What We’re Watching: The swing factor in house prices that no one is talking about – January 2023

February 2023

At CIM we believe all asset prices are driven by three factors:

• Fundamental: what is the intrinsic value of the asset?
• Technical: what is the supply/demand of the asset? and
• Hysterical: the unending battle between fear and greed

The way we think about hysteria really takes the fundamental or technical factor and extrapolates it beyond what is reasonably implied by the numbers.

When it comes to housing, the hysterical factor can at times seem to be the main factor driving valuations. It felt that way in 2021 and recent headlines around lack of supply of housing have us wondering if it may still be supporting house prices.

The bull case seems to be that house prices will rise driven by low vacancy rates which will be held low by a pick up in migration and slowing construction of new housing.

All this seems logical until you look at the data which shows that over the last couple of years building was robust, population growth slowed but vacancy rates actually declined?

So, over the last few years we built 472K net new dwellings, our population only grew by 638K (around 55-60% of the pre-COVID trend) and vacancy rates declined by 1.5%.

What gives???

Well, there are a few factors at play here but the biggest one is household formation rates. During COVID, household sizes shrunk which created additional demand for housing. Consider that in June 2019 we had 10.4 million homes and a population of 25.3 million, roughly 2.44 people per home. Fast forward to June 2022 and there were 26 million people and 10.9 million homes, roughly 2.39 people per home.

The change in housing formation rates is equivalent to net population growth of 500K or an additional 210K housing unit, equivalent to around 1.5 years of migration at pre-COVID levels.

Looking forward we can see new dwellings under construction. The government has set an ambitious plan to build 1 million houses in the next 5 years which would see around 170k net addition to housing (noting that around 30k properties are removed from housing stock annually). As the table shows below, at expected levels of population growth we only need to be adding 150K new dwellings per annum provided household formation rates stay constant.

So, to us the big question for house prices is ‘Will formation rates stay constant?’ In short, we think the number of people per home could increase to increase over the coming years, effectively adding more housing supply to the market.

The reason is that household formation rates are very sensitive to the economic cycle. During the Global Financial Crisis, it is estimated that 2.6 million less households were formed, effectively implying that the average person per household increased by 0.06 over the GFC relative to prior expectations.

In Australia, there are already signs that the household formation rates are slowing. Cost of living pressures (including strong rental inflation which seems to be annualising double digit levels) will inevitably drive more shared living arrangements as will any increase in unemployment. Similar trends can be observed offshore

Vacancy rates have started to increase even as our borders have opened and according to the ABS the average number of people per household actually bottomed in December 2021 and has increased fractionally from there.

On behalf of the team thanks for reading.

Pete Robinson Head of Investment Strategy – Fixed Income

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