S2 E1 - The five economic forces shaping the housing market with Martin Lakos

In this episode, host Andrew McCann is joined by Martin Lakos, Divisional Director at Macquarie Bank, to discuss the current economic conditions influencing Melbourne's housing market. 

Martin offers insights into major economic factors like interest rates, inflation, and population growth, while Andy shares real-world examples of these trends affecting the market. 

Transcript

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Welcome listeners. We're thrilled to be back again for our second season of Inside Melbourne's property market. We're proudly brought to you by Jellis Craig and I'm your host, Andrew McCann. Certainly delighted to be speaking with you today from Jellis Craig headquarters here in the heart of Melbourne. Jellis Craig certainly being part of the heart of Melbourne property and a big part of the city's real estate landscape. In today's episode, we're really excited to be delving deep into all things the economy and how that influences the property market and our real estate landscape, and we're very excited to have Martin Lacoss, the divisional director at Macquarie Bank. Well, Martin, it's a very good morning to you and thank you so much for being with us this morning. We're really excited about having a chat to you about the broader economic conditions and what's happening across Australia and how that might affect our property market. So maybe if we can start in that lane, how are you seeing things and what effects do you see for the future of the residential property market specifically? Andy, thanks for having me. Look, I think maybe we should maybe just go back a little bit towards big picture what's happening around the world because that clearly has influences for Australia as well, and I think when we think about 2023, there were huge challenges in front of us around this time last year. And in fact, although inflation was peaking around the world, central banks around the world were still raising rates 12 months ago. And so obviously we found ourselves now towards the end of 23 where the global economy really, which wasn't predicted, it was far more resilient from a global economic growth perspective than anyone had thought. Given 10 interest rate rises in the US, 13 interest rate rises here in Australia and of course the prospect of a US recession, possibly a recession in Europe and Japan as well. So leading countries that contribute to growth around the world. We clearly had been forecast to see significant softening in economic activity that basically has not really happened, certainly not in the US and it's been driven to some extent by the fact that across the demographic, not all components of households are doing it tough. There's no doubt there's challenges out there. Cost of living's been rising right around the world. Interest rate rises and energy prices have clearly been inflated, but what we have found is that households came out of the pandemic in actually pretty good financial shape that's now changing. But also we found that at the end of the day, this resilience was all around employment skills shortages around the world has seen unemployment much stronger, sorry, better than had been anticipated. It's the same here in Australia now we've moved into 2024, that momentum has been continuing and it does look to us now that in fact we've probably seen the worst, which was probably the December quarter of last year and that wasn't terrible. And now we're starting to see an improvement. All of the leading indicators that we use from an economic perspective are actually starting to turn up, which is also interesting given that we haven't seen any relief in interest rates from anywhere around the world. In terms of the major contributors to growth, we've gone through the last 18 months where the western world has been trying to tame inflation by raising rates and slowing economic activity. And the world's second largest economy has been doing exactly the opposite. They've been needing to stimulate their economy, they're just still battling with the backwash of basically a property boom and bust that's taking place. And so they're finding that's impacting things like consumer sentiment, business sentiment, retail sales, parts of the Chinese economy, particularly from a manufacturing perspective is doing okay, but it's not broad brush. And what's doing okay is things around energy transition, sustainability, electric vehicles, solar panels, panels, you get that picture. So what does that mean for Australia in that context? And again, from a broad brush economic perspective, although economic activity has slowed in Australia where our long-term growth is more like three and a quarter, three and a half percent, we are closer to two, two and a half at the moment. So things have slowed but not recession. And again, one of the key drivers of that resilience for our economy is really three things. Our exports, particularly on the mining sector, has really had a very positive effect on our economy, public spending. So the governments are spending a lot and in particular on infrastructure. And the third component of that is that employment now, although the unemployment rate is going up from about 3.4 now, 4.1 pre covid, it was five and a half. So again, we've got to put these things in perspective. And it's great to hear your confidence and it sounds like there are some green shoots out there at a Jellis Craig level. Martin, we're seeing all sorts of different patterns in behavior in the way that we're seeing properties transacted. We're seeing an investor sell off. We're certainly seeing a lot of enthusiasm for completed homes as opposed to renovation opportunities. But one of the biggest factors that we see is geared around the conversations of interest rates and inflation. What are your predictions around that rate piece and how can we expect that inflation might impact the market moving forward? Well, it would appear that inflation where we break inflation up into two segments. One is goods inflation and one is services and it's a services component that is troublesome, that's wages, that's rent and other components that fit into the services segment. And that's not going down as fast as we'd like to see. Now obviously inflation has come down, it peaked at 7.8% in Australia, but it's currently hovering around 3.6 and we had a monthly number. Now we obviously look at the monthly numbers releases that come through, but what's most important is actually the quarterly data. It gives really a full set of information, particularly around the services component. So yesterday's release was great for headlines, but really for economists, not a lot of information particularly around services side. So it's not that we ignore it, but it's just one of the pieces of the puzzle for us in terms of what we see the outlook for inflation and interest rates going forward. But I guess the key is most economists, including our own here at Macquarie, have been forced really to push out the timeframe by which they're expecting to see rate cuts and in our case, the quantum of what that rate cut will be. So it wasn't that long ago, we were looking for rates to come down across the next cycle from 4.35 to about 3.1%. That's one and a quarter percentage cuts. We've moved that to now only four cuts, not five. So in other words, about a 1% cut. And the reasoning behind that is clearly that it's taking so much longer for inflation, the inflation momentum to come down. Now we do think the reserve bank will certainly consider rate cuts when they're convinced that inflation will move into the range by which they want to manage inflation, and that range is two to 3%. So let's call the midpoint two point a half. They won't wait for it to actually get there as long as they're sure it will get there because clearly there are pressures in the economy that are being impacted by the higher rates. But the other side of it is then they've worked so hard to tame inflation, and let's face it, all central banks around the world were well behind the curve in terms of that inflation pulse, that momentum on the upside, and they had to pedal really hard and really fast to get it under control. So I've done all that hard work. They're not going to let that go quickly. They've got to be convinced that the timing and the quantum is right. So our current central view is that there'll be a cut probably in November, maybe December. And if they do cut then, then it's more likely that we'll see a cut and pause and then a cut and pause again. It's going to be part and parcel of ensuring that they up. And that's absolutely key and very, very important. So that's the first thing. Rates will come down at some stage, but probably not as much as everyone would like or hope. And secondly, the timing and the risk is that the timing can be pushed out into early 2025 and not see a cut this. Year. Thanks for your insights In relation to that, Martin, I think it's important to reflect that we're recording here in May, so that data is for current, we'll be releasing in July. Coming back to the implications of those rate cuts, whether it's late 2024, whether it happens in 2025, certainly from a real estate perspective, we see those conversations as being more positive. Is the outlook from your own perspective that that type of rate cut is a stabilizer in housing prices and market performance, or could it in fact be a stimulus for further price growth? I guess first thoughts would have to be that it's more likely to be a stimulus, not so much that there's a significant quantum in cutting funding costs, although it's clearly going to be helpful for those either sitting on mortgages or investors considering going into the market. But it's more likely going to be a bit of a confidence boost. It's really will be a signal that we've ended this cycle and about to start a new cycle. And the new cycle is obviously looking to see economic activity pick up and obviously to see the cost of funding coming down. I think the cost of funding is absolutely worth a bit of a conversation here, Andy, because obviously not only is it impacting the household budget, but we are finding that the cost of funding is the highest it's been for many, many years in terms of relative to income coming into households. And when you think about households and where they were positioned coming out of the pandemic, most households were actually in pretty good shape for a while. Obviously we couldn't spend as much money doing what we normally do. The household savings ratio hit a 40 or 50 year high. And we also found that many households with mortgages actually had the opportunity when rates were very low to reduce their principal component more substantially than they would normally do. So that's a positive, but that's now behind us. And in fact, with cost of living rises and higher interest rates the household budget, we found that the household savings ratio is now down and back to basically where it was on a pre covid basis. That is most of those savings have now been drawn down and the Reserve Bank would be absolutely cognizant of that in terms of one of the factors on pressures on households, the other component of that is on around funding is that those who've gone into the market are paying higher prices and therefore the total size of their mortgage is much larger. Again, cash rates at 4.35% historically is not high. Andy, can you remember where interest rates were pre GFC? I know that Macquarie was offering term deposits at 8.8%, which means the cash rate was at least at that level, if not higher. So 4.35 cash rates actually is not a high interest rate. The trouble is the mortgages are much larger in quantum. When we talk about that, we're shifting into a period of maybe what does become a new normal. People need to understand that the cost of living we'll probably maintain in certain segments of the market, and they're things that society needs to adjust and address where we look for stimulus in the markets. And one of the things that we're hearing both at an economic and then at a government level is the shortage of housing and then the population growth that's coming into Victoria and then Australia. How's that going to be impacted in terms of both supply demand and how are we going to see that resolved? And what impacts do you think that will have on the property market over the short and longer term? Well, again, let's put things in perspective. Pre covid, we already had a housing shortage, not at the high density end, but the free standing end. There was still a 30 or 35,000 free standing home shortage. Now that's just being exacerbated from the current situation that we're in in regards to population growth. Population growth has been obviously driven by natural means and immigration, and it's been well noted that we've seen an extraordinary influx of immigrants into our fabulous country. And understandably, why? What a great place we live both from a lifestyle and certainly from great weather. There's no question about that. But we have seen an extraordinary increase in population growth to the point where now Australia has got the fastest rate of population growth of any OECD country, and that's at around 2.5%. It was 1.8% growth rate pre covid, which is still very high, one of the highest. So this is just going to continue to force an imbalance in the housing or accommodation market. And clearly it's pretty obvious people coming to Australia as new Australians, the first thing they're going to do is basically look to rent. Rarely there'll be some who are at the high net worth end who would be coming in looking to buy straight away, but on the whole most are renting and trying to establish where they're going to live, where they're getting jobs, where the kids have go to school, have they got children, all those sorts of issues. So that's absolutely some of the key factors. So it's an interesting period, Martin, we're seeing 27% more sales volume coming through our Jellis Craig business. We're seeing renovated homes and turnkey opportunities selling for extraordinary highs in market versus properties that require renovation and construction selling at fairly mega sums based on people's deterrents for entering into that construction space. We're hearing about additional taxes, land tax investors reconsidering their positions as landlords, and we've got this housing shortage. What's required for those, I suppose, trends and headwinds to be rectified? Is it a government intervention? And from looking at budgets and the positions that government are taking, can you see that that's something that will resolve itself in time? Or are we going to be dealing in this current state over the next two to three years and is it something we need to get comfortable with? Yeah, we do see housing supply get turned back on, and it's always a combination of factors. It clearly is going to be around interest rates, so when rates come down, cost of funding improves, that has a beneficial impact, particularly for developers and construction companies the businesses. But it has that confidence boost that I talked about a little earlier on, both at the business end and at the consumer end looking to make a decision to build a new house or to buy a new house or to renovate. So that's clearly very, very important. And that's probably coming around the corner towards the end of this year, early next year as we've discussed. So that will provide some relief, but the reality is still got lots of red tape in the building industry in terms of housing approvals, the ability to access building materials and builders who've got skilled workers to undertake the construction. So I think I saw some numbers that of the 600,000 immigrants that have come into the Australia in the last 12 months, a thousand only were plumbers. So again, policy might be able to address that. The other side of that is the cost of building, not just the building materials side and the skills side, but about a third touch more than that of building a new freestanding home is government charges. So maybe you'd like to think there's some room to move to encourage building in that area, but we haven't seen any discussion around that anytime soon. And it certainly does feel like we're playing catch up in some of that respect around other legislation or stimulus. Man, it's been incredibly insightful so far. I think one of the things that we're always interested in is predictions. It sounds from our conversation today that maybe we've come through the bottom of some cycles and we're certainly seeing some green shoots. Certainly we might well be at the top of the interest rate cycle, and we might be in that position when we start to see some relief of rate cuts. What are your predictions in terms of 2025 and beyond, and where can we glean some confidence for what we're going to see in our property market over that period of time? Well, the outlook for 25 looks like it's improving, and the head of our global strategy wrote a piece at the beginning of this year entitled Light at the End of the Tunnel, which is a pretty positive title for him, who's naturally cautious. And so that theme is running not only through this year, but into 2025. So without getting overly optimistic, because there are always challenges in front of us, we think 2025 is going to see some improvement both at the economic growth level, lower interest rates level, and of course that's going to hopefully help households as well and businesses going forward. So the outlook for 25 Terrific. I think Martin, we're very glass half full at Jellis Craig. I mean, we're a big believer in a wonderful city here in Melbourne. All of the wonderful things that we have around livability, and I think when you do go back to those fundamentals that drive our business, which is supply and demand, all the metrics tend to suggest that we have all the fundamentals of what should be a stronger marketplace for the future, and it's just about at what pace does that move. Today's been incredibly insightful from our perspective, and we certainly appreciate your contribution and your time. So I'd love to thank you for being with us and wish you all the best, and we'll look forward to hopefully some of those predictions coming into fruition through 2024 and 2025. Thank you. My pleasure. And hope everyone and all you listen, stay safe. All. The best. Thanks, Martin. Well, thanks very much to Martin for that conversation. That certainly concludes our first episode of this series of Inside Melbourne property markets. Stay tuned for our upcoming episodes. We'll look forward to exploring more dynamic conversations in the world of Melbourne Property. If you've got any questions or topics you'd like to give us feedback on, please visit us at Jellis craig Jellis craig.com au. You can also read more about this topic in the report, which you can access via our website. You can also download a full transcript of this conversation in the show notes. Otherwise, thanks for joining us today. It's been an absolute pleasure, and we look forward to catching up with you at our next episode.