Why the housing supply deficit has never been so extreme
It’s no secret robust housing demand has fuelled home price growth, despite the higher interest rate environment.
What we are seeing is affordability constraints - that otherwise would have slowed the market - being outweighed by the effects of an extreme supply-demand imbalance.
Part of the story is also the growing working-age adult population, which directly increases the demand for housing.
More than 80% of population growth is currently stemming from net migration, which means more working-age adults than it would if growth stemmed from natural increase.
This means that growth in the adult population is steadily higher than total population growth, leading to a surge in demand for housing.
Meanwhile the residential construction industry has been challenged by capacity constraints and higher costs, leading to fewer new builds.
In fact, the supply deficit has never been so extreme.
Although this period follows one where growth in the working age population lagged new housing, net migration has caught up and outpaced the losses during the Covid period.
Although recent data suggests that average household sizes (AHS) have slightly increased from the historic lows seen during the pandemic, AHS remains below pre-pandemic levels at 2.5 people.
The lasting preference for living with fewer people is continuing to add to housing demand driving up house prices and rents.
And now net migration has fully caught up the pandemic losses and then some, meaning demand for housing is much stronger while supply fails to keep pace.
Despite some easing in population growth, this ongoing mismatch between supply and demand has offset the higher interest rate environment and is expected to persist in mitigating the downward effects of affordability challenges, fuelling further price rises.
Using the official population change in the year to September 2023, a potential 264,000 additional households would have needed homes.
Around 170,000 new homes were completed in that period, meaning a shortfall of around 94,000 homes based on potential new household additions, assuming average household sizes remained constant.
Typically, recent arrivals to Australia are more likely to rent, and existing dwellings are also housing options, but the deficit clearly illustrates the shortage impacting both prices for existing homes and the rental market.
This strength in housing demand relative to supply is one reason why home prices have remained resilient to the higher interest rate environment.
Strong labour market conditions, tight rental markets, home equity gains supporting upgrade activity and more recently interest rate stability have also been drivers of robust homebuying demand.
This dynamic has fuelled a strong start to the year with home prices rising quickly in early 2024, though it is reasonable to expect a slowing from here as we move into a seasonally quieter period for property markets, especially with interest rate cut expectations pushed back.
This week the PropTrack Home Price Index showed the pace of monthly growth has slowed since March in every capital city, except Darwin.
Annual growth rates also look to have peaked in most capital city markets, slowing in Sydney, Melbourne, Brisbane, Adelaide, and Perth. Though Canberra, Hobart and Darwin saw the pace of annual growth increasing slightly.
But despite slowing growth, the home price uptrend remains intact and prices in most markets are recording robust growth.
The smaller capital cities continue to outperform, and Perth, Adelaide and Brisbane remain the strongest markets over the past year with prices 20.16%, 13.99% and 12.82% above April 2023 levels respectively.
The relative affordability of these cities’ homes, population growth, and very tight rental markets are supporting home values. Low stock levels are intensifying competition amid strong buyer demand, resulting in a sellers’ market with home prices rising at a fast pace in 2024.
In fact, outside of houses in Perth (+20.80% year-on-year) the unit market in Brisbane is the top performing over the past year with prices up 15.08% compared to the same period last year.
Unit prices nationally have outpaced houses year to date, with affordability constraints in play. With housing affordability having deteriorated significantly, many buyers will shift down the value chain making trade-offs as dictated by what remains affordable.
The significant reduction in borrowing capacities and deterioration in affordability are being reflected elsewhere as lower value homes are recording stronger growth than more expensive homes across the combined capital cities. This is a direct contrast to the same time last year when the upper end was driving the recovery.
The stable interest rate environment has likely been a driver of confidence among buyers and sellers, and with housing supply unable to meet demand across the country, national home prices reached a fresh peak in April as robust demand has continued to push prices upwards.
Higher interest rates and inflation are squeezing household budgets, and many remain concerned about the economic outlook. But property prices are expected to lift further this year, with housing demand buoyed by population growth, tight rental markets, resilient labour market conditions and home equity gains, alongside the stable interest rate environment.
The supply side of the housing market has fallen short in responding to substantial demand. Building activity is at decade low levels, exacerbating the housing supply shortage and maintaining a floor under home prices.
Although higher than expected inflation in the March quarter has pushed back the expected timing of rate cuts most still expect that the next move for interest rates will be down. However, the timing remains uncertain.
As a result, prices are expected to lift further in the months ahead, though it’s likely the pace of growth will continue slowing as the seasonally quieter winter period approaches, particularly in tandem with rate cut expectations being pushed further out.
The smaller capital city markets, Perth, Adelaide, and Brisbane are likely to maintain their outperformance despite growth slowing as constrained stock levels are intensifying competition amid strong buyer demand.
***Article Written by Eleanor Creagh, Senior Economist at Proptrack