Chart of the Month: The Great Disconnect

Australian House Prices & The Borrower

Over the last 40 years, the increase in house prices has been driven by a corresponding rise in the borrowing capacity of households; as interest rates fell, wages rose, and dual incomes became the norm. What’s eye-catching about this cycle is the disconnect between prices and borrowing capacity – higher interest rates have reduced the borrower’s ability to pay, meanwhile house prices have continued their upward trajectory.

What is driving the current disconnect?

• Supply & Demand – with record immigration following Australia’s post-COVID reopening, there is a well-documented under supply of housing in Australia to support the higher population. Higher demand for housing with an inadequate increase in supply is resulting in elevated prices.
• % spent on mortgage payments – this chart assumes a constant % of income is spent on mortgage payments. In the current environment, it is likely borrowers are forced to commit a higher % of their income to mortgage repayments, leaving less available for discretionary/retail spending.
• Bank of Mum & Dad – whilst evidence if anecdotal, there is growing acceptance of a rise in intrafamily lending to bridge the gap between borrowing capacity and prices.

When will the prices again converge?

Looking back at previous dislocations, a brief disconnect can be seen post-GFC, followed by flat growth in house prices until the capacity line converged. History suggests a similar outcome is likely this cycle.

If we assume zero house price growth and an RBA Cash Rate of 3.5% (not expected to occur until 2026), we forecast this would still take ~5 years for the borrower’s capacity to catch up to current prices. This points to a sluggish period of real house price growth.