Addressing Australia's housing affordability: if you can’t beat ‘em.. Join ‘em..

October 1, 2024
By James Holliday Smith

Key insights

1. Navigating rising costs: Australian housing prices have surged to all-time highs, highlighting the importance of addressing affordability.
   
2. Supply and demand dynamics: fundamentals suggest affordability issues may become entrenched, with recent record migration and a modest increase in new housing construction.
   
3. A compelling investment proposition: the Australian listed real estate sector provides a compelling opportunity for investors to gain exposure to these long-term dynamics.

Australian house prices have become a focal point of intense debate and concern, as they continue to soar, making affordability an ever-growing issue for both potential buyers and renters. Despite expectations that a normalisation of interest rates might offer some relief, the opposite has occurred: property values have surged to all-time highs¹, exacerbating the affordability challenges. 

What is driving the affordability challenges?

In a global context, Australia’s capital cities are among the most expensive in the world. The 2023 Demographia International Housing Affordability report¹ reveals that all five major Australian capital cities are in the Top-10 most expensive cities worldwide, with Sydney’s  median price to income ratio at a staggering 13x, second to only Hong Kong, which had an eyewatering price to income ratio over 18x.

The root of this crisis is multifaceted, with home prices outpacing average incomes for years. This disparity has only worsened, particularly through the pandemic, highlighting a significant imbalance in the price-to-income ratios across the Eastern seaboard, as illustrated in Figure 1.

Figure 1: Home price to income ratio

Source: ABS, Bloomberg and Macquarie Asset Management.

In a balanced market, prices typically adapt to increased capital costs, as a rise in interest expenses reduces the size of loan a buyer can service based on their household income (HHI). This adjustment often leads to a decrease in the average loan size, which, in turn, lowers the amount a buyer is willing to pay for a home. Historically, in the Australian property market, this correlation between values and lending capacity has been somewhat consistent.  

Figure 2: Australian home price Forecast – (Household Income, Interest Rates, 75% Loan-to-value)

Source: ABS, Macquarie estimates

The commencement of the most recent RBA hiking cycle has disrupted this relationship (see Figure 2). There are many potential hypotheses for why this is the case, ranging from intergenerational wealth transfer, to buyers’ expectation that interest rates will eventually decrease. However, we believe the explanation is more straight forward: supply and demand dynamics.

In short, markets with limited supply and growing demand can prompt buyers to make decisions that may not seem economically rational, driven by the fear that affordability may further deteriorate. Globally, long term price increases in real estate often mirror trends in population growth and inflation as demonstrated in Figure 3.

Figure 3: House price growth follows population growth and inflation across regions

Source: OECD, Bloomberg, Macquarie Asset management. HPA = house price appreciation

Demand outpacing new home construction

In Australia’s residential real estate sector, new home construction has not kept pace with household formation, a trend clearly depicted in Figure 4. Oxford Economics recently highlighted that Australia may fall short of its goal to boost housing supply by 1.2 million dwellings over five years by over 20%, leading to a 164,000 home deficit². With the national residential vacancy already below 2%³, this gap will further intensify the existing undersupply issues in the residential market, maintaining upward pressure on prices. This shortfall comes at a time when the government forecasts an elevated net overseas migration in the coming years, underscoring the urgent need for a ramp up in housing construction, yet the sector is contracting as evidenced by declining home building commencements.

Figure 4: Household formation vs. dwelling commencements

Source: ABS, Macquarie Asset Management

Investment opportunities: the need for affordable housing

In response to these challenges, the Macquarie listed real estate funds are strategically positioned to leverage this supply-demand imbalance by gaining exposure to investments that we think will benefit from the need for more affordable housing. In our view, companies like Stockland Group are well placed to benefit from this scenario by offering entry level house and land packages, which should lead to attractive earnings growth over coming years. In an environment of stretched affordability, we expect many buyers will need to consider more modest dwellings to get a start on the Australian property ladder.

Similarly, the “land lease” model presents an innovative approach to affordability, separating land ownership from home purchase, to significantly reduce costs. In this space we see names like Stockland, Aspen Group, Ingenia, and Lifestyle Communities at the forefront of this movement, catering especially to seniors seeking cost effective downsizing options.

These names not only aim to address the immediate need for more affordable housing but also align with long-term demographic shifts, including household formation and an ageing population. The combination of structural tailwinds, and strong property economics means these companies score highly from a quality perspective. The land lease model in particular is highly capital efficient, which can lead to strong earnings per share growth over time when executed well.

In summary, the current landscape of the Australian housing market, marked by an affordability crisis and supply-demand imbalance, highlights the attractiveness of real estate investments that aim to provide innovative and affordable housing solutions. Our listed real estate funds provide an exposure to companies addressing these challenges, offering potential for good earnings growth and alignment with long-term demographic trends that we think are likely to be enduring.

Author

1. 2023 Demographia Report: International Housing Affordability

2. High costs choke supply of new homes: property experts, 2024  

3. SQM Research, Rental market steadies over winter, 2024

The Target Market Determination (TMD), available at macquarie.com/mam/tmd, includes a description of the class of consumers for whom the Fund is likely to be consistent with their objectives, financial situation and needs.