Housing Prices Drop as Interest Rates Rise Through the Roof

Australia’s housing market endured a challenging period in 2022. Housing prices fell 5.3% nationally over the calendar year, following eight consecutive interest rate rises by the Reserve Bank of Australia (RBA) between May and December. The interest rate hikes have rapidly decreased borrowing capacity, limiting potential buyers in the market. Between May 2022 and January 2023, housing prices fell 8.4%. This figure surpassed the previous record downturn where housing prices dropped 8.38% between October 2017 and June 2019.

Inflationary pressures played a major role in the RBA’s aggressive interest rate hikes, with the pandemic, high energy costs, and supply chain issues all contributing to rising inflation. Additionally, increased spending during the post-lockdown period has reduced household savings, which would have otherwise been used for a home loan deposit, resulting in fewer home sales.

Comparison across Australia

The most significant falls were seen in higher demand city areas which tend to have higher median housing values. Data from CoreLogic shows that Sydney experienced the sharpest decline in 2022 with a 12.1% drop, followed by Melbourne at 6.9%, both of which peaked in early 2022. Despite the sharp declines, housing prices still managed to remain above pre-COVID levels as of December 2022.

On the other hand, cities that showed a steady increase included Adelaide at 10.1% and Darwin at a 4.3%. Both Adelaide’s and Darwin’s housing values peaked later in the year, in July 2022. Adelaide's housing prices remained stable due to the competitiveness of its housing market. The area's relatively affordable regions and larger homes have sustained steady demand among buyers.

What influences housing prices?

A number of factors impact housing prices, including but not limited to:

• Interest rates
• Inflation
• Borrowing capacities of buyers
• Supply and demand in the market
• Economic outlook

The Australian housing market

At the end of 2022, The International Monetary Fund (IMF) warned of a potential housing market crash in Australia. It also noted that the average Australian household would need to spend more than 40% of its income in order to afford a median priced home.

The decline in housing prices between 2017 and 2019 was primarily due to restrictions on mortgage lending standards imposed by the Australian Prudential Regulation Authority (APRA), rather than increases in cash rates. Credit conditions play a significant role in the housing market. Turning to the current financial year, we expect that further interest rate hikes will contribute to a 15.1% decline in housing prices in 2022-23.

The finance sector

Federal and state government programs, including the First Home Buyer Scheme, First Home Super Saver Scheme, and First Home Loan Deposit Scheme, have helped to make homeownership more affordable for first-time buyers in recent years. Mortgage affordability is expected to decline as residential housing loan repayments continue to rise in 2023-24. While higher cash rates can be beneficial to firms in the finance sector such as mortgage lenders and credit unions, these operators face significant repercussions if the cash rate soars too high.

Rising interest rates and over-leveraged home loans make it harder for people to repay their mortgages, which translates to decreased revenue in the financial industry. Rising interest rates further restrict what buyers can borrow, reducing borrowing capacities and, in turn, curbing buyer demand, as higher lending rates heavily discourage new homeowners from entering the market. On the other hand, this also creates opportunities for financial companies to diversify their loan offerings into unexplored areas, such as non-residential real estate.

The construction sector

The Federal Government’s HomeBuilder program was introduced in 2020 to provide homeowner grants and stimulate construction activity. These effects supported housing price growth in 2021-22. However, the construction sector is also particularly vulnerable to inflationary pressures.

For example, global factors such as increasing energy prices and shortages in supplies needed for construction have challenged construction companies' ability to operate efficiently. This has had flow-on effects for other industries, hindering growth among construction suppliers and real estate agents.