The five economic forces shaping the housing market

1. High interest rates

Like many other countries, Australia experienced an inflation shock following the pandemic. The Reserve Bank of Australia responded by raising the cash rate from 0.10 per cent to 4.35 per cent over an 18-month period, which was the largest and most rapid increase in the cash rate in over 30 years. 

It is the rate of change in interest rates, rather than the level of change, that can be important for house price growth, and this sharp increase led to price falls throughout 2022. However, with rates remaining on hold since November 2023, prices have rebounded. 

For the overall economy, it is the outright level of interest rates that is most important. High interest rates coupled with strong consumer spending continue to restrict household borrowing capacity and the ability to service mortgages. However, interest rates affect different parts of the market in different ways. The upper end of the market in the larger capital cities is far less sensitive to interest rate rises than the lower end. The upper end usually purchases on a much lower loan to valuation ratio than the lower end or the first-home buyer segment of the market.

We can assess the pressure existing borrowers are under by assuming a maximum serviceability threshold of 40 per cent of gross disposable income and comparing it to the current serviceability requirements. On average, interest repayments have been around 30 per cent of gross disposable income, or 10 percentage points below the maximum serviceability threshold. However, the recent sharp rise in interest rates has cut this to just 4 percentage points, which is the lowest level since the late 1980s, meaning that servicing a loan today is as tough as it was in the 1980s.

Debt servicing buffer as a percentage point of gross disposable income

2. Low unemployment

Despite cost pressures and slowing demand, Australian businesses continue to hire, and this has helped households absorb the cost-of-living pressures. Consequently, there has been no evidence of forced selling of either homes or investment properties.

Workers were particularly scarce as the economy reopened after the pandemic, when high household savings and government stimulus were driving spending. The current slower consumer demand has softened labour hiring, but it has not reached a point where businesses are looking to shed jobs in a significant way. The economy should be supported by the Stage 3 tax cuts in the second half of 2024, so it seems unlikely that there will be significant job losses and therefore no negative impact on the housing market in the near term.

3. Strong population growth

Demand for the benefits provided by housing is strong. The latest Australian Bureau of Statistics data shows the population increased by 172,700 in the September 2023 quarter alone. Net overseas migration accounted for 145,200 (84 per cent) of this increase and most of these people likely moved into rental accommodation. Therefore, it’s no surprise that rental growth in the large capital cities continues to be strong, given that these cities attract most of the migrant intake. Rental growth is around 9 per cent in Sydney and Brisbane and 7 per cent in Melbourne¹.

4. Limited supply

New housing supply has not been able to keep up with demand.

High interest rates limit the borrowing capacity of property buyers and increase the cost of construction financing for developers. This simple economics means that the supply of new property entering the market has slowed.

Furthermore, the supply of vacant properties is being quickly absorbed by our strong population growth. The inevitable result is that vacancy rates for rental accommodation are extraordinarily low – 1.1 per cent in Melbourne in March 2024, compared to 2.4 per cent in March 2022².

Developers are continuing to struggle with rising construction costs and the high costs of finance even though new house prices are increasing. This tight supply is likely to continue until interest rates come down and the economics underpinning property development improve.

In 2022 and 2023, investors saw rising interest payments, land tax and maintenance costs, which resulted in some forced selling of more discretionary property purchases. However, interest rates have remained unchanged for six months while rents continue to rise at a solid pace. Distressed selling has eased and the market for investors has now normalised.

Australian households cumulative excess savings

5. Pandemic savings buffer

Australia saw its household sector flooded with government stimulus cheques during the pandemic. Our economy was still closed due to the pandemic, so much of this additional household income went unspent and was saved.

Following the pandemic, these savings have been gradually drawn down and used to prop up consumer spending as well as to support financial goals – such as a deposit on a property purchase. Australian household savings peaked in mid-2022 and the drawdown has been relatively slow since then.

Nonetheless, the rising costs of living and high borrowing costs have cut into savings and the savings rate is now below pre-pandemic levels. The impact of the pandemic savings buffer is coming to an end and households will be increasingly under pressure to draw down savings at a faster rate while interest rates and the cost of living remain high, nonetheless excess savings from the pandemic are still high.

In summary, the housing market outlook would improve markedly if interest rates were about to be cut. For now, the market is likely to remain solid, led by the smaller capital cities, which have an affordability advantage over Sydney and Melbourne. Immigration is slowing, but the rental market is already tight, and we are unlikely to see a significant increase in new stock entering the market . High savings and low unemployment are both likely to provide an important safety net, meaning a significant amount of distressed selling is unlikely.

¹ Source: Australian Bureau of Statistics (ABS)
² Source: SQM Research