Housing ‘bubble’ to deflate slowly in Sydney and Melbourne as house values gently roll back

Brendan Rynne, Partner, Chief Economist
Brendan Rynne, Partner, Chief Economist

Median housing prices in Sydney and Melbourne are currently overvalued by 14 percent and 8 percent respectively, but will decline gradually, rather than sharply, over the next few years.

KPMG Economics’ latest report finds Sydney house prices will experience a greater adjustment than Melbourne in the coming years, although neither market will suffer a collapse in value.

The current situation is not unprecedented. Australian house prices have experienced similar surges before and returned to equilibrium without the sort of crash we have seen in other countries after the GFC. From our modelling we similarly expect that prices will cool rather than plummet on their way back to equilibrium.

Current prices are clearly over-inflated but by historical standards do not quite reach ‘bubble’ territory.

The report, Housing affordability: What’s driving house prices in Sydney and Melbourne? shows a dramatic rise in annual sales to FIRB-approved overseas purchasers in the last four years has been a key driver of the price surge.

Anecdotal evidence suggests the demand of Chinese investors for Australian residential property has softened in recent months due a combination of factors. These include the adoption of differential stamp duty in some states, the introduction of vacant property taxes for foreign buyers, the tightening of currency controls in China and the move to introduce a 50 percent cap on developers selling to foreign investors. Combined, these regulatory risks have contributed to weaker sentiment from Chinese property investors.

In Sydney, our modelling forecasts a median dwelling price peak of about $980,000 in FY2019 (up from $880,000 at 30 June 2016), before gradually rolling back to between $930,000 and $950,000 by the end of FY2021.

By contrast, Melbourne median dwelling prices are expected to peak next year, pause for a year or two, and then start to grow again. Median dwelling prices in Melbourne are expected to rise from about $650,000 at the end of June 2016, then rise to sit between $720,000 to $740,000 by the end of FY2019. After plateauing, they will regain momentum to sit between $775,000 and $825,000 by the end of FY2021.

In both markets, domestic investors will be affected by APRA’s move to curb interest-only mortgages and monetary policy tightening which we expect will start sooner rather than later.  Investors both here and overseas have been the key driver behind the housing price boom and policymakers are now addressing this. If government and regulators are to continue tackling housing affordability there are a number of policies that should be considered, including:

A reduction in the capital gains tax discount from 50 percent to 25 percent, thereby making property investment marginally less attractive.

Abolition of stamp duty on the transfer of residential property and conflation of rates, land tax, insurance taxes and emergency service levies into a new Property Services Tax.

Systemic reforms aimed at maintaining the supply and diversity of land and housing in established and growth areas, through setting targets, streamlining planning and empowering public supply.

Targeted reforms aimed at improving access to those groups who are the most excluded from affordable home ownership. This package would focus on more low cost housing, improved assistance to those who need it, and promoting shared equity.

Housing is an area where government actions can have major consequences for the market, sometimes unforeseen. Recent measures by state and federal governments have started to cool the large price increases and they need to keep a close focus on housing affordability with carefully targeted actions.

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