Last year, when uncertainty about the impact of the COVID-19 pandemic was at its peak, several forecasters, including economists from some of the country’s biggest banks, predicted falls in property values of as much as 10-20% over the next 12 months.

Worst-case scenarios suggested prices could fall as much as a third. Reserve Bank of Australia (RBA) researchers also published stress tests measuring how sensitive indebted households would be to the shock of any sharp fall in house prices. They modelled a 40% fall in house prices, which the bank called “an extreme but plausible scenario”.

Now, a year into the pandemic, not only has that dramatic outcome been avoided, but we’re seeing the reverse. Prices have risen more than 6.0% in the year to March and values in most capital cities are achieving record highs. More surprisingly, this growth is occurring while net migration has been decimated by Australia’s pandemic related border restrictions. This has resulted in a slowdown in the rate of population growth (traditionally seen as a proxy for underlying housing demand) to 0.9% in the year through September, from a pre-COVID rate of 1.4%. The strong market rebound is also occurring in an economy that, although recovering, is doing so unevenly. Industries based in the centre of capital cities, or that rely on foot traffic, mass gatherings, international students and tourism remain heavily impacted by the pandemic.

What prevented the dire scenario?

Australian residential property prices declined initially due to COVID. Values fell by just 1.7% between March and October, before returning to a positive trajectory, despite Australia experiencing its worst economic downturn since the Great Depression. There are several reasons why the fall in values was not more extreme, and why the recovery has been so rapid and strong, including:

  1.  The impact of falling migration is focused on the inner-city rental market in Sydney and Melbourne.

To understand the impact of the fall in net overseas migration (NOM) on housing, CoreLogic analysed the composition of migrant flows, and where migration is geographically centered. It found that temporary migrants comprise the large majority of NOM to Australia. CoreLogic says the large majority of temporary migrants rent rather than purchasing a home. Additionally, most permanent migrants tend to initially rent. This is why falling migration has been a major factor in driving down rents in Melbourne and Sydney.

Last year 84% of all overseas migration flowed into the capital cities. Three quarters of those capital city migrants arrived in Sydney and Melbourne, according to CoreLogic. Within the cities, the largest number of overseas migrants are generally centred around the CBD, and precincts close to the CBD, where high density housing options are common, and to a lesser extent, middle ring suburbs close to educational precincts or transport hubs such as Parramatta in Sydney or Clayton in Melbourne.

  1.  Workers in the sectors worst hit by COVID are more likely to be renters – often in the inner city.

These inner city market segments were also impacted by other factors beyond migration. Some of the worst hit parts of the employment market during the COVID-19 shutdown and recession were highly casualised industry sectors such as food, accommodation, arts and recreation workers. Workers in these segments are more likely to be renters than homeowners relative to other industries of employment. Additionally, fewer workers may be demanding rentals in the CBD’s due to remote working arrangements.

The flipside is that outside of Melbourne and Sydney, housing demand derived from NOM is less significant, and therefore the impact of falling migration is less significant.

  1.  Massive amounts of economic stimulus supported the economy.

Fiscal stimulus including the federal government’s $90 billion JobKeeper wage subsidy scheme helped keep the economy afloat as whole industries were forced to close to stop the spread of COVID-19. JobKeeper initially gave businesses $1,500 per fortnight per employee to help pay their wages. It helped to keep a connection between employers and employees, allowing a faster economic recovery when the pandemic was under control, and prevented a sharp rise in unemployment. At one point, almost a third of all Australian workers were on JobKeeper.

  1.  Low interest rates and other central bank measures have supported the economy and helped drive mortgage rates to record lows.

The RBA reduced the cash rate twice in March 2020, to 0.25%, and to 0.1% on 3 November 2020. This is boosting the cash flow of businesses and the household sector, and helping trade-exposed industries through the exchange rate.

Also in March 2020, the RBA announced a target for the yield on the three-year Australian Government bond of around 0.25% and reduced this target to around 0.1% on 3 November 2020. The central bank purchases bonds on the secondary market to help achieve this target.

The central bank has also been keeping borrowing costs low through its bond repurchase program. The RBA announced in November that it would purchase bonds issued by the Australian Government and by the states and territories in the secondary market under a $100 billion bond purchase program. In February 2021, it announced that it would purchase an additional $100 billion of government bonds when the current bond purchase program is completed in April.

In addition, it is providing a term funding facility (TFF) for the banking system, to support lending to businesses. The TFF was announced in March 2020, and an increase and extension of the facility was announced in September. Under the TFF, authorised deposit-taking institutions (ADIs) have access to funding from the RBA for three years at an interest rate substantially below their funding costs. In November, the interest rate on the TFF was reduced from 0.25% to 0.1% per cent.

  1.  APRA adjusted bank capital expectations.

The Australian Prudential Regulator Authority (APRA) also introduced temporary changes to its expectations regarding bank capital ratios, to ensure the banks were well positioned to continue to provide credit to the economy in the challenging environment during the pandemic. Over the past decade, the Australian banking system has built up substantial capital buffers. The highest quality form of capital, Common Equity Tier 1 (CET1) capital, reached $235 billion at the end of 2019. As a result, banks were typically maintaining capital levels well above minimum regulatory requirements.

In 2017, APRA set benchmark capital targets for banks to enable them to be regarded internationally as unquestionably strong (which was a recommendation of the 2014 Financial System Inquiry). These benchmarks are well above current minimum regulatory requirements. For the four major banks, for example, this benchmark equated to having a CET1 ratio of at least 10.5 per cent of risk-weighted assets. A lower benchmark applies for smaller banks. In comparison, the actual CET1 ratio of the banking system by the end of 2019 had reached 11.3 per cent.

In March 2020 APRA advised all banks that, given the prevailing circumstances, it envisaged they might need to utilise some of their current large buffers to facilitate ongoing lending to the economy. Provided banks were able to demonstrate they could continue to meet their various minimum capital requirements, APRA wouldn’t be concerned if they weren’t meeting the additional benchmarks announced in 2017.

  1.  Mortgage freezes kept a lid on defaults.

High levels of regulator driven liquidity assisted in the banks’ ability to offer six-month mortgage payment freezes, minimising defaults. There were very low levels of distress in the residential and commercial markets in 2020. In December, there were just five distressed residential listing out of hundreds of thousands. For the full year here were 71, even less than in 2019 when there were 98, according to REA. “The unusual nature of the recession being productivity driven, as opposed to finance, led, meant house prices across Australia didn’t fall,“ said REA in its 2021 Property Outlook Report.

  1.  Supply is lagging demand.

Despite steady population growth in Australia in recent years, home construction has been slowing. When COVID hit, forecasts were for as few as 110,000 homes to be delivered in 2020, less than half the near 230,000 built in 2016.

As the economy has recovered, the upswing in buyer demand has not been met with an equal rise in inventory, CoreLogic said in its Home Value Index report: “This has resulted in strong selling conditions, amidst a palpable sense of urgency amongst buyers, putting upwards pressure on housing prices.”

The rise in valuations has been stronger in free standing houses than in units, where more supply has come online in recent years. Knight Frank reports the median house price across Australia rose by 5.8% in 2020 compared to a 0.9% rise in median apartment values.

A report from SQM Research revealed that higher demand in major Australian property markets than the rise in home listings during February, caused a notable decline in supply by 13.1% year-on-year.

  1.  Incentives supported first home buyer demand.

Many state incentives for first home buyers were expanded on, and the federal government introduced the First Home Buyer Deposit Scheme, which allows first home buyers to put down a deposit of just 5% and avoid having to pay the added impost of the insurance.

  1.  Sydney prices are still not much above 2017 levels, but incomes have risen.

While values have remained surprisingly buoyant during the pandemic and are now back on the rise after a slight downturn, it is easy to forget that this buoyancy followed a significant downturn in the market in recent years.

Between September 2017 and June 2019, Australian residential property prices experienced their biggest fall in 40 years, following a period of exceptionally strong growth.45 As discussed in our reports at the time, those value declines were largely driven by tightening in the availability of credit as the Australian Prudential Regulation Authority (APRA) had implemented measures to reduce the risks in the mortgage market, causing a fall in lending to investors.

In the second half of 2019, as APRA began easing constraints on lending, the residential market was beginning to recover from the downturn, and then the pandemic struck in early 2020.

In an article examining the long-term property cycle, Christopher Joye of Coolabah Capital notes that in the 3.5 years since the peak of the last major housing boom, Sydney dwelling values have appreciated by just 1.1%. That equates to an annual rise of just 0.3% a year. At the same time, wages growth has been running at a much higher 2% 46. The resultant higher income, along with ultra-low interests, is adding to the net purchasing power of Australian households.

Australians are wealthier than ever, and this has been reflected in strength in the prestige end of the housing market. Total household wealth hit a record high in the December $12.03 billion, driven by the rising value of deposits, superannuation balances, and residential assets, according to the Australian Bureau of Statistics.

The REA Insights Property Outlook Reports that of the 30 suburbs with medians priced over $3 million, only five saw a price decline in 2020. More than half the suburbs on the list saw double digit price growth. And the number of $3 million plus suburbs doubled during the pandemic. REA predicts that the number of A$3 million suburbs will jump from 30 to 60 by the end of 2021.

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