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.

Figure 2

More than 90% of first home buyers have a mortgage but they now make up only 16% of all loans for owner-occupied housing. In contrast, only two thirds of second and subsequent buyers need to borrow for their purchase and, of course, they tend to buy higher priced properties than first home buyers.

Thus the market appears to be driven to a greater extent than would be expected historically by buyers who do not need to borrow (or at least not within Australia). These buyers are looking for housing that costs more than first home buyers can afford, thus raising the average price of recent sales.

In other words, the average price of dwellings is higher simply because higher cost dwellings now comprise a larger proportion of all sales (thus it is possible for prices at the bottom end of the market, say, to actually be falling even though the overall average is rising).

Dr Ellis also notes that the strong rise in home prices over the past year or so reflects both supply-side and demand-side factors.

However as the remarkable data in Figure 3 shows, population growth, which has historically been lower than the rate of home building, has been well in excess of the growth in the number of dwellings over the past year.

But it’s not all demand – she has a message for State Governments:

“ housing prices have been under upward pressure in Australia. The nature of the demand shock Australia faces means that it would be helpful if more of that demand could be accommodated with extra homes for occupation, instead of by higher prices”.

(all figures from RBA)

Figure 3

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