The International Monetary Fund’s (IMF) latest report, entitled Housing Market Stability and Affordability in Asia-Pacific, included the below chart showing why house prices must continue falling in both Australia and New Zealand if homes are to become affordable:
Specifically, the red chart lines denote median housing prices. The gray chart lines denote the level of house prices consistent with a debt-service-to-income ratio of 30% for the median-income household. Whereas the blue bars denote the deviation of actual median house prices from this benchmark.
According to the IMF, in both Australia and New Zealand, “an affordability gap opened in the 2010s, but low and declining interest rates kept it somewhat in check through 2021”.
“However, as interest rates increase, affordability is declining rapidly, despite falling housing prices”. The IMF estimates that in 2022, “housing prices may be as much as 70% and 50% above what a median household can afford in New Zealand and Australia, respectively, and the average household would need to spend more than 40% of its disposable income to afford housing priced at the median”.
Given interest rates in both Australia and New Zealand are expected to rise from here, this necessarily means that affordability will worsen unless house prices fall further.
Basically, house prices in both nations have risen well above what the typical household can afford at prevailing interest rates.
Therefore, house prices must continue to fall to bridge the affordability gap.
Separate data on borrowing capacity gives similar results. For example, the Reserve Bank of Australia’s (RBA) cumulative 3.0% of official cash rate (OCR) hikes has increased variable mortgage repayments by around 40%:
In turn, borrowing capacity has shrunk by around one-third, such that a borrower now needs an income of $180,000 to service a $500,000 mortgage, up from $122,000 before the RBA’s first OCR hike in May 2022:
Lower borrowing capacity means lower house prices. The equation is that simple. And the more the RBA tightens, the further house prices will necessarily fall.
