Low risk of sharp correction in Australia’s housing market, new Vanguard analysis shows

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Aerial view of suburban housing

A big unknown is how households deal with their high debt.

Vanguard has released new analysis focused on four of the world’s largest and most developed housing markets, including Australia, examining valuations, the sectors’ interaction with the business cycle, and implications of a housing market crash.

The rapid growth in housing prices has added to recession fears globally, and in the markets examined by Vanguard’s Investment Strategy Group – Australia, United States, United Kingdom and Canada – common measures evaluating the health of the housing sector raise concerns. While most markets appear highly valued, Australia and Canada stand out for both the high cost of housing and high levels of household debt.

The house price to income ratio currently in Australia is in its highest quartile relative to history, while household debt to GDP is approaching its all-time high at 122 per cent.

Significant drivers of heightened house prices include the balance of housing demand versus supply, interest rates and foreign investment, however Australia’s housing market rally has exceeded expectations beyond what these measures can explain.

While affordability is a huge concern, particularly in large cities, Vanguard economists consider that the risk of a sharp correction – defined as a correction in the space of a year which severely impacts the economy or causes a recession – is low for markets studied, including Australia.

Vanguard cautions however that forecasting peaks or troughs in this market is as challenging as predicting recessions, and investors should be prepared for a range of possible scenarios.

“A big unknown is how households deal with their high debt given the slow income growth in Australia however, and this will be a large factor in what transpires in Australia’s housing market”, said Matthew Tufano, Vanguard economist and co-author of the paper.

“However the large pipeline of housing – mostly apartments – coming into the market in Australia could effect a more gradual moderation in house prices, rather than a sharp correction”.

Other scenarios that were considered were that house prices would correct over three years, with limited economic impact or that house prices would correct over five years with marginal impact if any.

The paper concludes that housing is a complex asset with many close links to the economy and is generally considered a good indicator of the broader health of the economy. Investors’ concerns of a correction are understandable given the strong performance of the sector.

“While house prices are softening in the markets we studied, our economic outlook has not changed for these countries”, Mr Tufano concluded, “but we do expect, as with any asset class,  that real estate valuations will fluctuate over time, which is why investors should exercise patience and discipline to stick to their long-term investment objectives.”

Read the report.

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