Investors plunging into residential property have been warned by the Reserve Bank of Australia (RBA) that they are taking on risks when prices are already high and growth in rents has slowed.
Following October’s Board meeting, the RBA indicated that property prices had continued to grow into the September quarter.
What’s been driving prices?
The rise in house prices over the last two decades – most recently in Sydney – can be attributed to two key factors:
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Low interest rates: A sustained period of low interest rates has enabled Australians to borrow more for a given level of income. Consequently, this higher borrowing has allowed Australians to pay more for homes.
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Undersupply: Restrictive land supply policies coupled with high stamp duty and infrastructure charges have subdued the supply of real estate in Australia. Reflecting this, residential vacancy rates remain relatively low.
Please note: While foreign and SMSF buying is playing a role in some areas, it can be argued that their overall impact is small.
Tightening the reins: Macro-prudential policies are being considered
The RBA has indicated that it is in discussion with the Australian Prudential Regulation Authority (APRA) on steps that could be taken to ensure sound lending practices are maintained with a focus on investors.
This could involve limits on loan-to-valuation ratios, or more likely, measures that would force banks to either put aside more capital for loans to property investors or impose tougher tests when granting loans. We expect to hear more on these measures in the months ahead.
What about interest rates?
Despite strong gains in property prices, the RBA has indicated that interest rates will remain unchanged for now, adding that the most prudent course forward would likely be a period of rate stability.
At the moment, the RBA is reluctant to raise rates given uncertainty regarding the rest of the economy and the risk a rate hike would put upwards pressure on the Australian dollar, which is still too high for the RBA’s liking.
Final thoughts
We expect that investors could see further gains in house prices in the short-term, but at a more modest pace. This trend is likely to continue until the RBA starts to raise interest rates (possibly around mid-next year).
As a medium-term investment, residential property currently looks somewhat less attractive. The total return over the medium-term is expected to be around 4 to 5% per annum. This is currently lower than shares and commercial property.
In saying this, over the very long-term (almost 100 years) residential property has provided a similar return as Australian shares; both have delivered around 11 to 11.5% p.a. to investors since the 1920s.
About the Author
Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.
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