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What does it mean for the RBA?
This week saw the release of data that paint an interesting story of the challenges facing the Australian housing market. In this week’s Brief we take a look at the current state of supply and demand for housing, and how it might influence the RBA’s thinking.
ABS data for February show building approvals fell by 1.9% in the month and 5.8% over the year to be running at an annualised rate of just 150k. This is its lowest level in a decade and corresponds to a time when the cash rate was last over 4%. During the first half of 2021, when the cash rate was close to zero, building approvals rose to an annualised rate of 240k, but this was artificially boosted by the federal government’s Homebuilder grants.
Loan approvals for the construction of new homes remain particularly weak, suggesting interest rates are having their desired impact on slowing demand in the economy. The rise in interest rates has reduced housing affordability, with the Housing Industry Association (HIA) measure of housing affordability at the end of 2023 falling to levels not seen in the 27-year history of the series. Weak disposable income growth combined with the rising burden of higher interest rates and house prices is crimping households’ ability to afford new homes.
However, despite the deterioration in affordability, strong population growth has kept underlying housing demand growing at robust rates. Following growth of 635k in 2022/23, the Centre for Population expects population to grow by 510k in 2023/24. This translates to demand for an additional 200k homes in 2023/24. ABS data for the labour force and overseas arrivals and departures suggests upside risk to these population projections, and hence, upside risk to estimates of underlying housing demand.
Supply has been unable to keep pace with this rapid demand growth. Residential building completions have been running at an annual rate of around 175k, well below the additional demand created by population growth in 2022/23 and 2023/24. The RBA cites capacity constraints in the form of skilled labour for finishing trades, which has been transferred to the rapidly expanding non-residential construction sector.
Another constraint on housing supply has been an increase in bankruptcies in the construction sector which operates on high volumes and low margins. As input costs rose at unprecedented rates due to supply chain disruptions during Covid, some builders with fixed rate contracts were unable to operate profitably. Construction industry insolvencies have more than tripled since their lows in 2021 and have increased their share of total insolvencies to 28%, from an average of 18% prior to Covid.
The increase in bankruptcies has undermined consumer confidence in the residential construction sector, which is weighing on people’s desire to build and leading to a preference for buying existing properties instead. This is contributing to the weakness in building approvals which keeps the construction pipeline depressed. In this context, the capacity constraints on the supply of housing suggest the government’s target of building 1.2m new homes over the next five years will be a challenge to achieve.
With supply constrained and underlying demand still strong, the housing market faces excess demand pressures. This is why prices and rents continue to rise despite affordability constraints. CoreLogic’s measure of house prices for the 5 capital cities rose 0.6% in March and by 10.1% in the last year. Prices have pushed to new highs in Brisbane, Perth and Adelaide, while Sydney and Melbourne, the markets which are least affordable, are currently 1% and 4% below their pre-rate-hike price peaks, respectively.
While the RBA doesn’t target house prices, it does target inflation and rents make up almost 6% of the CPI basket. Listed rents are growing by 8.5% nationally according to CoreLogic data. This is higher than the rate of rental growth recorded in the CPI, of 7.6% in February. But increased government subsidies for Commonwealth Rent Assistance late last year are holding down the measured CPI rent growth by around 1.5% so the two measures paint a similar picture. And with the national vacancy rate hovering around 1%, rental growth is likely to remain firm.
Rental inflation has been adding just under half a percentage point to CPI inflation. The purchase of new dwellings also contributes to the CPI, with a weight of almost 9%. The cost of building a new home ballooned during 2022 as Covid supply chain disruptions pushed up input costs. While housing cost inflation has moderated to just over 5%, it is still running ahead of the inflation target. Adding the cost of building a new home to rental costs suggests the total cost of housing is driving around one-quarter of CPI inflation, despite accounting for just 14% of all goods and services in the consumption bundle.
This is but one example of the sticky inflation referred to by RBA, as a reason they are reluctant to ease monetary policy. Reducing interest rates will help households struggling with mortgage cost pressures, but it may risk stoking additional demand for housing at a time when supply has little room to respond. This will force the RBA to be certain that other sectors of the economy have the slack required to ensure inflation is below trend, making room for the inflationary impacts of housing. With an unemployment rate still below 4%, the RBA cannot yet have that confidence. We don’t expect to see rate cuts from the RBA until late this year.