INSIGHT

Property outlook for 2017 – Citi Insight

January 2017

Property outlook for 2017 - Will the boom continue?

Australia is not the only market experiencing record house price growth, as Citi's latest Global Economic Focus reveals.

The report into global house prices, trends, consequences and risks shows Canada, New Zealand, the Nordic countries and China also show a stretch in valuation metrics, while other countries (including the US) are now close to recovering any losses experienced during the financial crisis.

"Australia, Canada, China and the Nordic countries have all performed strongly in the past few years," comments Citi Economist Paul Brennan, who co-authored the report. "What sets these countries apart is their very strong population growth, adding to underlying housing demand."

Rising price to income and price to rent ratios also make these markets look more highly priced than the US - even though all markets are also experiencing record low interest rates.

"It's very hard for supply to catch up quickly to demand in these markets as well - and that's a recipe for higher prices," says Brennan.

It's important to note that not all Australian markets are equal. "Sydney, and to a lesser extent Melbourne, are still booming, but the rest of the country is experiencing much lower price growth."

Foreign investment fuels demand

Foreign buyers invested $60.75 billion in Australian residential real estate in FY2015 - up 75% on the year before - and a large proportion of that came from China. The Foreign Investment Review Board (FIRB) expects that interest to continue, despite tighter restrictions on capital outflow from the Chinese government.

"Canada has also benefited from Chinese interest, but it is now imposing additional taxes on foreign property buyers and that is impacting demand," notes Brennan.

"Some Australian states now have differential stamp duties for foreign buyers, but it is still an attractive market for many reasons and there is still an underlying appetite in China (and other Asian countries) for investing offshore. As the middle class in China continues to grow I suspect demand may become even more significant, because they want to diversify where they hold their wealth."

He says that while the Chinese government has put some measures in place to limit foreign investment, "it's hard to monitor when money is easily transferred between family members. For example, one partner may live in Shanghai while the other lives in Melbourne with their children who are studying here."

Meanwhile, anecdotal evidence from real estate agents here indicates that while mainland Chinese investors may be pulling back, Chinese buyers who already live here are continuing to upgrade to new homes and make investment purchases. There's also increasing interest from other Asian buyers - including Singapore, Malaysia, Hong Kong and Thailand, according to FIRB figures.

The impact of interest rates

Brennan expects Australia's current low interest rate cycle to continue, despite recent rises in the US. "With inflation very low and a fall in GDP in the third quarter, there are still risks for the Australian economy - and if the RBA makes any changes at all it's more likely to be another cut."

This is an important economic risk to the housing market, as household debt is also close to record highs. One study has found that a 1% increase in short-term interest rates could see real house prices decline by over 6%.

What's more, the IMF has also noted that more than two-thirds of the past 50 banking crises were preceded by boom-bust patterns in house prices - especially toxic when combined with a rapid increase in household leverage.

So could any interest rate rise trigger price drops in Australia? Brennan says Citi's view is that households generally have enough positive equity to provide a buffer - it's more likely prices would plateau (in Sydney at least) unless there was a major economic downturn.

"Australia, Canada, China and the Nordic countries have all performed strongly in the past few years. What sets these countries apart is their very strong population growth, adding to underlying housing demand." Paul Brennan

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Watch out for the apartment ‘super cycle'

If you are considering a new property investment in Melbourne or Brisbane, be wary of inner city off the plan apartment developments.

"We've never seen anything like the current levels of apartment construction before, and it could result in short term over supply. This will weigh on any potential for further capital gains - there could even be some downward pressure on prices, and also on rental yields."

Lessons from global property ‘super performers'

When we look at the experience in other countries, it's clear that China is a very different market.

"Demand is still strong in the first and second tier cities, but there may be over supply in the third and fourth layers," comments Brennan. "With continued migration from rural areas to the major cities, it is also facing the challenge of increasing supply fast enough - especially with looming demand from the next generation of college graduates." Household debt in China is currently low, but the affordability ratio in China's first tier cities is now one of the highest in the world.

Meanwhile, the Nordic countries have experienced almost uninterrupted house price growth since the mid-90s, thanks to favourable tax laws and constrained supply. "Norway and Sweden are using more macro prudential tools to restrict lending, such as higher LVRs," says Brennan.

So if you're looking globally for a sound property investment, he suggests paying attention to the lessons of these markets.

"As we've seen, strong demand is driven by population growth and immigration, combined with an inability to increase supply quickly enough. So watch out for a market with those features," he concludes.

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