No bubble, but housing on the up

An uptick in the housing sector is critical if Australia is to successfully rebalance economic growth away from the fading mining investment boom.

House prices need to rise to help boost household wealth and support consumer spending, but more importantly to encourage an upturn in the housing construction cycle.

Of course the fear is that we end up with another boom-bust housing cycle.

There has been a huge swing in sentiment towards house prices this past year. A year ago fears were rising that Australian house prices might be on the brink of a sharp fall; now it seems most of the chatter is about whether we are back into another housing bubble.

House prices on the up

After initially failing to respond to rate cuts it’s clear house prices have turned back up, with annual capital city average house price growth running at about 5 per cent.

Unlike other countries that also are experiencing an upturn in house prices, Australian house prices are turning up from a high level.

Fears of a renewed bubble have also been heightened by a surge in Sydney’s auction clearance rate above the 80 per cent level, well above its normal cyclical high of around 70 per cent.

Still overvalued

While Australian house prices have worked off some of their overvaluation, they nevertheless remain overvalued, as evidenced by the ratio of house prices to incomes, for example. In Australia this is 21 per cent above its long-term average, leaving it toward the higher end of OECD countries.

Not a bubble

However, apart from overvaluation and hot Sydney auctions there is little evidence of a housing bubble at present.

House price strength is not broad based. Prices in Melbourne, Brisbane and Adelaide are running between 1 per cent and 4 per cent a year. Perth is very strong but it’s hard to see this being sustained as the mining investment slowdown leads to slower economic growth in Western Australia.

And while Sydney is strong it’s worth noting that Sydney property prices have had no real growth since 2004 – averaging 2.7 per cent per year, which is identical to the average 2.7 per cent inflation rate over the same period.

There is also a more cautious approach on the part of homebuyers since the GFC – Australians have become fearful of taking on more debt.

This is not to say that it won’t turn into a house price bubble but at this stage the property market is a long way from that.

What hope a pick up in dwelling construction?

Australian economic recoveries invariably start with a housing upswing. This boosts economic activity via increased construction but also as new house completions boost demand for household retail items and rising house prices boost wealth.

While the initial response to interest rate cuts for most housing related indicators has been lacklustre, there are some encouraging signs on the dwelling construction front.

New dwelling sales are up by around 25 per cent after bottoming in September last year, according to the Housing Industry Association.

While the cyclical recovery in house prices likely has further to go, it’s unlikely to become a bubble given more cautious attitudes on the part of homebuyers and job insecurity.

And if house prices do rise too quickly it will probably be because the economy is much stronger, in which case interest rates can start to rise anyway. More broadly there are signs that dwelling construction activity is likely to rise over the year ahead.

Shane Oliver is head of Investment Strategy and chief economist at AMP Capital