How higher interest rates turned housing into a ‘luxury good’

The sheer demand for housing in the face of chronic undersupply cancelled the effect of higher rates on the property market in 2024.

A string of pandemic-related symptoms continued to distort the market in an unusual property cycle. It left well-heeled buyers competing for the few homes available, driving prices higher with some experts saying housing had turned into a “luxury good”.

Pandemic-related aftershocks distorted the property market in 2024. Credit: Rhett Wyman

But Melbourne bucked the trend because more homes hit the market than there were buyers due to a better pipeline of homes being built and the introduction of land tax, which encouraged investors and second-home owners to list their properties for sale.

PEXA chief economist Julie Toth said a handful of factors outweighed the effect of higher interest rates in 2024.

The primary reason was the chronic and sheer imbalance between the supply and demand for homes in Australia. This was driven by a tight rental market pushing more renters into buying, rapid population growth due to a peak in immigration and the ongoing trend of smaller household formation – a hangover from the pandemic.

“The other influences on house prices have been stronger [than higher interest rates] ... in particular, we’ve had an unusual housing supply and demand crunch for a variety of reasons,” Toth said.

She said Australia’s population growth of 2.9 per cent a year was very high in global terms, tracking three times that of the UK, for example.

Pronounced housing supply constraints in cities such as Sydney translated to worse housing affordability than in cities like Melbourne, which had delivered more homes and a shallow albeit sustained downturn in prices.

“Melbourne has had a strong pipeline of new housing supply than Sydney, particularly with inner-city apartments,” Toth said. “Adding new stock has been stronger consistently for a number of years and that has helped keep a lid on house price growth.”

Toth said not only has Victoria been more open to new housing development, partly due to its more forgiving geography than Sydney with its harbour, the state government also implemented land taxes for investors and second-home owners, driving them out of the market.

With housing supply forecast to fall short of demand for another five years, Toth did not believe affordability would improve in the near term.

“The cash rate is a bit of a red herring to the whole housing affordability debate, other factors are much stronger … Demand is going to outstrip supply.”

Barrenjoey head of economic forecasts Johnathan McMenamin said pandemic savings, extra hours worked and the mountain of fixed-rate mortgages saved households from selling off, which prevented an avalanche of supply coming onto the market.

“Meanwhile, the demand side remained pretty strong from the additional people in the country but also from a reduction in the number of people per household,” McMenamin said. “So basically, the labour market strengthening let people move out of home earlier and lifted demand for housing countrywide.”

He also highlighted Melbourne as a city that bucked the trend in 2024 because there was more supply than demand due to the land tax encouraging investors out as well as more home building.

Sydney house prices had only begun to fall after spring as listings increased above the long-term average, he said, adding both cities would continue to fall into 2025 until a rate cut.

The unusual property cycle in 2024 has meant home buying had become the preserve of the wealthier.

“Borrowing capacity has fallen about 30 per cent since it’s peak and yet house prices have increased fairly substantially,” McMenamin said.

“The type of buyer has changed where the typical borrower has shifted further up the income distribution [scale],” he said. “In that sense, housing has become more of a luxury good.”

AMP chief economist Shane Oliver said higher rates for longer did not take a toll on property prices because it was an atypical cycle distorted by the after-effects of the pandemic on several fronts.

“The rebound in immigration levels, particularly in students, the savings buffers built up during the pandemic and the reliance on the bank of mum and dad messed up the cyclical relationships, which would normally see rates go up, prices go down,” Oliver said.

“That normal relationship was completely messed up as a result of those factors.”

But as 2024 came to a close, two years of higher rates had begun to wear down on the property market.

“It does seem that high interest rates have got the upper hand again. We’re seeing house price falls in half of the capital cities and Sydney seems to be accelerating,” he said, adding that affordability constraints had kicked in and most savings buffers worn down.

He said housing affordability could improve if rates remained higher for longer than necessary, missing a soft landing and entering a recession instead.