Capital city dwelling values edged a further 0.2% higher in November, according to the CoreLogic home value index. Although values rose in November, the month-on-month change was the lowest since December last year (2015), potentially indicating that the reacceleration of housing market conditions, which has been evident over most of the second half of 2016, may be starting to abate.
Although the pace of capital gains has moderated compared with previous months, the stronger conditions across most capital cities since the May and August rate cuts have pushed the annual trend of growth higher. The combined capitals index is up 9.3% over the past twelve months, after recording an annual growth rate as low as 6.1% in July earlier this year. Sydney (+13.1%) and Melbourne (+11.3%) are both once again recording double digit annual growth, while Canberra and Hobart are now recording annual growth rates higher than 8%.
Interestingly, and somewhat surprisingly, the Darwin market has also shown an improvement in growth conditions, with annual capital gains moving back into positive territory. Darwin dwellings recorded a 1.1% increase in dwelling values over the past twelve months. The results are supported by a consistent rise in transaction volumes over recent months, however listing numbers remain very high across Darwin which is likely to keep a lid on the pace of capital gains for the time being.
Perth is the only market where values remain lower than a year ago. Over the past twelve months Perth dwelling values have fallen by 3.4%, taking the cumulative decline to 9.2% since values peaked in December 2014.
The softer monthly result was largely attributable to a weak result within the Melbourne unit market where values were 3.2% lower over the month and 1.1% lower over the rolling quarter. Ongoing concerns around an oversupply of units is likely having an effect on buyer confidence and dampening the potential for capital gains within the inner city high rise apartment market. The weak trend across the Melbourne unit market is similar in Brisbane, with annual growth rates for units in both cities tracking well below the growth in the detached housing sector. The past twelve months has seen Melbourne house values rise by 12.2% while unit values are up by less than one third of that at 3.9%. Similarly, in Brisbane, house values are 4.3% higher over the past 12 months while unit values are down 0.9%.
The Sydney housing market has not seen anywhere near the same differential in house and unit value growth rates. House values across Australia’s largest city are up 13.5% compared with a 10.8% rise across the unit market. Although the Sydney metro area is recording a similar number of units in the pipeline, the development trend is much more geographically diverse compared with other cities. Additionally, Sydney has a well-developed densification trend, with attached housing construction outpacing detached housing since the mid-1990’s.
ABS dwelling approvals data has been showing a trend towards fewer high rise unit approvals, which is arguably a healthy outcome considering the concerns around oversupply within key inner city precincts of Melbourne and Brisbane. According to the ABS data, unit approvals were down 23.5% over the month to be 41.8% lower compared with October 2015. House approvals, which tend to show a steadier trend, were down 2.5% over the month to be 4.5% lower compared with a year ago. While approvals remain high compared with the long term average, it is becoming increasingly clear that approved dwelling supply has moved through the peak, suggesting the construction pipeline is likely to follow suit over the coming year.
While dwelling values were generally rising in November, rental rates have remained relatively subdued. Capital city rents were down half a percent over the past twelve months while dwelling values were up 9.3%. The by-product of lower rents and substantially higher dwelling values has been further compression in the rental yield. The typical capital city house is now returning a gross rental yield of 3.1% and units are showing an average gross yield which is slightly higher at 4.1%.
Yields have fallen the most substantially across the markets where capital gains have been the highest; Sydney and Melbourne. The average gross yield on a house in both cities is now 2.8%. However, with steep falls in Darwin unit values, the top end capital city is now showing the lowest gross rental yield for units at 3.6%, although Sydney isn’t far behind at 3.8%.
With rents showing no signs of accelerating higher, and dwelling values still trending higher, the likelihood is that rental yields will continue to reduce to new record lows over the coming months.
The low yield profile does not seem to have been a concern to investors, with housing finance commitments for investment purposes tracking consistently higher over recent months. Since May, which coincided with the first of two rate cuts this year, the value of investor housing finance commitments has risen by 14.5%. Excluding refinanced loans, investors now comprise 49% of all new housing finance commitments.
Investors, as a proportion of all new housing finance commitments, are the most active in New South Wales, where investment accounts for 57% of the mortgage demand. Tasmania is attracting the smallest proportion of investment activity, with finance commitments for investment purposes comprising 28% of the Tasmanian market.
It appears that investors are focussing their strategies on areas that have demonstrated high capital growth with little concern about the low yield profile. With other asset classes such as cash or bonds offering shallow returns and equity markets showing a high amount of volatility, it is easy to understand the appeal of housing. Total returns, which include capital gain as well as the gross yield, are generally above 8% per annum across each of the capital cities, except for Darwin and Perth where the yields and capital growth are low.
If the current trend of investment activity in the market persists, we are likely to once again see investors outweigh owner occupiers nationally; a feature of the market that we haven’t seen since June 2015. It is likely that regulators and policy makers will be uncomfortable with this level of investment in the housing market, particularly after four and half years of strong capital gains and record low rental yields. If this is the case, we may see a further regulatory response from APRA aimed at cooling investment demand across the housing market. These changes could take the form of higher capital requirements for lenders issuing investment loans, higher loan to valuation ratio requirements for investors, or a tightening of the investment lending speed limit that was introduced in December 2010.
Another facet of the housing market that has changed over recent months has been transaction numbers. The number of settled sales reached a recent low point in August earlier this year at approximately 36,000 settlements over the month. Since that time, settled transaction numbers have risen 16.4% nationally to the end of November, and 21% across the combined capital cities. The bounce back in sale numbers could be the result of higher buyer demand fuelled by the August and May interest rate cuts.
If this is the case, renewed speculation that interest rates could move higher next year may dampen some of this renewed enthusiasm. Most economic commentators seem to be aligned that the rate cutting cycle is over. Additionally, the ASX cash rate futures market is indicating that traders are also speculating that interest rates may move higher over the coming year.
If we do see rate hikes in 2017, the likelihood is that they will be gradual and limited to only modest increases. The reserve bank is likely to be wary of increasing the cost of debt at a time when the domestic economy is still relatively fragile and the level of household debt is at record highs.
Overall, after four and a half years of strong value growth, it is hard to imagine a reacceleration in property values could be long lived. Affordability constraints are creating high barriers to entry, particularly in Sydney, and lenders are becoming more cautious in their lending practices. Despite the recent easing in unit approvals, the supply pipeline is substantial for inner city units, which is likely to dampen value growth in these precincts as well as dent buyer confidence and push vacancy rates higher.
Additionally, there has been new speculation that interest rates could rise late next year, with fixed rates already starting to edge higher. With household debt at record levels, Australians are very sensitive to the cost of debt, and an expectation that the period of record low mortgage rates is approaching an end may reduce buyer demand.