune of the post-2006 period seems highly unlikely. Contrary to the current fervour of house buying, the risk of lower house prices over the next two years is high. As in most financial markets confidence is always highest at the peak in prices.

The first investment conclusion is that banks should be thinking in terms of building provisions against the risk of weaker prices, rather than continuing to release provisions as seen over the past 12 months. The failure to do so would risk P/E multiples de-rating once the oversupply of housing become clear to financial markets.

The second investment conclusion is that there is really only one way to avoid a large oversupply of housing, and that is to stop building so many of them. Our base case has a significantly larger decline embedded than the consensus view and is well below that of the RBA which is currently forecasting of dwelling investment declining just 0.5% in 2022, before rising again.

The only way Australia avoids a significant excess of housing by 2023 is if approvals fall far more than anyone expects. With full knowledge that building material company earnings will remain robust as the backlog of homes and renovations to be built remains large, it is the trajectory of housing approvals that has historically governed the share prices of these companies.

It has been a great ride up for the building material companies, but we are past the peak, and the outlook today looks increasingly gloomy.


Tim Toohey is Head of Macro and Strategy at Yarra Capital Management. To the extent that this article discusses general market activity, industry or sector trends, or other broad based economic or political conditions, it should be construed as general advice only. References to ‘consensus’ throughout relate to Bloomberg consensus unless otherwise stated.


Unrealistic chump
March 19, 2022

This is why they called it a bubble burst coz we all see it coming. Keep buying everything going higher and higher. Debt has no ceiling, keep going deeper and deeper the sky not the limit anymore! To infinity and beyond. Why home owners think they can keep playing property monopoly forever is fascinating until a new generation come alongs and decide they don’t like monopoly and decide to destroy the whole game forever. 

September 09, 2021

have faith in our property market. it's double guaranteed by the RBA and the Government. don't waste your time with expensive degrees, or starting a business do a real estate course. borrow $1,500 and buy 3 cheap half-canvas MJ bale suits and you will make a motza by becoming a real estate agent.

don't worry. bet on property. it always pays off, and get your real estate license.

equity mate. safe as houses.

September 07, 2021

I'm pleased that first home buyers (some of whom actually get an investment property instead as they move around for employment) have got into the market. As for substantial renovations, this money is only available for projects over $150 000, which you must stump up if you want the grant; there is a lot of cash in bank accounts, and the govt knows this will encourage that money out of accounts and into circulation in the economy. I have heard for many years that the market will collapse. I doubt there will be a serious correction for another few years. People are putting cash to work in their own homes or real assets. There is a demographic problem in many countries, but no matter which govt we have, they will eventually bring in new migrants, and unlike some countries, there will for the foreseeable future be people who want to move here.

David Knife
September 05, 2021

It continually perplexes me that these so called experts take a macro view of a massive nation like Australia where each location has its own unique micro factors determining demand vs supply. To look at it with a blanket nationwide approach is simply criminal. Agree there will be places where supply outstrips demand but there are other places that will be the complete opposite. Buying a house in the Pilbara versus an inner city unit in Brisbane is like buying chalk versus buying cheese.

September 05, 2021

House prices will never go down! That won’t be allowed.

September 06, 2021

Demonstrably not true - in the Pilbara they tanked and in the early 1990's they tanked across the country with 15% interest rates!

September 07, 2021

thanks, bobby. I told me mate to hang on to his fibro shack in Sydney as it will be worth $10m in 10 years.

you beaudy mate. equity mate. cheap debt interest rate never gonna increase. borrow heaps gud on ya.

Andrew Smith
September 02, 2021

Good analysis and the 'nebulous' NOM is key with govt. assuming continued high levels of temporary churn over in future.

High levels are contingent upon international education which was near a peak before Covid19, dependent upon major cohorts of students from the Sub-Continent e.g. India, and PRC or China; it may well be unlikely that such enrolment levels will be reached again.

Reasons are many but students from China have been in decline due to trade politics, megaphone diplomacy and becoming aware of many other quality study choices via English e.g. EU nations, Canada, UK, US etc. where most also give international students restricted work rights and post graduate work visas.

However, Australian media, selected MPs and lobby groups see international education as an existential threat to be dog whistled (starting in noughties) e.g. describing students as 'immigrants' (falsely suggesting both uncapped permanent migration and widespread rorting of visas etc.), which has not gone unnoticed elsewhere.... especially source nations....

House prices have been supported and increased through a variety of measures and dynamics but still difficult to see substantive support in future, especially with the significant baby boomer 'bubble' transitioning into and through retirement; should have an impact on asset prices.

ScottHochgesang PropertyCoach
September 04, 2021

Your analysis seems to 100% ignore the Covid empowered trend for people to prefer to live in larger houses, with space to work from home, vs units. It is very possible the lack of demand will continue to be in units, especially if our borders do not fully re-open in 2022 and the 200,000 overseas students who normally come are kept out.

Also I see nothing factoring in the return of hundreds of thousands of Aussie Expats.

You have not convinced me there will be a house oversupply. Certainly not in booming areas with low néw land supply-Brisbane, Sunshine Coast, Gold Coast, Newcastle, etc….

Perth may be oversupplied i. houses give. it’s high per capita use of the Home Building Grants.

Andrew Smith
September 05, 2021

If you are 'property coach' then surely one possesses accurate data and understanding of the market?

Is there any support to show the real estate market involving a preference for larger houses vs. units or apartments, especially outside family groups i.e. more significant cohort of singles or couples?

One would assume most Australian expats, with the ability or inclination to return and buy, have mostly done already, while many Australians onshore would intend (champing at the bit) to depart again; backgrounded by many Australians not in a secure employment position to take out a mortgage.

Most FIRE analysis has shown an increase in financing and new construction during Covid19 as an economic stimulus with buyers bringing plans forward, but predicting a drop in prices in coming years, while it's unclear where the growth in buyers will come from when baby boomers have started their transition to retirement with a focus on income, not asset (value/growth) and also a chance to help children and grandchildren financially)?

One finds real estate analysis in Australia perplexing in contradictions and wall to wall media PR based upon indirect indicators and sentiments....

September 05, 2021

Don’t worry property always goes up and doubles every 7 years.

They have been trying to “warn us” about a looming “crash” for the last 20 years and it just keeps going up.

Even if we were attacked with a nuclear bomb people in Sydney would be queuing to buy property with their full radiation Resistant suit on.

Relax it always goes up guaranteed by the govt. Look at the auction clearance rates 80% +

Nothing can stop our property and our love of property that‘s who we are as a people we r into property. And getting drunk.

Tim Hammond
September 02, 2021

So what was the net population increase over the past year? Approx 1/2 a million people. They could ramp it up to a million / year. This ponzi doesn't end yet in my opinion.

Andrew Smith
September 02, 2021

Not sure where you access data from but the property sector would be happy to accept, e..g prices rise due to population growth..... but in fact our population (growth) is stagnant.

In the past financial year according to APH, the NOM Net Overseas MIgration (or more accurately net border movements for residents staying 12/16+ months) is -70k, while our estimated resident population (including temporary non PRs/citizens) grew by 136k, according to the ABS (possibly more about returning Australian PRs/citizens).

September 02, 2021

The Australian government is king manipulator, every time the market tries to correct itself they step in, keeping prices up and never allowing a proper correction. This policy is destroying the chance of home ownership, of our children at the same time.
Where are our kids going to live. This place is turning to crap.
That cannot be denied.
The regulator should of already stepped in, but none of them have any decency to care for the generations to come. Selfish pigs the lot of them.

September 02, 2021

"Where are our kids going to live.":

At home - with you.

For 67 year olds with Age Pension assessable assets between $884,000 and $405,000, each conversion of $1 to non-assessable assets - fond memories or, more especially, Home Improvement(s) - increases the annual Age Pension payments by $0.08. A Government Guaranteed return of 8% tax free for spending your money.

Home prices have typically increased about 6% per year, tax free, and home owner imputed rent is about 4% per year, also tax free.

With negative 'risk free' interest rates and returns from securities uncertain, and taxed, what would a rationally thinking Age Pensioner with homeless offspring do?

Home Improvement.

Withdraw all super, invest $405,000 personally, dump remaining assessable assets in capital efficient home improvements such as another floor, a granny mansion, or a larger home for themselves and their homeless kin. The re-homed rent-free offspring pay the family expenses leaving the Age Pension to be spent on Gilding the Stairways To Heaven.

Government more quickly converts retiree's capital expenditure to income tax and GST, retiree has more income risk and tax free, homeless are homes and may inherit a mansion. Everyone a winner.

September 02, 2021

Agreed Dan.

September 03, 2021

Agree that markets have never been able to correct. There are to many retirees with multiple rentals to allow the housing market to fall. You would loose to many votes.

Andy D
September 02, 2021

If the oversupply causes property price decline by 2023, then what is the risk and to whom? How will banks and government manage that scenario? What will happen to average household and to broader economy?

I think we need to think about the impacts. Even with a decline in 2023, prices will be still back to 2018/19 levels and only speculative investors may be impacted. Unless it has cascading impact of recession and unemployment, the housing price decline may well be absorbed and rebound within next few years.

September 03, 2021

Andy D you seemed to be mistaking this thread for a place of rational discussion. Let them miss the point and vent their political bias and financial insecurities

September 04, 2021

Nothing to see here! Just plain old data analysis which has nothing real about it. Property prices like all assets only go up over time due to one important factor - inflation! As long as you live long enough!

Also, I am buying cryptocurrency for the long haul!! To the moon...


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