No ‘quick fix’ for housing supply-demand imbalance, RBA warns

In her speech at the Real Estate Institute of Australia (REIA) Centennial Congress in Hobart on 16 May, the Reserve Bank of Australia’s (RBA) assistant governor (economic) Sarah Hunter said the central bank is closely eyeing the imbalance between new supply of housing and growth in demand, given its impact on rents, construction costs, and activities.

She said there are several ways to restore balance in the housing market but warned that “it will not be a quick fix”.

“Demand pressure, and so upward pressure on rents and prices, will remain until new supply comes online,” Hunter said.

“We expect this response to take some time to materialise, given the current level of new dwelling approvals and the information from liaison that many projects are still not viable. In the meantime, we expect residential construction activity to remain relatively subdued.”

According to the RBA’s assessment, there are several potential avenues through which the imbalance could be addressed. Hunter noted that while rents and house prices have already surged, average household size could also increase (which would dampen demand for a given population size), and the pace of growth in construction costs could soften.

“These responses will work towards rebalancing the market and resolve the current squeeze,” Hunter said.

“For example, we are hearing reports from our liaison program that some developers can see the strength in underlying demand and expect to respond with new supply (although it is early days). Federal and state government initiatives that streamline the approvals and build process will also reduce costs, which will ultimately lift supply.”

A larger household size could have a significant impact on the housing supply and demand balance.

Just under 27 million people live in Australia in about 11 million households. According to RBA and Australian Bureau of Statistics (ABS) data, the average number of people living in each household has decreased from around 2.8 in the mid-1980s to around 2.5 of late.

While this may sound like a small change, Hunter said that if for some reason the average household size rose back to 2.8, 1.8 million fewer dwellings would be required to house the nation’s current population – “no small difference”.

“Understanding the changes in average household size is therefore important for understanding demand for housing,” Hunter said.

“At the RBA, we assess that part of the long-run decline in average household size can be explained by demographic factors. The ageing of the population means we now have more older couples and singles living alone, and lower birth rates means that the average size of a family is falling over time.

“Working in the other direction has been an increase in the share of young adults living with their parents. This might be because more young people are going to university and living at home for longer, but it could also be due to affordability considerations. And this hints that demographics are not the only factor affecting household size – affordability affects people’s choices of where and who to live with.”

The COVID-19 pandemic also changed the demographic drivers of housing demand, as lockdowns confined Australians to their homes and preferences grew for more physical living space per person.

According to the ABS, 37 per cent of employed persons worked from home in 2023, meaning a home office has become increasingly desirable.

Hunter said this suggests that the recent falls in the average number of people per home will be “at least partially permanent”.

Additionally, the level of interest rates is also a component of costs, and the RBA is monitoring the impacts of interest rate changes on new housing construction, she said.

Noting that many dwelling construction projects are funded by debt, Hunter said higher interest costs will dampen the flow of new housing supply.

“There is some correlation between dwelling approvals and the mortgage interest rate, but it’s not perfect,” she said.

“So, while we are very aware of the impact cash rate changes have on the decision to proceed with a building project, there are a number of factors that determine whether or not a developer or individual goes ahead.”

As per the RBA assessment, Hunter said, the impact of changing interest rates is cyclical rather than structural.

Rising interest rates tend to result in falling dwelling approvals, which then flows into commencements and completions. However, this typically reverses when the cash rate is slashed.

“Over the long run, it is the fundamentals of demand and the structural build cost that ultimately dictate supply – monetary policy does not have an impact on either of these underlying drivers,” Hunter said.

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