Updated: Oct 30, 2019
In the simple behavioral model, dwelling values are driven by demand in the short run and by supply in the long run (Madsen, 2011) (Mohler and Van Der Merwe, 2015). Credit supply is an inextricable determinant of dwelling values in Australia. UBS Analyst, Jonathan Mott (2019), argues in the short run house prices are determined not by the demand and supply of “housing” but by the demand and supply of “credit availability” (Johnson, 2019). The availability of credit is largely dependent on income, which determines an applicants maximum loan size. Thus economic growth, which bolsters income, increases credit availability which subsequently determines dwelling demand and thus determines dwelling values. For instance higher income allows an agent to have a larger loan meaning a larger budget causing higher auction clearance rates thus higher dwelling values, AMP (2018) also noted that the housing cycle is often driven by volume rather than price (AMP, 2018).
Furthermore, as seen in the below model, statistically, you can explain 81% (Adjusted R squared) of the change in house price multiples over the past 20 years by changes in the average cost of borrowing. The lower mortgage costs, increase credit availability, and in turn create the negative correlation evident in figure 3 which shows how lower mortgage rates increase housing demand. This corroborates that credit availability is a key determinant of dwelling values.
Moreover, evidence portraying the short run connection between consumer sentiment and dwelling prices is vast. For instance: QIC’s Principal Economist estimated that every 10% fall in house prices leads to a 0.7% drop in real consumer spending, ceteris paribus (QIC, 2019)(Lowe, 2019), Figure 8 portrays the obvious correlation between consumer confidence & dwelling transaction volume (a key economic driver) and as the many models suggests , through the reasonably high Adjusted R squared of 0.65, the inverse relationship implies housing wealth is a key determinant of consumer sentiment. Therefore, consumer sentiment is a key determinant of dwelling values.
Confident consumers with optimistic expectations are willing to invest, whereas pessimistic consumers save. Confidence is derived from strong economic performance which encourages housing consumption. Whereas weak economic performance could potentially encourage a rational agent to sell their property, as economic contraction is correlated with a decrease in dwelling values. Subsequently low confidence means low short run demand as why buy now if prices are falling. Thus as Madsen (2011) stated, dwelling values would decrease, as the excess of dwelling supply increases. A self fulfilling cycle regarding consumer expectations and house prices is thus likely to form.
Furthermore, dwelling prices fell by 1% in Sydney and Melbourne in February 2019 (Combank Global Market Report, 2019). Part of this fall is potentially due to the Australian consumer confidence index being at its lowest in over a year at 99.6 points in January 2019 (Westpac - Melbourne Index, 2019). This 1% fall was also in line with predictions from the leading indicators of property prices (monthly lending to owner occupiers and investors decreased) demonstrating a lack of economic confidence. Further, the RBA is concerned that Australia may reach a tipping point where falling dwelling prices produce negative spillovers to the broader economy (Mohler and van der Merwe, 2015).