Tuesday, July 16, 2024
Home Investment NewsReal Estate Investing Housing Market Cycles and Fundamentals

Housing Market Cycles and Fundamentals

by xyonent
0 comment
Property Market.jpg

Key takeaways

The underlying demand for housing is determined by the size of our population and the number of people that live (on average) in each dwelling.

Population growth in Australia is faster than in other advanced economies.

The average household size has declined over time, with more older couples and singles living alone, and lower birth rates. Young adults are also living with their parents longer, possibly due to affordability considerations.

Short-run response to rising demand is determined by rental and housing prices, underlying construction costs and the time to design, approve and build.

The last couple of years have seen a perfect storm of constraints on activity in the new dwelling construction sector, with materials, fixtures and fittings, and skilled labour in short supply, and shipping delays significantly extending build timelines.

The cost of building a home has risen sharply in recent years, and we do not expect it to fall back significantly. The cost of land, the approvals process, infrastructure availability and the time it takes to complete a project also contribute to the cost.

Interest rates are a component of costs for new housing construction, and higher interest costs will dampen the flow of new housing supply. However, over the long run, monetary policy does not have an impact on demand or structural build cost.

The imbalance between new supply of housing and growth in demand is currently causing upward pressure on rents and prices. The RBA expect this pressure to continue until new supply comes online, and we expect residential construction activity to remain relatively subdued.

The Reserve Bank sees no “quick fix” for the housing crisis and warns that an imbalance between Australia’s supply of new housing and growth in the nation’s demand for housing is pushing up rents and construction costs and also has implications for economic activity.

In a speech on Housing Market Cycles and Fundamentals, RBA assistant governor Sarah Hunter said that strong demand for housing will keep putting “upward pressure” on rents and prices until new supply comes online.

Here’s what she said:

The drivers of underlying demand

The underlying demand for housing, whether people rent or own their own home, is fundamentally determined by the size of our population and the number of people that live (on average) in each dwelling.

Although it has ebbed and flowed over time, the pace of population growth in Australia is typically faster than in other advanced economies.

Cycles in population growth tend to be driven by net overseas migration – a trend shown clearly during the pandemic.

Border closures saw population growth fall to zero in mid-2021, and the reopening drove a rebound to 2.5 per cent per annum in mid-2023 (Graph 1).

A growing population clearly implies that the underlying demand for housing is rising over time – all of these extra people need a place to live.

Right now, just under 27 million people live in Australia, in about 11 million households.

The average number of people living in each household has trended lower, from around 2.8 in the mid-1980s to around 2.5 in late (Graph 1).

Household size

This may sound like a small change.

But, if for some reason, the average household size rose back to 2.8, we would need 1.2 million fewer dwellings to house our current population – no small difference.

Understanding the changes in average household size is therefore important for understanding the demand for housing.

At the RBA, we assess that part of the long-run decline in average household size can be explained by demographic factors.

The ageing of the population means we now have more older couples and singles living alone, and lower birth rates mean that the average size of a family is falling over time.

Working in the other direction has been an increase in the share of young adults living with their parents.

This might be because more young people are going to university and living at home for longer, but it could also be due to affordability considerations.

And this hints that demographics are not the only factor affecting household size – affordability affects people’s choices of where and who to live with.

The demographic drivers of housing demand tend to be slow-moving, but the pandemic period saw some dramatic shifts and acted as a catalyst for change.

During the pandemic, there was a shift in preferences towards more physical living space per person, which is understandable when lockdowns forced us to spend more time at home.

This was particularly the case for people who shared a home with non-family members, such as young people living in a flat share.

This group shrank as a proportion of households, while the share living with their partner increased –as a result, the average household size declined.

The shift to working from home has also reinforced this change.

While some people have returned to their workplace full-time, there has been an increase in the proportion of people working from home – for many, a home office space is now highly desirable (Graph 2).

Work from home

 

This suggests that the recent falls in the average number of people per home will be at least partially permanent.

Short-run response to rising demand

As many here today will know, the housing supply does eventually respond to this growing demand.

The speed and magnitude of that response can vary, however, and is determined by rental and housing prices, underlying construction costs and the time to design, approve and build.

In the meantime, prices and rents do the adjusting.

The extent of this adjustment differs through each cycle and depends on the relative movements in demand and supply.

The pandemic period – and its aftermath – stands out as a particularly sharp cycle.

Growth in demand for new dwellings slowed rapidly in 2020 before rebounding strongly (Graph 3).

Underlying Demand And Supply Additions Per Financial Year

Supply, as measured by dwelling completions, has been much less volatile and has trended down in recent years.

Overall then, growth in demand is currently running well ahead of supply.

The impact of the imbalance between new supply and new demand for dwellings can be seen in both the rental market and the established housing market.

In most capital cities, rents are growing at a relatively rapid pace.

And in the established housing market prices have risen significantly in recent years – demand versus supply fundamentals appear to be alive and kicking.

In the rental market, our assessment is that the level of demand relative to the stock of properties available is the key driver for market rents (Graph 4).

Vacancy Rate And Rent Growth

There are a number of other potential drivers, one of which is the level of interest rates.

Given the RBA’s role in setting these, we are very aware of how interest rate settings transmit through the economy, and I will return later to the role interest rates play in determining the response of new housing supply.

At first glance, it does appear that there could be a positive relationship between interest rates and market rents – the two often move together.

However, our preliminary analysis suggests that market conditions (captured via the vacancy rate) explain most of the movement in market rents, and there is little to no evidence of direct pass-through to rents from higher interest costs in the short term.

As such, the observation that market rents and interest rates move together appears to be a case of correlation, rather than interest rate rises causing rents to increase.

For example, a strong economy with a pick-up in income growth will see increased demand for rental properties, which will put upward pressure on rents.

You may also like

Leave a Comment

About Us

Investxyon

At InvestXyon, we empower individuals with knowledge for informed investing, financial navigation, and secure futures. Our trusted platform covers investments, stocks, personal finance, retirement, and more.

Feature Posts

Newsletter

Subscribe my Newsletter for new blog posts, tips & new photos. Let's stay updated!