Despite price falls unaffordability crisis to persist

House prices could fall at least 19% in the next 12 months, according to modelling by the Australian Institute for Progress.

The AIP Housing Affordability Index suggests that when the institute’s repayment affordability index hits a figure around 160* buyers will not be able to participate in the market. Over the last 28 years the index has peaked at 172.2 in 2008, 155.57 in 2011, and 159 in 2021.

The first quarter this year saw the index come down from the 2021 peak to 146.2. This was because of a 7.84% decline in the average house price.

Since then, the RBA has raised interest rates 1.5 percentage points. Unless house prices fall by a further 11% or so, then we are back at peak levels of unaffordability on the back of that increase with the index hitting 166.2. If the RBA adds a further 0.5 percentage points we would eclipse even the GFC levels.

The current boom took off from a figure of 121.1, a level similar to all previous bounces post 2008. To get back to that figure house prices will need to fall by 33.5%, unless the RBA decides to lower rates, or there is a strong uptick in average earnings.

History suggests that interest rates and earnings will move in opposite directions. If earnings increase, as is suggested by recent pay deals, then interest rates will stay high, because these pay rises are likely to be seen as inflationary by the RBA.

But pay increases are likely to be patchy, meaning that while affordability will improve for some, it will get worse for others. In this case we would suggest there is scope for greater than 19% falls across the country, but not by as much as our worst case scenario because wages at least should improve.

Counterbalanced against that is the inflation in building costs that is occurring at the moment. This is partly due to COVID supply chain interruptions, an increase in energy costs due to decarbonisation and the war in Ukraine, and diversion of construction resources into government, and government supported, infrastructure projects.

New houses set the marginal value of real estate, so any increase in new house costs will feed back into existing house costs.

Rents are also rising, which improves the investment case for investing in real estate, as well as encouraging renters to become owners.

Australia looks set to have a continuing housing affordability crisis at the same time as average house prices, and therefore average household wealth, decrease.

For further information contact Graham Young on 0411 104 801 or graham.young@aip.asn.au

*The index is calculated from a combination of house prices, average earnings and interest rates. A rise in rates or prices will decrease affordability, while a decrease in average earnings would have the same effect. Affordability increases when prices and rates decrease, or average earnings increase.