housing outlook Australian Housing Outlook Prepared by BIS Shrapnel October 2012

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1 housing outlook Australian Housing Outlook Prepared by BIS Shrapnel October 2012

2 housing outlook DISCLAIMER: The information contained in this publication has been obtained from BIS Shrapnel Pty Limited and does not necessarily represent the views or opinions of QBE Lenders Mortgage Insurance Limited (QBE LMI). This publication is provided for informational purposes only and is not intended to constitute legal, financial or other professional advice and has not been provided with regard to the investment objectives or circumstances of any particular reader. While based on information believed to be reliable, no guarantee is given that it is accurate or complete and no warranties are made by QBE LMI as to the accuracy, completeness or usefulness of any of the information in this publication. The opinions, forecasts, assumptions, estimates, derived valuations and target price(s) (if any) contained in this material are as of the date indicated and are subject to change at any time without prior notice. The information referred to may not be suitable for specific investment objectives, financial situation or individual needs of recipients and should not be relied upon in substitution for the exercise of independent judgment. Recipients should obtain their own appropriate professional advice. Neither QBE LMI nor other persons shall be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including lost profits arising in any way from the information contained in this material. This material may not be reproduced, redistributed, or copied in whole or in part for any purpose without QBE LMI s prior expressed consent. QBE Lenders Mortgage Insurance Limited ABN

3 contents 1. Executive summary 4 2. Economic outlook 10 State of play 10 Interest rates Housing finance 16 Buyer demand 16 Loans to first home buyers 16 Loans to upgraders 20 Loans for residential investment 20 Loan activity and the effect on prices Rental markets 24 Vacancy rates and rental growth 24 Rental growth Home affordability Capital city overviews and price forecasts 40 Sydney 40 Melbourne 42 Brisbane 44 Adelaide 46 Perth 48 Hobart 50 Canberra 52 Darwin Appendix Demand 30 Overseas migration 30 Interstate migration 32 Population 36 Demand and supply 38 1

4 housing outlook introduction I m delighted to introduce to the latest lmihousing OUTLOOK covering the expected trends for the Australian housing market over the next three years; exclusively researched and compiled by BIS Shrapnel. Ongoing volatility is proving a challenge for many forecasters and last year s lmihousing OUTLOOK was delivered amidst a tumultuous time in the global economy. Events in Europe and the US continue to weigh heavily on global markets, but the outlook for Australia continues to remain cautiously optimistic. Notwithstanding the relatively strong performance of the Australian economy, residential property prices nationally experienced their second year of decline in 2011/12. However, BIS Shrapnel are forecasting price growth for Perth (6% in 2012/13), Darwin (5%), Brisbane (4%) and, more modestly, in Sydney (3%). Meanwhile, minimal price growth is expected for Melbourne (1%) and Adelaide (1%) and prices are forecast to fall in Hobart (-1%) and Canberra (-1%) in 2012/13. The affordability of housing is currently at its best level across most capital cities since the first half of last decade, with the exception of a brief period in 2009 when affordability spiked due to aggressive cuts in interest rates. Notably, affordability is expected to further improve as standard variable interest rates are tipped to fall by another 25 basis points in 2012/13. Consequently, we should see increased housing turnover in the market as first home buyer numbers pick up and have a positive effect on upgrader activity, which in turn is predicted to further spur investors return to the market. QBE LMI has been supporting the mortgage industry for over 45 years and we continue to do so through the provision of flexible products that offer lenders the security and confidence they need to respond to the changing needs of borrowers. Our sponsorship of the lmihousing OUTLOOK has continued for over 10 years as part of our ongoing commitment to provide insights in relation to trends in the mortgage industry. This report provides comfort that Australia is well placed to deal with any uncertainty that our housing market faces in the next few years. I hope you find it informative. Jenny Boddington CEO 2

5 affordability is expected to further improve as standard variable interest rates are tipped to fall by another 25 basis points in 2012/13. 3

6 housing outlook 1. executive summary Median house price growth across most of the eight capital cities experienced their second year of decline in 2011/12, with the capital city weighted average median house price falling by 2.6%. While the economy strengthened, with Gross Domestic Product (GDP) growth increasing from 1.9% in 2010/11 to 3.4% in 2011/12, conditions outside the mining related sectors remained weak and this continued to weigh on consumer confidence reflected by the Westpac/Melbourne Institute Consumer Sentiment indicator being below 100 (where pessimists outnumber optimists) for all but two months of the year. Although rising by 14% in 2011/12, the number of first home buyers in the market remained low following a total 47% decline in the two years to 2010/11. Without first home buyer demand for entry level properties, upgrader volumes were also relatively weak, while the weak price performance also discouraged investors. The standard variable interest rate of 7.8% up to October 2011 also influenced price growth in the early part of 2011/12. As a result, median house prices fell across nearly all of the capital cities in 2011/12, with only Darwin (+10.7%) recording a rise. Marginal falls occurred in Sydney ( 0.7%), Brisbane ( 1.1%), Adelaide ( 1.3%), and Perth ( 1.0%). Larger median house price declines were experienced by Melbourne ( 5.3%), Canberra ( 5.0%) and Hobart ( 3.5%). 4

7 While the economy strengthened conditions outside the mining related sectors remained weak and this continued to weigh on consumer confidence. The price performance in 2011/12 was weaker than forecast in the 2011 lmihousing OUTLOOK Report. The subsequent release of the 2011 Census data has indicated that household formation up to 2011 was approximately 40,000 households lower than originally estimated, resulting in a more benign demand/supply balance at June The lower rate of household formation has also resulted in a lower forecast of future underlying demand. Combined with weaker than expected economic conditions outside the mining related sectors, there was little to promote price growth in 2011/12. Nevertheless, conditions for price growth are forecast to begin to improve over 2012/13. However differing economic conditions and demand and supply fundamentals across the states are expected to result in a patchwork performance across the capital cities. The improvement in economic growth over 2011/12 is forecast to continue, with the rising investment in the minerals sector increasingly resulting in flow on effects permeating through to the rest of the economy. While there are some external risks e.g. global financial stability and commodity prices most of the resource investment is already underway and should continue to rise through to completion over the next two to three years. On this basis, unemployment is forecast to fall and income growth should remain solid, which will underpin private consumption expenditure levels. First home buyer demand is now trending upwards following depressed activity since 2008/09. The fall in first home buyer numbers over 2009/10 and 2010/11 occurred after future demand had been pulled forward into 2008/09 by increased Federal Government incentives. Changes to State Government incentives will influence the timing of this recovery with some buyers also pushing back their purchase to accommodate announced incentives but loans to first home buyers should be close to reverting to their underlying level (based on the size of the first home buyer aged demographic) of around 120,000 to 130,000 per annum by the end of 2012/13. This should also provide impetus for an improvement in upgrader demand. Affordability has also improved. The Reserve Bank cut the official cash rate by 125 basis points in 2011/12, and a further cut of 25 basis points was made in October Whilst this only translated to a 115 basis point reduction in the standard variable interest rate, due to increased funding costs for banks, the reduction has improved affordability for purchasers. Outside of the brief low interest rate period in 2009, affordability in most capital cities is now at similar levels of the start to middle of the 2000s. On this basis, the current standard variable rate of 6.65% is expected to be low enough to encourage buyers into the market, with an additional rate cut before the end of 2012 anticipated to provide additional stimulus. As a result, after the declines over 2011/12, median house prices are forecast to steady in 2012/13, with some capital cities showing minor growth. Growth in the capital city weighted average median house price of 1.3% between the March and June quarters in 2012 suggests that prices have bottomed out, which should encourage investor activity to return to the market. This should result in increased momentum in dwelling turnover which will be carried into 2013/14. Dwelling turnover is forecast to accelerate through 2013/14 as strong economic growth continues and rising prices boost confidence. Rising migration nationally will outpace the addition of new dwelling stock, resulting in a growing housing deficiency placing upward pressure on prices. The Reserve Bank is then forecast to adopt a tightened interest rate policy in 2013/14, although the initial rises are expected to have little effect given the more buoyant residential market and strong economic conditions. 5

8 housing outlook 1. executive summary (cont.) Price growth is forecast to peak in 2014/15, coinciding with a peak in economic growth and low unemployment creating wage-price inflationary pressures. This is expected to lead to a further tightening of interest rates in 2014/15. The standard variable interest rate is forecast to peak at 8.1% in the first half of 2015, which is anticipated to slow median house price growth, and also have the desired effect of slowing the economy into 2015/16. The weak residential market in the resource states has set the scene for the strong upturn over the next three years. Weak recent rent and price growth has led to a low level of construction which, together with an increase in the rate of population growth, is seeing a rapidly rising dwelling deficiency in Queensland, Western Australia and Northern Territory taking vacancy rates in each of the state capitals to well below the balanced market rate of 3%. Consistent weak construction figures over an extended period means there is also a sizeable deficiency in New South Wales. Price growth will be assisted by the more buoyant economic outlook in these states. In contrast, the states that had the strongest rebound in construction after the Global Financial Crisis (GFC) Victoria, South Australia, Tasmania, and Australian Capital Territory have all had their dwelling deficiency eroded and moved into oversupply in 2011/12. Lower interest rates and some improvement in economic conditions should see the decline in median house prices stabilise over the next three years, however there is little to promote any major price growth. Price growth into 2012/13 is forecast to be strongest in Perth (+6%), Darwin (+5%) and Brisbane (+4%). Affordability in Perth and Brisbane has improved substantially in 2011/12 and a rapidly rising dwelling deficiency is developing. In Darwin, meanwhile, median house price growth of 10.7% was registered in 2011/12 driven by substantial levels of investment in mining and resource capacity leading to significant income and migration growth. Falls in vacancy rates are also expected to continue across all three cities, placing upward pressure on both rents and dwelling prices, attracting demand from investors in particular. Modest growth of 3% is forecast for Sydney in 2012/13. Whilst Sydney does not have the same economic drivers as the mining/ resource states, demand for housing will be driven by a substantial deficiency in underlying stock. Furthermore, affordability is currently at 2002 levels, elevating the potential for median house price growth. A mix of minimal price increases and declines are forecast for Melbourne (+1%), Adelaide (+1%), Hobart ( 1%) and Canberra ( 1%) in 2012/13. All four cities moved into an excess of housing stock in 2011/12 after a strong period of construction in recent years. While low interest rates should prevent any major declines in 2012/13, without major exposure to resource investment economic growth in these centres is expected to underperform national growth. As a result, even medium term median house price growth is forecast to be marginal. Median house price forecast comparison Chart 1 shows the forecast record of the lmihousing OUTLOOK since the inaugural 2002 report, comparing the forecast national median house price in each report over each of the three years of the forecast period with the actual movement in the national median house price. The national median is derived from a weighted median of each of our capital city forecasts (See Appendix for comparisons between forecast and actual median house prices for each individual capital city). BIS Shrapnel s median house price forecasts have typically been slightly more conservative than the actual median price rises over most three year periods. Through the middle of the decade, the sharp rises in prices over

9 Table 1: Median house prices by capital city Source: Real Estate Institute of Australia, Forecasts: BIS Shrapnel Quarter ended June Sydney Melbourne Brisbane Adelaide Perth Hobart Canberra Darwin $ 000 % Var $ 000 % Var $ 000 % Var $ 000 % Var $ 000 % Var $ 000 % Var $ 000 % Var $ 000 % Var * * * Total Forecast Growth (%) * * BIS Shrapnel forecasts 7

10 housing outlook 1. executive summary (cont.) and 2008 were not anticipated. The interest rate rises at the time were expected to have a greater dampening effect on price growth. Forecasts made over 2007 to 2009 were generally on track in terms of total growth over three year forecast period, despite the challenging economic conditions and negative expectations at the time that made forecasting difficult. However, forecasts of the national median house price in the 2010 and 2011 editions of the lmihousing OUTLOOK have been more optimistic than eventual growth. The 2010 estimate of the national median house price was 12% above the June 2012 median of $521,000, while in the 2011 estimate was 7% above. The over estimate of price growth in the 2011 report was partly due to an overestimation of the dwelling deficiency in a number of states in An analysis of the 2011 Census data suggests that household formation rates, and therefore underlying demand, have been lower than originally envisaged since the 2006 Census. This means that there was less pressure on prices than originally expected in 2011/12. In addition, the weaker than expected economic environment has had a larger drag on confidence and demand. Nevertheless, a number of market assumptions outlined in previous reports (such as a rising deficiency, reductions in vacancy rates in a number of cities, and a strengthening in economic conditions) are slowly coming through. Where this is happening, there should be a push through greater activity and price growth, albeit slightly delayed compared to recent forecasts. Impact of reductions in interest rates on median house prices Chart 2 shows the response in median house prices after previous periods of interest rate reductions. The chart indicates the progression of price growth in the quarters immediately before and after the standard variable rate had fallen by a total of 100 basis points. Price growth is measured in real (inflation adjusted) terms and indexed to the quarter when the standard variable rate had fallen by 100 basis points from its previous high. In all three previous periods when interest rates had recorded a decrease of more than 100 basis points, real median house price growth had picked up within six months of the decrease. Interestingly, over the first six quarters (18 months), the total price growth had been similar in all three circumstances. However, eight quarters, or two years after the interest rate reductions in 2001 and 2008, prices began to decline in real terms, while the upturn continued longer after the 1996 cuts. The response to interest rate reductions previously suggests that price growth should return after the 95 basis point reduction in the standard variable rate in 2011/12. However, real median house price growth will not necessarily be as rapid given that median house prices are starting from a slightly more constrained level of affordability compared to when interest rates had been reduced at previous points in time. 8

11 Chart 1: Comparison between actual and three year forecasts, national weighted median house price Source: Australian Bureau of Statistics, Real Estate of Australia, BIS Shrapnel Forecasts Median house prices ($000) Quarter ending June Actual Forecast Chart 2: Real median house price growth after 100 basis point cut to housing interest rates, Australia Source: Reserve Bank of Australia, Australian Bureau of Statistics, Real Estate Institute of Australia Price index Quarters since rate cut Dec 96 Dec 01 Dec 08 Jun 12 Forecast 9

12 housing outlook economic outlook State of play BIS Shrapnel forecasts the national economy to grow by more than 3% per annum through to 2014/15 (Table 2). Despite this solid aggregate growth, conditions for many businesses remain difficult, with most of the growth occurring in the mining and mining-related sectors. Outside of mining, the overriding business logic is to secure growth by reducing costs. These businesses are still cutting back on investment, making growth uneven. The market s current focus is on minerals projects that have been placed on hold or cancelled. However, the impact of these decisions will not be felt until the latter half of the decade. Currently, there are estimated to be two to three years worth of projects already under way in Western Australia and up to five years worth of investment activity in Queensland. With these projects too far advanced to be cancelled, the impact of any changes in policy or shift in commodity prices that cause a pause in new investment will not be felt until these projects are completed. The severity of the impact on the rest of the economy will depend on the level of the next round of projects coming through. As mining investment reaches its forecast peak in 2014, non-mining investment (i.e. housing and other business investment) is anticipated to stabilise and will start to pick up, taking over as the economy s principal engine of growth and smoothing the transition. In the same way that increases in interest rates and the value of Australian dollar have held back other sectors and freed up resources to make room for the mining boom, they will adjust as commodity prices ease and resource investment falls, creating conditions for other industries to come in and fill the gap. Despite recent falls in commodity prices, mining-related investment is expected to continue to grow over the next two years, underpinning solid growth in the rest of the economy. BIS Shrapnel forecasts mining related investment to rise by a total 22% in this period. Minerals export volumes are also forecast to grow strongly as the mining-related investment projects start production. Also supporting growth will be household spending, which is projected to grow at around 3.5% per annum as it has for the past year or so supported by wage and employment growth and below average interest rates. Dwelling building is expected to start growing from the end of 2012, due to below average interest rates and dwelling shortages in New South Wales and increasingly in Queensland and Western Australia. These two factors should ensure that the forecast unemployment rate holds at its current level of just over 5% in 2012/13. Offsetting these drivers of growth are trade-exposed industries which are expected to remain under pressure from the high Australian dollar, and fiscal tightening will weigh on a number of industries. Nevertheless, by the second half of 2013, a gradual broadening of growth is anticipated to start eroding the excess capacity currently prevalent in many parts of the economy. Emerging capacity constraints will encourage many non-mining businesses to start investing again after an extended period of underinvestment. This increase in business investment, particularly non-dwelling building, will in turn further reinforce the broadening of growth and support employment growth, pushing the unemployment rate below 5% towards the end of Economic growth should continue to stay solid through to 2014/15 as investment activity works its way through. The resultant solid employment and income growth will facilitate confidence and growth in consumption expenditure. However, the Reserve Bank of Australia (RBA) is expected to begin to adopt a tightening of monetary policy towards the end of 2013 as the unemployment rate continues to fall and the risk of wage-price inflationary pressures increases. Initial interest rate rises forecast for 2013/14 will have limited impact given the relatively buoyant economic conditions, with further more aggressive rises anticipated over 2014/15 eventually slowing the economy.

13 Table 2: Key economic indicators Source: Australian Bureau of Statistics, Forecasts: BIS Shrapnel Year Ended June Expenditure on GDP (at average 2008/09 prices) Consumption Private Consumption Government Consumption Private Investment New Public Investment Gross National Expenditure (GNE) GDP (Average) Inflation & wages (Jun on Jun) CPI Baseline Average Weekly Earnings ( Yr. Ave.) Employment (%) Employment Growth (August on August) Unemployment Rate (August) Interest Rates (% at 30 June) Cash rate Housing (variable)

14 housing outlook 2. economic outlook (cont.) Risks to the economic outlook Commodity prices have recently received a great deal of market attention, in particular, where they will go from here and what impact they will have on the Australian economy. BIS Shrapnel s view is that most commodity prices are around their trough, and are likely to strengthen a little towards the end of 2012 as short-term supply and demand imbalances work themselves out. Prices of some commodities have fallen below profitable levels for higher cost mines and production is being wound back. The Chinese Government is expected to undertake another round of stimulus spending, which is expected to absorb the current stockpile, allowing commodity prices to then show a mild recovery. The risk is that industrial production in China and other key regional markets does not recover to the extent that is anticipated, resulting in continued lower commodity prices. Irrespective of what happens to commodity prices over the next few months, it is not anticipated to have a large impact on forecast growth in mining-related investment over the next two years. Rather, it would be the medium to longer term outlook for the economy that would be most at risk. Events in Europe are the other concern at the moment. Bad news is expected to continue to filter out of Europe over the next few years and this is reflected in the forecasts. There is the potential for the European situation to strongly deteriorate, causing financial markets to freeze up (as they did in 2008), confidence to fall sharply, and commodity prices to decline. However, as occurred in 2008, the most severe effects tend to be short lived, with the Australian dollar likely to fall along with interest rates. In that situation, the Reserve Bank has a large toolkit to keep financial markets operating, including further loosening of monetary policy. Less severe, there is the risk that the forecast recovery in dwelling building does not take hold towards the end of If the leading indicators over the next few months do not support this recovery, then the Reserve Bank is expected to be more aggressive in lowering interest rates, given that inflationary pressures currently appear benign. This should eventually underpin the recovery in dwelling building, albeit a few months later than forecast. Interest rates The Reserve Bank cut the overnight cash rate by a total of 125 basis points between November 2011 and June 2012, with a further 25 basis point cut in October However, the rising cost of funds meant that banks only passed on 115 basis points of this reduction in their standard variable rate. While not all the cuts to the overnight cash rate were passed on, this was anticipated by the Reserve Bank. It is the standard variable rate that influences spending in the economy, so the cash rate is set with a desired standard variable rate in mind. The current standard variable rate of 6.65% quoted by the RBA (and based on an average of large lenders) compares with a peak of 7.8% in October 2011 and has been referred to by the RBA as mildly stimulatory. Interest rates were increased in line with the rebound in the Australian economy after the GFC, while the subsequent higher costs of bank funds has resulted in the margin between the cash rate and the standard variable interest rate widening from 180 basis points in late 2007 to 340 basis points in October

15 Chart 3: Interest rates and inflation Source: Australian Bureau of Statistics, Forecasts: BIS Shrapnel % As at June Standard variable rate Cash rate CPI Forecast 13

16 housing outlook 2. economic outlook (cont.) In the months prior to the initial November 2011 rate cut, there was an expectation that rising investment in the mining sector would flow through to other parts of the economy, creating a tightening bias as inflation hovered around the upper end of the RBA s preferred band of 2% 3%. However, economic conditions outside the mining and mining-related sectors weakened and inflationary pressures receded, with the overnight cash rate being progressively reduced. At this stage, inflation is not a concern, being comfortably within the RBA s target range (outside of an anticipated brief spike due to the carbon tax). Following the RBA s 25 basis point cut on 2 October 2012, it still has room to lower interest rates further if it needs to and is forecast to lower the cash rate once more before the end of However, it is expected that only 40 basis point of the total 50 basis point reduction will be passed on in the standard variable rate (taking it to 6.45%). Although funding costs for the banks do not appear to have increased since the first half of 2012, their total cost of funds is likely to have increased as older, less expensive funding is progressively rolled over. However, if the current round of cuts do not gain traction, and a persistently high Australian dollar, soft commodity prices, the European debt crisis, United States political ructions, domestic political uncertainty and low consumer and business confidence further cloud the economic outlook, it is possible that the Reserve Bank could still make one further rate cut around March/April It seems that the flow on effect from mining related investment is taking longer to come through than envisaged twelve months ago and this has left a hole in the non-mining sectors of the economy. Nevertheless, with further growth in mining related investment forecast for at least the next two years, the forecast broadening in economic growth and eventual decline in the unemployment rate is expected to still come through and see inflation pressures emerge, pushing inflation toward 3% during With this in mind, the Reserve Bank is expected to start raising interest rates again from late 2013 and into Initial rises in the cash rate are expected to be limited, with a 50 basis point rise forecast over 2013/14. Economic activity is subsequently forecast to peak in 2014/15 as improvement in other sectors of the economy supplement the peak in resource investment, with wages and inflationary pressures anticipated to become more acute. In this environment, the RBA is expected to adopt a more aggressive stance on tightening interest rates, pushing up the cash rate by a forecast 125 basis points over 2014/15. This is expected to take the standard variable rate to 8.1% by June 2015, with bank margins being cut back from the current 340 basis points to 335 basis points as the world financial environment becomes more stable over the medium term and funding costs for banks are reduced. The peak in the standard variable rate will have the desired effect of slowing economic conditions beyond the forecast period over 2015/16. 14

17 inflation is not a concern, being comfortably within the RBA s target range it still has room to lower interest rates once more before the end of

18 housing outlook 3. housing finance Buyer demand Chart 4 illustrates the monthly year on year percentage change in residential lending to first home buyers, non first home buyers (i.e. upgraders and downsizers, which encompass all purchases made for owner occupation and where the buyer has previously owned another dwelling) and investors. The number of loans to first home buyers has been trending upwards nationally in 2011/12. This reflects first home buyer numbers beginning to revert to their underlying level of 120,000 to 130,000 loans per annum (see 3.2) after the collapse of first home buyer numbers over 2010 and 2011, due to first home buyers who had brought forward their purchase to beat the expiry of the Federal Government First Home Owner s Grant Boost Scheme (FHOGBS) at the end of The recovery in first home buyers appears to be coming through more slowly than originally envisaged. Uncertainty in the economic outlook is likely to be delaying some purchases, while higher deposit requirements by lenders since the GFC means that some first home buyers will also take longer to save a deposit. While loans to first home buyers are higher nationally, there have been large monthly variations through 2011/12 as a result of changes in state based incentives that have influenced demand. Depending on the timing, these changes have either caused first home buyer demand to surge (to beat the expiry of incentives) or be delayed (as first home buyers wait for a proposed increase in incentives). Despite the improvement, the number of loans to first home buyers remains below its estimated underlying level of 120,000 to 130,000 per annum, at 101,100 loans in 2011/12. As the negative impact of changes to incentives over previous years flows through, first home buyer loans are anticipated to increase further in 2012/13 and return to their underlying level in 2013/14. While first home buyers are not a large component of the market, at around 20% of total purchasers on average, they are important in that they form the foundation market for upgraders and downsizers, who make up the majority of purchasers. This was evident in the rise and subsequent fall in loans to non-first home buyers following movement in first home buyer loans from late 2009 and into While annual growth in loans to non-first home buyers has moved into positive territory in 2012, progress is slow with only small rises in loan activity still being recorded. Nevertheless, overall activity should improve as first home buyer activity continues to rise and promote upgrader and downsizer movement. The value of loans to investors has also begun to show signs of growth in the first six months of 2012, although investor activity remains weak after having been in decline since the middle of Investor demand is driven by rental yields and price growth, and with median prices having declined in most capital cities in 2010/11 and 2011/12 investor demand has remained muted despite the consequent improvement in yields. Evidence that the decline in median house prices is stabilising in a number of capital cities, and the prospect of price growth in 2012/13, point to some further improvement in investor demand over the next twelve months, albeit small. Loans to first home buyers Becoming a first home buyer is typically associated with various life stages for example, moving out of the family home, moving out of rental, moving in with a partner, marriage, etc. Consequently, underlying first home buyer demand is relatively steady as segments of the population move through these life stages. However, year-to-year demand can vary as conditions can promote or delay first home buyer purchases. This has been evident in recent years as future demand was pulled forward into 2009 by low interest rates and various Federal and State Government incentives, and numbers then subsequently fell over 2010 and

19 The number of loans to first home buyers has been trending upwards nationally in 2011/12. Chart 4: Annual growth in home loans percentage change on same month the previous year Source: Australian Bureau of Statistics Note: investor activity based on value of lending while owner occupier data based on number of loans % Investors Non-FHBs FHBs Jun 07 Sep 07 Dec 07 Mar 08 Jun 08 Sep 08 Dec 08 Mar 09 Jun 09 Sep 09 Dec 09 Mar 10 Jun 10 Sep 10 Dec 10 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 17

20 housing outlook 3. housing finance (cont.) First home buyer demand averaged 124,500 loans per annum over the four years to December 2008 a period where (apart from three months at the end of 2008) the market has been largely unaffected by first home buyer incentives. Loans to first home buyers subsequently rose to 188,000 in 2009, suggesting that future demand equivalent to 63,500 first home loans had taken advantage of Federal and State Government incentives that had been introduced in late Subsequently, after the Federal Government incentives expired at the end of 2009, loans to first home buyers fell to an average 92,000 per annum over 2010 and This was 65,000 loans in total below the four year average to 2008 and suggests that the pull forward of future demand has been largely worked through. However, loans to first home buyers so far in 2012 are still depressed, at 101,000 in the twelve months to July As the number of potential first home buyers is unlikely to have decreased, given growth in the typical first home buyer demographic of 25 to 34 year olds, it is likely that the next round of first home buyers are delaying their entry into the market until the economic outlook becomes more certain. However, it is unlikely that first home buyers will delay their purchase indefinitely, and they are more likely to eventually compromise with the purchase of a smaller dwelling, or in a more affordable suburb. This occurred in 2006/07 and 2007/08, when loans to first home buyers remained at around 127,000 per annum, despite rising interest rates through the two years. As a result, the growth in loans to first home buyers, which started showing year on year growth from third quarter 2011, and recorded 14% growth in 2011/12 (Table 3), should continue to increase. So far, the strongest growth in loans to first home buyers has been evident in Queensland, Western Australia and Northern Territory. These states are benefiting from outperforming economic growth that is encouraging first home buyers confidence and accelerating population growth particularly in the first home buyer age groups, who are the largest component of migration into these states. The abolition of the First Home Owner s Grant for established dwellings in Queensland (October 2012) and increasing of the Grant to $15,000 for purchasers of new dwellings is expected to have little impact on the improving first home buyer demand. This is because the timing of the Budget announcement in September does not allow for many future first home buyers of established dwellings to rush forward their purchase before the established home grant is removed. There has also been relatively solid growth of 14% in loans to first home buyers in New South Wales in 2011/12, although activity through the year has been influenced by variations in first home buyer incentives. The 63% surge in fourth quarter 2011 was the result of purchasers seeking to beat the expiry of stamp duty exemptions to first home buyers of established dwellings. The consequent easing of activity in the first half of 2012 has reflected this pulling forward of demand, as well as a pause in first home buyers of new dwellings, who have waited until October 2012 to take advantage of the introduction of an increased cash incentive for first home buyers of new dwellings. Similarly, first home buyer demand strengthened in Victoria and South Australia in the first half of 2012 due to cash incentives to first home buyers of new dwellings expiring or being reduced at the end of June While the Victorian incentive did expire as scheduled, the South Australian incentive was extended for another year on 31 May 2012, which meant that many first home buyers had already purchased in June quarter As a result of this rush, first home buyer demand in these states will drop off over the second half of the year. 18

21 Table 3: Number of loans approved to first home buyers for owner occupation Source: Australian Bureau of Statistics FHBs loans (% change from previous period) % Change on corresponding quarter the previous year State 2009/ / /12 Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 Jul 12 NSW VIC QLD SA WA TAS NT ACT Australia

22 housing outlook 3. housing finance (cont.) It should be noted that the improvement in first home buyer demand in 2011/12 comes from a very low 2010/11 base. Most of the impact of changes to first home buyer incentives at the state level is expected to have been washed through by the end of 2012, with loan activity to maintain a steadier upward trend nationally through All states are consequently anticipated to show a rise in loans to first home buyers in 2012/13, although the resource-based states of Queensland, Western Australia and Northern Territory are likely to continue to show the strongest growth due to strong economic conditions and higher migration. Given the current low base in 2011/12 and low interest rate environment, there should still be scope for a rise in first home buyer demand in the other states, although at a more moderate rate. With the largest component of first home buyers aged 25 to 34 years old, the underlying level of first home buyer demand should also increase in the coming years in-line with growth in this population segment. In the fifteen years to 2007, the national 25 to 34 year old population was steady at around 2.9 million persons, before rising to 3.3 million by This corresponded with the number of loans to first home buyers rising from an average of 108,000 per annum in the fifteen years to 2007, to 123,000 per annum in the five years to With the 20 to 34 year old population projected to rise to 3.6 million by 2017, the underlying level of first home buyer demand is projected to rise to around 130,000 loans per annum, and be in the 120,000 to 130,000 range on average in the five year period to Loans to upgraders Upgraders and downsizers represent the largest component of residential demand, at around two to three times the size of the first home buyer market, and therefore have the most influence on the market. However, there is less impetus for potential upgraders to enter the market to move to their next dwelling unless required by life stage movement, or encouraged to by capitalising on a strong market for their current dwelling. Consequently, while there is always an underlying level of upgrader activity taking place, demand from upgraders is greatest when there is strong demand for their current dwelling. Ultimately this needs healthy demand from first home buyers at the entry level to provide demand for their existing dwelling and entice them to move on. The number of loans approved to non first home buyers declined by 2% nationally in 2011/12 (Table 4). This varied across the states from low growth in New South Wales (1%), Western Australia (3%) and Northern Territory (2%) to a contraction in loan volumes of up to 7% in both Victoria and Tasmania. Growth in non-first home buyer activity has begun to re-emerge nationally in After recording zero year-on-year growth in loans to non-first home buyers in each of the March and June quarters, there was a 2% national rise in July Growth, or a receding rate of decline, was recorded in almost all states in the month. The 95 basis point reduction in standard variable interest rates between November 2011 and June 2012, combined with flat to falling median house prices across most capitals, has improved affordability and in turn upgrader sentiment. The strongest growth in loans to non first home buyers in the first half of 2012 has occurred in Queensland, Western Australia and Northern Territory, where rising first home buyer demand, and an increasingly positive economic outlook, has also flowed through to improved upgrader activity. Loans for residential investment The Australian Bureau of Statistics provides data on residential investment in terms of the value of total loans rather than the number of loans. As a result, changes in the value of loans over time reflect both a change in values for property as well as purchaser volumes. The total value of residential investment loans has remained steady nationally over 2011/12, although after an annual decline in the six months to December 2011, there has been a year-on-year 20

23 Table 4: Change in number of loans approved to non-first home buyers Source: Australian Bureau of Statistics Non-FHBs loans (% change from previous period) % Change on corresponding quarter the previous year State 2009/ / /12 Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 Jul 12 NSW VIC QLD SA WA TAS NT ACT Australia Table 5: Change in value of investment loans for the purchase of property for rent/resale Source: Australian Bureau of Statistics Value of investment loans (% change from previous period) % Change on corresponding quarter State 2009/ / /12 Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 Jul 12 NSW VIC QLD SA WA TAS NT ACT Australia

24 housing outlook housing finance (cont.) rise in the first half of 2012 (Table 5). Highlighting this emerging upward trend, the value of loans for residential investment has increased by over 5% in the six months to June 2012 when compared to the corresponding period in 2011.Given that median house price growth has been weak so far in 2012, investors are likely to have been attracted by improved yields, and encouraged by the prospect of a return to capital growth with signs that economic conditions have been strengthening. Over the first six months to June 2012, the value of loans for residential investment has increased by 35% in the Northern Territory compared to the first half of 2011, followed by growth of 27% in Queensland and 14% in Western Australia. Substantial investment in the resource and mining sectors in 2011/12 has led to rising net inflows of migrants from interstate and overseas in these states due to greater job creation and income levels. However, new dwelling construction is yet to experience a commensurate rise and the lack of new rental supply has seen rental vacancy rates in these states tighten quickly during 2011/12. Stronger rental growth has also been emerging, which should continue through the next two to three years until a recovery in construction catches up to the stronger underlying demand. The rising rents and the prospect for resultant capital growth should further buoy investor demand in these states. Although not experiencing the same strength in population drivers, a persistent shortfall of additional dwelling stock in New South Wales has ensured that rental vacancies remain tight. This appears to have underpinned the 3% annual rise in the value of residential investment loans in the first half of 2012 in the state. Investor demand should strengthen as the forecast strengthening in economic conditions increases the scope for solid rental growth and improved sentiment. The value of loans to investors in 2011/12 fell in Victoria ( 7%), South Australia ( 8%) and Tasmania ( 3%). These three states all experienced solid price growth in the post-gfc years which resulted in a deterioration of yields, while strong construction has seen vacancy rates creep up and rental growth slow. This has removed the prospect of any short term capital gains and investors have been discouraged. Loan activity and the effect on prices A key assumption of this report is that the recovery of first home buyer demand back to long term levels will encourage greater turnover by upgraders, with the increased overall activity having a positive impact on median house prices. The impact on the level of turnover on price growth can be seen in Chart 5. Turnover has been indicated by the 12-month moving average of new owner occupier loans for established dwellings. Periods where turnover has increased have coincided with stronger median house price growth, while periods of slowing turnover have seen price weakness. The 12-month moving average of new loans for established dwellings dropped from a peak of 31,750 in November 2009 to just below 23,000 in January Nationally, turnover has remained at this weak level since. As a result, the Australian median house price experienced a downward trend in growth in-line with the decline in turnover, with annual growth in the weighted median house price becoming negative since June Loans for established dwellings have barely risen in 2011/12, with this being reflected in the negative median house price growth over the year. While nationally there has been little change in lending activity, there is some disparity across the states, with rises in some states offsetting declines in others. Nevertheless, the marginal rise in loans that did come through over 2011/12 is expected to gain more momentum through 2012/13 as first home buyer demand continues to recover and flow through to greater upgrader activity. Turnover and confidence should also be encouraged by the 95 basis point decline in standard variable interest rates over the year and the prospect for further falls in the second half of The anticipated upward trend in established dwelling loans in 2012/13 should see some price growth return through the year, rising into the following year as turnover continues to grow.

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