House price rises were meant to ease. So what’s happened?

If we have an affordability crisis in Australian housing, how is it that house prices are still rising and plenty of economists expect them to rise about 10 per cent over the next year?

For years, we have been told that a lack of affordability will place a lid on the rising price of housing – but still, the prices continue to rise to the point where the median price for a capital city home has hit the $1 million mark.

What happened to the affordability brake?Credit: Jessica Hromas

The theory that the Australian home market will bump up against affordability constraints has made a mockery of these predictions by many experts for many years.

There is clear statistical evidence that when interest rates move into a downwards cycle – as they are now – the property market takes off.

And while house prices dip when rates go up, it is by a lesser amount than they rise when rates eased.

Couple this with a shortage of supply of housing stock and conditions become fertile for the value of homes to rise.

We underestimate the tax policy on capital gains that encourages home ownership, and the changing immigration policies that can pervert demand.

This is where the lack of affordability is meant to step in and literally exhaust people’s ability to pay higher prices. This is the theory at least.

I think part of this problem is definitional. We look at the market as homogeneous, rather than layered.

Sure, there are some would-be home buyers who are priced out of the market, but there is another cohort that are not, and for them, the current prices are affordable.

There are existing home owners who are able to trade up and high-income earners who are not constrained by higher rates.

Governments are focusing more attention on building the supply of housing stock.Credit: Louie Douvis

And given we are at the start of a falling interest rate cycle, there is a brigade of would-be first-time buyers experiencing extreme FOMO (fear of missing out). They see home prices running away again and are keen to get a foothold in the market before that happens.

And bear in mind that when rates fall people can afford to pay more.

In theory, this stretched affordability should be kicking in about now (or realistically it should have kicked in a while ago).

But we know that more than 90 per cent of borrowers opted to retain their monthly mortgage payments at the same level when the last rate cut came through, choosing instead to pay off their borrowings more quickly. We also know that the big banks are not witnessing above-average mortgage arrears rates.

Meanwhile, much of the theory of affordability is based on averages – such as the average income relative to average prices and the relationship between them – but overlook the cultural obsession in Australia with home ownership and ignore the distortions to the market.

Chief among the distortions is the politics of home ownership, including those that enable the more financially stretched first home owners to get a foothold in the market.

We underestimate the tax policy on capital gains that encourages home ownership, and the changing immigration policies that can pervert demand.

And we overlook the intergenerational passage of wealth that allows some lucky younger buyers to rely on their Baby Boomer parents to provide them with a home deposit.

Some would-be home buyers are priced out of the market, but there is a cohort that are not.Credit: Dion Georgopoulos

And if there are two incomes in the household, then affording the interest rate is difficult but doable.

To be fair, governments are now focusing much more attention on building the supply of housing stock, but it’s a long-term response to a more immediate problem. It won’t factor into the current interest rate-led supply/demand situation.

But economists still point to stretched affordability and buyers eventually tapping out as prices breach new levels and those left in the market begin to thin.

Let’s see how long that takes.

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