The housing market is changing. Everyone knows prices are falling as interest rates rise, but the composition of the market is also changing dramatically as well and if you own property—or would like to—it is important to understand how the parts assemble to form the whole.
Forensically dissecting the housing market lets us understand how it works and gives us the best insights into what will happen in the final quarter of 2022—spring selling season—and in 2023, when interest rates are predicted to finally top out.
Let’s start with prices. They’ve been falling, but not equally everywhere. Prices fell in Sydney first, then Melbourne, and as the next chart shows those cities have seen the biggest falls. That echoes the patterns of the 2017 house price correction, when those markets fell first and recovered first.
Within the two big capitals, prices have fallen first in the most expensive suburbs. In those suburbs, what changes hands, primarily, are established homes. Meanwhile prices for newly built homes are rising, due to rising input costs and the fact builders have no spare capacity.
So why do Melbourne and Sydney fall first? The answer is the loans are bigger in those two capital cities. As the next chart shows, the average new home loan in Sydney and Melbourne is large:
As interest rates rise, larger loans get more expensive to service. This matters because the gap in average loan size is higher than the gap in incomes between states in Australia. People in NSW are more stretched by their mortgages and therefore interest rate rises hit harder.
The rise in interest rates is affecting appetite for loans, clearly. What type of loans are hit most?
As the next chart shows, investors and owner-occupiers can sometimes be in very different moods. For example, investors were growing their share of the market in 2021 as owner-occupiers shrank away. But in 2022, with rates rising much faster and sooner than expected, both investors and owner-occupiers are taking out fewer and/or smaller new loans. The decline in owner-occupier lending follows a tremendous, unprecedented surge in 2020 however, so even after a few months of shrinkage there are still some buyers out there.
First home buyers are joining the rush to the exits, after enjoying a very strong pandemic where a lot of people moved into their first owned home. The volume of lending to first home buyers has swiftly retreated to its pre-pandemic level.
So what’s next for the housing market? If the predictions of Australia’s big banks are anything to go by, there is still a way for the market to fall. Their house price predictions cluster on a fall of 15-20%, and the timeline over which they expect this to manifest is 6-18 months from now.
Forecasts can be wrong. So can the wisdom of the crowd, but that, via market expectations, is the best guess of what interest rates will do. But for what it’s worth, the market expects official interest rates to top out in 2023 at around 3.5% before stabilising or slightly easing. That would be another big lift in official rates from where we are today at 2.4%. But of course official interest rates and what people are paying on their mortgage can be very different.
As the next chart shows, there is a group of Aussies who are largely unaffected by rate rises. They are the ones who took out fixed rate loans in 2021. When the RBA hikes rates, they feel nothing. Then there are those who took out fixed rate loans more recently. Some of them have locked in new higher rates. Then there are people on new variable rate loans: they pay more than those on fixed rates, but less than the least lucky group: the people with older loans. The average interest rate paid on outstanding loans is still higher than the average on new loans. Which is why you should always consider refinancing: the banks profit from inertia.
When the RBA hikes interest rates it is trying to curb inflation. The mechanism is indirect: by diverting household spending to mortgage repayments, and by reducing household wealth via falling house prices the central bank hopes to reduce household spending on goods and services. That reduction is intended to balance supply and demand so businesses feel less need to hike prices. (There are other ways monetary policy works too:, affecting household savings, the exchange rate and business spending, but these are less relevant now).
Of the two main effects described above, the fall in house prices is happening already. But the diversion of household spending to mortgage repayments is slower. There is a lag, even for the households with variable interest rates. Analysis from the Commonwealth Bank shows it takes two or three months for an official interest rate hike to hit a family’s mortgage repayments.
In normal times these relatively minor delays don’t matter. But when the RBA hikes rates two entire percentage points in the space of 91 days (from 0.35% on 8 June to 2.35% on 7 September), it means they are pointing more hoses at the economy before the water has had a chance to properly douse the flames. The RBA says its actions will be guided by incoming data, but data comes via a long delay and the bank is acting boldly before the full impact of their actions can be known.
This is what the RBA Governor is talking about when he describes a path “clouded in uncertainty”. It is possible they have not yet done enough. It is possible they have done too much. We can’t know.
Watching the evolution of household spending is an adrenaline rush at the moment. ANZ Bank is producing a daily series of spending, and it is yet to show a downturn. But consumer confidence is at deep recessionary levels. One of the two curves must bend, and much depends on which one it will be. If consumer spending collapses, the RBA might stop hiking rates much sooner. If it doesn’t, the bank might have to push rates higher still, with all the impact on house prices that will bring.
