Residential Property Market

The residential property market is hotting up. We've seen a variety of numbers pointing to this conclusion in recent months.

Last month showed continuing growth in housing finance, correlated with rising house prices. Then we saw high inflation in housing prices.

More recently, the ABS released volume measures showing that building work is on the rise. In the December 2013 quarter, there was a spike in the volume of new residential building, and the flow-through of that is now evident in the March quarter, as the two charts below show.

Volume of new work commenced, building

Volume of work, buidling

By contrast, construction in general was weak in the past couple of quarters.

Volume of work, construction

This all presents a few problems for policy-makers. It will be making the RBA a little bit nervous, because unemployment is continuing its slow and steady upward trajectory, while inflation is sitting comfortably in the 2-3% target band. This gives the Reserve little wiggle room to act on house prices, by raising rates (see here for brief explanation). Meanwhile, three of the big four banks last week announced cuts to their five year fixed home loan rates, indicating they expect easy money for some time to come. This will blow more air into what is increasingly looking like a bubble (sorry to mix metaphors here).

The rise in lending should also be cause for concern. As some economists have been warning, the climbing rate of private debt is putting economies into an unstable position (see here and here).

There are a few options for addressing a hot residential property market. Changes to negative gearing could go some way to cooling the market. By reducing the tax incentives for property investment, government would effectively push investment dollars into other (more productive) parts of the economy. The hotter the property market gets, the more investors (rather than home-buyers) will flood in, taking advantage of the rising prices. Changes to negative gearing could, to some extent, address this.

Beyond that, there are a range of more extreme measures that policy-makers will be reluctant to impose. Macroprudential reform (effectively raising deposit requirements), for example, is seen as a measure of last resort, because of the distortions that it can cause in markets.

Interesting times ahead. Stay tuned.