Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 446

House prices: are we heading for oversupply from 2022?

According to CoreLogic, Australian house prices increased +22.1% in 2021, led by Australia’s largest city of Sydney (+25.3%). There are a few culprits behind this stellar performance, including record low interest rates, healthy household balance sheets and a desire to re-invest in the home as some workers contemplate an extended ‘work from home’ environment.

The uplift in residential prices is not a local event. The value of homes has soared across the world, including New Zealand (+27.6%), the United States (+19.1% to October), the UK (+10.0%) and even places like Turkey (+40.0% to October). And for those who believe interest rates drive property prices, the average key interest rate in Turkey during 2021 was 18%, up from 11% in 2020.

As we head into 2022, there is an expectation that interest rates will rise around the world in response to recent inflation data. That may be true, but we do not believe this will be enough in itself to stop the gains. In fact, rising rates may add to further gains, as per Turkey.

The biggest risk for investing in residential property is, as always, excess supply.

The housing cycle

While there are many theories as to what drives house prices, ranging from interest rates and lenient tax rules to immigration, residential property prices ultimately mean-revert around replacement cost. As prices increase above the ‘cost to build’ there is almost always a supply response, as developers try to cash in on the margin. Ultimately, increasing supply dampens prices back to a level where supply is restricted and the cycle starts all over again.

So, is the surge in residential property prices causing a supply response? In Australia, the answer is an emphatic yes.

Source: ABS, Quay Global Investors

The surge in new housing starts since COVID is similar, albeit sharper, to the 2015-2018 cycle which ultimately saw prices correct in 2019. We have yet to see any heat come out of the Australian market. Completions have yet to increase as they lag starts by around a year. Inevitably, completions will surge this year to match the starts, which may be somewhat ominous for the Aussie housing market.

Quantifying the oversupply (if any)

A surge in supply is not always a bad sign. The critical question is whether there is more total housing stock relative to overall housing occupier demand. To answer this, we will need to quantify the magnitude of the potential oversupply, if there is any. This is always a difficult task, as it not only relies on supply data but also household formation data, which can be notoriously fickle.

We can get a general sense of any imbalances using historical trend data. For example, Australian household starts ran at a consistent 40,000 per quarter between 2000-12, which appears to reflect a balanced housing market (no acceleration or deceleration in supply). Post 2012, supply accelerated as immigration increased. Adjusting for the increase in annual immigration from 1.4% per annum (2000-2011) to 1.7% per annum (2011-2019), steady-state supply can be estimated at ~50,000 per quarter, being household starts of 40,000 increased pro-rata with a higher immigration rate.

Using this assumption and based on housing starts data, we can estimate the cumulative supply shortfall since 2010.

Source: ABS, Quay Global Investors

Generally, the Australian housing market has defied most gloomy predictions. Indeed, there was almost a small cottage industry dedicated to predicting the imminent collapse of Australian house prices in the post-financial crisis world.

However, the chart above demonstrates that there has never been a situation where there has been excess supply of housing in Australia. Accelerating housing starts (as prices rise above replacement cost) were quickly absorbed by new households.

For Australia, population growth has generally provided Aussie housing the ultimate ‘get out of jail free card’ just as the market begins to cool. We made a similar observation in our June 2019 article What now for residential property?, where we reversed our earlier bearish 2017 call.

However, with COVID, population growth effectively halted right at the time supply was accelerating. For example, if we were to reduce our household growth assumption to 20,000 per quarter (60% reduction), the residential market would quickly become oversupplied (once current projects complete later in 2022).

Source: ABS, Quay Global Investors

We don’t believe it is time to call for a market correction just yet, but based on the above chart it seems unlikely recent national residential price growth will be repeated in 2022.

What about the US?

Recent strong increases in US residential property prices have also come with a surge in new supply, in both houses and apartments.

Source: St Louis Fred, Quay Global Investors

Does the US face the same supply headwinds as Australia?

To answer, we have applied the same methodology as the Australian analysis above. Specifically:

  • We have assumed a normal supply run rate of 2 million single family homes per annum (consistent with pre-GFC bubble average) and 3 million apartments per annum (consistent with pre-GFC bubble average), and
  • We have also assumed this required supply falls by 60% from mid-2020 to account for the collapse in immigration.

The following charts reflect the result for each sector.

Source: St Louis Fred, Quay Global Investors

For single family, there was a significant increase in excess supply leading to the GFC, which offers no surprise since prices boomed and were well above replacement cost. However, the single-family sector was crushed post crisis in terms of price (and ultimately resources), resulting in a significant deficiency in supply, even after allowing for the pandemic-induced collapse in immigration.

Conversely, US apartments never felt the effects of excess supply in the lead-up to the GFC. Also, unlike single family homes, apartment supply recovered more quickly in response to the demographic demands of millennials leaving home in the first half of the 2010s. However, with the decline in immigration there appears to be a growing risk that apartments are moving into excess supply for the first time in decades.

Risks of oversupply

The boom in global residential prices is another side-effect of the pandemic that seems to have caught many by surprise (us included). With any residential boom come concerns of a ‘new bubble’ and imminent crash. This type of reaction is understandable, given the deep scars left from the financial crisis a decade ago.

But by digging into the data, it is clear not all markets face the same risk. The cumulative undersupply in US single family housing is still significant and may take many years to rectify, especially now the sector has a demographic tailwind with the millennials, the largest US demographic cohort, seeking a more stable accommodation to marry and raise a family in a home.

The outlook for US apartments and Australian residential is less sanguine. For the first time in decades, there is a real risk these markets are facing a headwind of persistent oversupply, exacerbated by pandemic-induced immigration declines.

A word of warning: this analysis is not meant to be all-encompassing and each market has its own subtleties and nuances. We are not necessarily predicting a ‘crash’, or even a correction in these markets. The investment market is littered with the dead bodies of housing perma-bears.

But the data suggests that one of the best risk/return profiles is in US single family housing, which is where our fund maintains a significant investment position. 

 

Chris Bedingfield is Principal and Portfolio Manager at Quay Global Investors. This article contains general information only, and does not constitute financial, tax or legal advice. It has been prepared without taking account of your objectives, financial situation or needs.

 

5 Comments
Carol
February 17, 2022

The pandemic resulted in thousands of Australians being stranded overseas. As it ends and our borders reopen with few restrictions, I predict a surge in returning Australians keen to come back, settle and buy their own homes. Additionally the pandemic created a massive skills shortage and backlog in desired migration, which will rapidly be addressed as the borders open, soaking up much of the predicted 'oversupply' in housing IMO. Australia managed the pandemic so well it is now seen as a desired destination for many people seeking a permanent change in lifestyle. Time will tell.

Peter Symonds
February 16, 2022

Chris, housing prices move for lots of reasons but the one and only heavyweight champ is Interest rates. In your computer model algo put mortgage interest rates at 6% and see how many properties there are for sale. Most will be investment properties that are currently returning 2% per annum.

John
February 16, 2022

In the well developed suburbs of major Australian cities, land scarcity, local council and other controls/delays on new development ensure that there will be almost no net new supply in those suburbs. In my LGA, population growth is forecast by council to average 0.3% p.a.for the next 15 years. Yet, it remains a highly desirable location to live, so prices will continue to rise, albeit more slowly than in 2021, even with zero immigration for 15 years. The real question is whether those price rises will exceed inflation.

Michael2
February 18, 2022

When we sold our house for a very good price recently, I was very surprised after using an inflation calculator to see we actually lost money over the 11 years of ownership. This is a Perth property.

Kevin
February 19, 2022

I live in Perth too.When houses are mentioned I am constantly baffled by the claim nobody can afford to buy etc. There is very little movement in prices on a nominal /real basis it seems. A house that cost 4 years wages in 1990 at 18% mortgage rates might cost 4.5 years wages now at 3% interest rates. There are a lot of houses in Perth that are 4 bed 2 bath ,swimming pool etc that are valued at 350K to 600K depending on suburb. Starter homes with 3 bedrooms built in the 1970s are from $200K to $400K depending on suburb. Public transport is a problem but in general it is a 40 minute drive anywhere for work ,or cycle to the local station and lock the bike up to get the train to the CBD. Those electric scooters are everywhere when I am out on the bike,people use them to get to work with the cycle paths being everywhere. The gig economy and expanding casual employment is a problem,I can see that. This needs solving. Sometimes out on the bike I see houses,multiply the cost by the interest rate and just shake my head at how cheap they are,and how low repayments are. However a full time job is needed with reasonable security of employment in these changing times.

 

Leave a Comment:

     

RELATED ARTICLES

Financial pathways to buying a home require planning

Australian stocks will crush housing over the next decade

The most important industry globally which few understand

banner

Most viewed in recent weeks

Meg on SMSFs: Clearing up confusion on the $3 million super tax

There seems to be more confusion than clarity about the mechanics of how the new $3 million super tax is supposed to work. Here is an attempt to answer some of the questions from my previous work on the issue. 

Welcome to Firstlinks Edition 566 with weekend update

Here are 10 rules for staying happy and sharp as we age, including socialise a lot, never retire, learn a demanding skill, practice gratitude, play video games (specific ones), and be sure to reminisce.

  • 27 June 2024

Australian housing is twice as expensive as the US

A new report suggests Australian housing is twice as expensive as that of the US and UK on a price-to-income basis. It also reveals that it’s cheaper to live in New York than most of our capital cities.

The catalyst for a LICs rebound

The discounts on listed investment vehicles are at historically wide levels. There are lots of reasons given, including size and liquidity, yet there's a better explanation for the discounts, and why a rebound may be near.

How not to run out of money in retirement

The life expectancy tables used throughout the financial advice and retirement industry have issues and you need to prepare for the possibility of living a lot longer than you might have thought. Plan accordingly.

The iron law of building wealth

The best way to lose money in markets is to chase the latest stock fad. Conversely, the best way to build wealth is by pursuing a timeless investment strategy that won’t be swayed by short-term market gyrations.

Latest Updates

Investment strategies

Have value investors been hindered by this quirk of accounting?

Investments in intangible assets are as crucial to many companies as investments in capital equipment. The different accounting treatment of these investments, however, weighs on reported earnings and could render ratios like P/E less useful for investors.

Investment strategies

Investors are threading the eye of the needle

As investors cram into ever narrower areas of the market with increasingly high valuations, Martin Conlon from Schroders says that sensible investing has rarely been such an uncrowded trade.

Economy

New research shows diverging economic impacts of climate change

There is universal consensus that the Earth is experiencing climate change. Yet there is far more debate about how this will impact different economies across the globe. New research sheds more light on the winners and losers.

SMSF strategies

How super members can avoid missing out on tax deductions

Claiming a tax deduction for personal super contributions can end in disappointment if it isn't done correctly. Julie Steed looks at common pitfalls and what is required for a successful claim.

Investment strategies

AI is not an over-hyped fad – but a killer app might be years away

The AI investment trend looks set to continue for years but there is only room for a handful of long-term winners. Dr Kevin Hebner also warns regulators against strangling innovation in the sector before society reaps the benefits.

Retirement

Why certainty is so important in retirement

Retirement is a time of great excitement but it is also one of uncertainty. This is hardly surprising given the daunting move from receiving a steady outcome to relying on savings and investments.

Economy

This vital yet "forgotten" indicator of inflation holds good news

Financial commentators seem to have forgotten the leading cause of inflation: growth in the supply of money. Warren Bird explains the link and explores where it suggests inflation is headed.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.