Why the Megaboom is Coming and Interest Rates Won't Stop It

In theory, house prices shouldn’t be going up.

At least, not when you look at where interest rates are heading.

Following the drop to record-low rates to stimulate the economy during COVID-19, house prices boomed.

But then, in May 2022, it was no longer possible to sustain such low rates, and the RBA began a prolonged cycle of rate increases.

And predictably, house prices dropped from around $750,000 to $700,000.

That’s what you’d expect.

But then, despite 4 more increases in the first half of 2023, plus high inflation and not much in the way of wage increases, house prices reversed direction and headed back up again.

In fact, all Capital Cities have shown robust growth since bottoming out, with Brisbane, Adelaide, and Perth recording their highest median sales value in October 2023.

sales value growth-01-01

Normally, that shouldn’t happen.

Today, with the official cash rate of 4.35%, house prices are almost as high as when the official cash rate was 0.1%.

Dwelling values now mere 0.5% below previous peak-01-01

How does this happen?

How can we go through a huge increase in interest rates plus extremely high inflation and still have house prices increase?

House prices are determined by the supply and demand for houses, which in turn are affected by a combination of factors.

Interest rates are an important determinant of demand, but they’re not the only factor. Moreover, there also exist supply-side elements.

In our case, these other factors are simply outweighing the impact of rate rises.

At the moment, the impact of our supply and demand situation is overwhelming.

Let’s take a look at both these factors to see how significant the impact is.

Demand

Australia is going through a mini population boom, particularly with overseas migration.

In the year to March, 454,000 immigrants headed here, which led to a massive new demand for housing. That’s the population of Canberra to be squeezed in.

Plus, international students have started to arrive again.

We’ve also seen a significant number of purchases from overseas. Australia is the top choice for Chinese buyers, and we have the highest inflow of high-net-worth individuals in the world.

To add further pressure, household sizes have been constantly increasing, from around 3.0 in the 1980s to around 2.5 in the last census.

Auction_Nov_22 (1)

Supply

Supply is just as important as demand.

And while supply levels have been falling for over 15 years, COVID-19 accelerated the fall to disastrously low levels.

The availability of materials and labour during the pandemic slowed down our building capacity drastically.

So have high interest rates as well, with borrowers unable to finance deals, particularly since the cost of building a house has soared by 29% since March 2021.

It’s no surprise that building approvals have slumped from a peak of r 21,000 in March 2021to under 14,000 in September 2023

Currently, our research indicates we are 100,230 homes undersupplied.

With building approvals low and government inaction on opening up new housing supply, this number is more likely to increase than decrease.

In an attempt to reverse the trend, the federal government has set a target of 240,000 houses a year to close the gap.

Various developers and institutions have commented that this is not feasible. “It doesn’t matter what number they make it, whether it’s 1.2 million or 5 million, it’s all the same. We won’t be getting there,” said Robert Lynch, chairman of residential builder Tamawood.

After all, the construction cycle, starting with the purchase and subdivision of land right through to completing houses, can easily be 3 to 4 years.

The best we can hope for now is to start putting the brakes on the widening gap before we even dare think about closing it.

Where to now?

We know demand is soaring and supply is falling.

And we know the pull from this is even outweighing the sudden increase in interest rates.

So it’s no surprise that KPMG is predicting house prices to rise nationally by 4.9% over the next 9 months, and then surge by 9.4% in the year to June 2025.

value growth forecast-01-01

We’re also going to see stage 3 tax cuts come into force from July 2024, increasing peoples’ borrowing capacity.

The latest statistics from the ABS show that wages are beginning to increase once again.

Given that the banks have also factored in interest rate cuts from mid-2024 as well, we’re going to see more money flow into the market over the next year at the same time our population surges.

And no increase in supply in sight.

This is why our analysis leaves us certain that a mega boom is on the way.