The value of homes has soared across the world, including New Zealand (+27.6 per cent), the United States (+19.1 per cent to October), the UK (+10.0 per cent) and even places like Turkey (+40.0 per cent to October). And for those who believe interest rates drive property prices, the average key interest rate in Turkey during 2021 was 18 per cent (up from 11 per cent in 2020).
In Australia, house prices increased +22.1 per cent in 2021, led by Australia’s largest city of Sydney (+25.3 per cent).
Generally, the Australian housing market has defied most gloomy predictions. However, it would be dangerous to dismiss concerns in the current environment. That’s not to say that we are expecting a collapse in prices, but rather there are some key indicators that suggest there are some differences to the past.
Around the world, different markets are facing different risks. In the US, for example, the cumulative undersupply in US single family housing is still significant and may take many years to rectify, which will continue to support prices.
However, Australian residential property and US apartments have a less positive outlook. For the first time in decades, there is a real risk these markets are facing a headwind of persistent oversupply, exacerbated by pandemic-induced immigration declines.
As we head into 2022, there is an expectation that interest rates are likely to rise around the world in response to recent inflation data. However, we do not believe this will be enough to stop the gains – in fact, rising rates may indeed add to further gains (as per Turkey). The biggest risk for investing in residential property is, as always, excess supply.
As prices increase above the “cost to build”, there is almost always a supply response as developers try to cash in on the margin. Ultimately, increasing supply dampens prices back to a level where supply is restricted – and the cycle starts all over again.
So, is the surge in residential property prices causing a supply response? In Australia, the answer is an emphatic yes.
Completions have yet to increase as the lag starts by around a year, so we have yet to see any heat come out of the Australian market. However, completions will inevitably surge this year.
A surge in supply is not always a bad sign. The critical question is whether there is more total housing stock relative to overall housing occupier demand. To answer this, we will need to quantify the magnitude of the potential oversupply, if there is any. This is always a difficult task, as it not only relies on supply data but also household formation data, which can be notoriously fickle.
Our analysis has resulted in the following record of cumulative supply shortfall since 2010 (Chart A).
The chart demonstrates that there has never been a situation where there has been excess supply of housing in Australia. Accelerating housing starts (as prices rise above replacement cost) were quickly absorbed by new households.
For Australia, population growth has generally provided Aussie housing the ultimate “get out of jail free card” just as the market begins to cool.
However, with COVID, population growth effectively halted right at the time supply was accelerating. We don’t believe it is time to call for a market correction just yet, but it seems unlikely recent national residential price growth will be repeated in 2022.
What about the US?
Recent strong increases in US residential property prices have also come with a surge in new supply, in both houses and apartments.
Does the US face the same supply headwinds as Australia? To answer, we have applied the same methodology as the Australian analysis above.
The results show that for single family residences, there was a significant increase in excess supply leading to the financial crisis, which offers no surprise since prices boomed and were well above replacement cost. However, the single-family sector was crushed post-crisis in terms of price (and ultimately resources), resulting in a significant deficiency in supply – even after allowing for the pandemic-induced collapse in immigration.
Conversely, US apartments never felt the effects of excess supply in the lead-up to the financial crisis. Also, unlike single family homes, apartment supply recovered more quickly in response to the demographic demands of millennials leaving home in the first half of the 2010s. However, with the decline in immigration, there appears to be a growing risk that apartments are moving into excess supply for the first time in decades.
This analysis is not meant to be all encompassing and each market has its own subtleties and nuances. To be clear, we are not necessarily predicting a “crash”, or even a correction in these markets. But it seems clear from the data that right now that one of the best risk return profiles is in US single family housing, while caution about the Australian residential market could be warranted.
Chris Bedingfield, portfolio manager at Quay Global Investors.
