Why are home prices rising when lending is down?

One of the puzzles in the current housing market is why loans for housing have fallen but prices nevertheless have continued to increase.

According to a speech given earlier this week by Dr Luci Ellis from the Reserve Bank, the number of new loan approvals in March was 16% lower than their peak late last year. In a feature last Saturday titled “The Great Property Puzzle”, the Financial Review reported that loan approvals are now at a nine year low.

Figure 1

Yet as Figure 1 shows, prices continued to rise well into 2010. In its May 2010 Statement on Monetary Policy, the RBA said “Overall, the divergence between aggregate nationwide loan approvals and housing prices remains something of a puzzle”. The Financial Review continued this theme: “Home loan approvals are falling, but property prices just keep rising. The fundamentals are all out of whack and nobody seems to know why”.

There seem to be a number of factors at play. First, immigration is strong and some migrants bring capital with them from assets they’ve sold in their former country. Second, some temporary residents are buying properties using funds raised overseas – although that’s arguable, because according to the Financial Review, the FIRB says they only account for 2% of purchases.

However what seems to be the most important factor is shown in Figure 2 – lower income buyers are dropping out of the market as home prices and interest rates rise and as assistance to first home buyers is wound back. Read the rest of this entry »