By Hal Pawson, City Futures Research Centre.

At the start of the pandemic, when it became clear that extensive economic disruption lay ahead, there was alarm about the possible housing system damage that could result. In Australia, one of our largest banks projected a possible 32% hit to house prices. Most other forecasts at this time anticipated a major downturn in property prices and construction.

In fact, after only a short pause, house price inflation has come back with a roar in the later months of 2020 and into 2021. Forecasters are now projecting a general increase of at least 5% over the coming year with some predicting 10-20% over the next 2 years.

Negative trends in housing demand fundamentals

It’s striking that this is taking place in defiance of what we could call housing demand fundamentals. Although less serious than originally expected, unemployment is substantially higher than a year ago. It’s officially expected to peak during this year at well above 7% with only a slow recovery thereafter. And for those still in employment, there’s little prospect of significant wage growth.

Most importantly, migration into Australia, traditionally a key driver of housing demand, has not just reduced, but reversed. Instead of a net annual inflow to Australia of over 200,000, the government is now predicting a net outflow of 70,000 in the current year.

How the market is defying housing demand fundamentals

So what we’re seeing is that – at least for the moment – the negative effect on housing demand from all of these ‘fundamentals’ is being outweighed by more powerful factors.

Probably the most important is that base rate cuts by the Reserve Bank and global access to cheap money saw typical mortgage rates cut by over 0.5% in response to the pandemic to stand just above 3% at the end of 2020. More than that, the Reserve Bank stated late last year that base rates would remain at their record low levels until at least 2023. New borrowers are therefore feeling quite insulated from short term risk in this respect.

The effect of cheaper borrowing has been compounded by government programs offering taxpayer funded grants to private individuals building or renovating homes. Under its HomeBuilder program, grants of up to $25,000 have been made available by the Federal Government, with total program expenditure now estimated at $2 billion. In combination with state government grants, some beneficiaries have been able to land a no-strings attached subsidy totaling over $50,000 – more than 10% of the total purchase price of a newly built home in many parts of the country.

A third important factor is the longer term trend that has seen housing becoming an increasingly attractive low risk asset class over the past 10-20 years, as returns on other asset classes like commercial property and equities have either fallen back or become more volatile. The financialisation of housing is being given another twist by the wider economic uncertainty that has resulted from the pandemic.

In combination, mortgage rate cuts and government homebuyer subsidies are fuelling the renewed house price inflation Australia has been seeing since late last year. And, of course, market psychology and the fear of missing out that is always a factor in housing markets, is now kicking in.

Is this sustainable?

How long this situation can, or will, persist is debatable. At the moment housebuyers and their advisers are effectively predicating their decisions and behaviour on assumptions about the recovery of fundamental housing demand drivers – especially the population growth that results from high immigration rates.

At the moment, though, there is still no certainty on when international travel will be able to resume at any level. And even when we know that, there will still be questions about whether demand for migrating to Australia will return to pre-pandemic norms. Considering the currently frosty relations between Australia and China, there are particular doubts about the international student part of this equation. Beyond this, it’s not certain whether pre-pandemic immigration policy measures will be resumed exactly as before.

A second batch of uncertainties on housing demand fundamentals surrounds the economic impact to be seen when temporary employment subsidies are ended at the end of March. If employer subsidies are withdrawn as planned many businesses helped to remain in existence since March 2020 may go bust, adding some unknown – but probably significant – number of workers to the unemployment register. That may have a depressing impact on housing demand.

Thirdly, there is no certainty on the ‘additionality’ of the demand stimulation resulting from the HomeBuilder program. Past experience suggests that demand subsidy initiatives of this kind can have the effect of bringing forward housing expenditure decisions rather than triggering actions that would otherwise not have occurred. The corrollary is that when the program ends, there can be a damaging vacuum effect and a rapid decline in activity.

All of which means it may be a good idea to avoid premature celebration that Australian housing has ‘dodged the bullet’ in terms of a pandemic-triggered market downturn. If it has, and Australia instead undergoes a further round of asset price inflation, and an accompanied further widening of wealth inequality, this should be of at least equal concern to government.