Forecasting the housing boom using a key RBA model

Kieran Davies

Coolabah Capital

In a new research paper (download here), Coolabah’s Chief Macro Strategist, Kieran Davies replicates one of the RBA’s internal models on the Australian housing market and finds that house prices are expected to appreciate by about 25% over the next few years. Read the overview enclosed below.

Like nearly every other advanced economy, Australian house prices increased during the pandemic, which was a marked break from the large declines seen in past recessions. Admittedly the pandemic was different in that interest rates were relatively low leading into the outbreak, but the striking resilience of prices stands as testament to the unprecedented and immediate easing of fiscal and monetary policy, particularly the success of the JobKeeper wage subsidy in limiting the rise in unemployment and banks deferring mortgage repayments for stressed home-owners.

With house prices picking up after languishing over recent years, Coolabah Capital Investments (CCI) has applied the Reserve Bank of Australia’s (RBA) ground-breaking model of the housing market developed by Peter Tulip and Trent Saunders to produce internally-consistent forecasts for the next few years. The model, which allows for feedback between housing construction, rents, vacancies and prices, points to a large gain in prices of around 25% through to the end of 2023, driven by low interest rates. (This is consistent with the forecasts previously released by CCI’s chief investment officer, Christopher Joye.) Rising house prices and low rates should underpin a similar gain in real residential investment, although rents are expected to be weak given a relatively high vacancy rate.

The model estimates how the housing market will behave on the basis of past relationships, where CCI has calculated margins of error around the model’s predictions based on past forecast errors. The estimated margins of error are wide, which is not surprising given the volatility of house prices and rents. Clearly, though, the pandemic has created significant additional uncertainty around the outlook given entirely new developments such as the closure of Australia’s border and the move to working from home. That said, we believe that past behaviour provides a very useful starting point for considering the impact of any lasting changes from the outbreak.

The RBA should take comfort from rising house prices because higher asset prices are a key part of the transmission mechanism of both conventional and unconventional monetary policy (QE in its current form being an exception given banks do not offer long-term fixed-rate mortgages). While we expect the RBA will keep policy loose until it achieves its economic objectives, there is always the risk that banks lower lending standards as house prices strengthen, which would trigger a regulatory response that would challenge the model’s forecasts. To date, though, regulators are only monitoring the situation given credit spreads for riskier mortgages remain unchanged with the RBA reporting that lending standards remain conservative.

A large rise in house prices would intensify concerns over affordability and inequality. Homes are very affordable insofar as debt-servicing costs are very low thanks to ultra-cheap mortgage rates, but raising a deposit remains a barrier to entering the market and home ownership has trended lower for the first home-buyer age group. Easy monetary policy reduces income inequality by lowering unemployment, but can add to wealth inequality, which reflects very low home ownership among low-income/resource households. CCI’s view is that concerns over affordability and inequality are better addressed by government via the tax/transfer system. The other step that government can take is to address the longstanding inflexibility of the supply side of the housing market, which has seen lower interest rates manifested in higher house prices more than the construction of new homes.

Download the full research paper with the detailed housing forecasts here.

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Investment Disclaimer Past performance does not assure future returns. All investments carry risks, including that the value of investments may vary, future returns may differ from past returns, and that your capital is not guaranteed. This information has been prepared by Coolabah Capital Investments Pty Ltd (ACN 153 327 872). It is general information only and is not intended to provide you with financial advice. You should not rely on any information herein in making any investment decisions. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. The Product Disclosure Statement (PDS) for the funds should be considered before deciding whether to acquire or hold units in it. A PDS for these products can be obtained by visiting Neither Coolabah Capital Investments Pty Ltd, EQT Responsible Entity Services Ltd (ACN 101 103 011), Equity Trustees Ltd (ACN 004 031 298) nor their respective shareholders, directors and associated businesses assume any liability to investors in connection with any investment in the funds, or guarantees the performance of any obligations to investors, the performance of the funds or any particular rate of return. The repayment of capital is not guaranteed. Investments in the funds are not deposits or liabilities of any of the above-mentioned parties, nor of any Authorised Deposit-taking Institution. The funds are subject to investment risks, which could include delays in repayment and/or loss of income and capital invested. Past performance is not an indicator of nor assures any future returns or risks. Coolabah Capital Institutional Investments Pty Ltd holds Australian Financial Services Licence No. 482238 and is an authorised representative #001277030 of EQT Responsible Entity Services Ltd that holds Australian Financial Services Licence No. 223271. Equity Trustees Ltd that holds Australian Financial Services Licence No. 240975. Forward-Looking Disclaimer This presentation contains some forward-looking information. These statements are not guarantees of future performance and undue reliance should not be placed on them. Such forward-looking statements necessarily involve known and unknown risks and uncertainties, which may cause actual performance and financial results in future periods to differ materially from any projections of future performance or result expressed or implied by such forward-looking statements. Although forward-looking statements contained in this presentation are based upon what Coolabah Capital Investments Pty Ltd believes are reasonable assumptions, there can be no assurance that forward-looking statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements. Coolabah Capital Investments Pty Ltd undertakes no obligation to update forward-looking statements if circumstances or management’s estimates or opinions should change except as required by applicable securities laws. The reader is cautioned not to place undue reliance on forward-looking statements.

Kieran Davies
Chief Macro Strategist
Coolabah Capital

Based in Sydney, Kieran Davies joined Coolabah Capital in 2020, an asset manager than runs over $7 billion in fixed-income strategies, and is responsible for macroeconomic research and investment strategy, contributing to the investment decisions...

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