Falling prices won't fix housingaffordability

Source: Linkedin

Australia’s housing market is starting to cool. Monthly price growth has slowed, and in some markets, particularly Sydney, prices are now declining as higher interest rates and global uncertainty weigh on sentiment. At face value, this might suggest that affordability pressures are beginning to ease.

However, this is not what the underlying data is showing. The key drivers of housing affordability are moving in the opposite direction, and point to conditions becoming more difficult rather than improving.

The core issue remains supply, and more specifically, the rising cost of building new homes. Over recent years, construction costs have been pushed higher by a combination of labour shortages and supply chain disruptions. A lack of skilled tradespeople, alongside elevated material costs, drove a sharp increase in costs through 2022 and 2023. While this growth moderated for a period, it never returned to normal levels. More recent increases are again being driven primarily by labour shortages, with capacity constraints in the construction sector continuing to place upward pressure on costs.

Importantly, the drivers of this cost growth are now broadening. Last year’s increases were largely domestic and labour-driven. Now, supply chain pressures are re-emerging. The escalation of conflict in the Middle East is contributing to higher fuel costs and renewed disruption to shipping routes, which will flow through to increased material and construction costs in the months ahead.

This creates a compounding effect. Labour shortages have not been resolved, and now supply chain disruptions are adding a second layer of cost pressure to the construction sector.

The impact on housing supply is significant. Higher and more volatile construction costs reduce the feasibility of new developments. Projects are delayed, scaled back or abandoned, while builders remain cautious in an environment of cost uncertainty and tighter financial conditions. At the same time, demand for housing continues to grow, supported by strong population growth and limited existing stock.

This imbalance remains evident in the latest price data. While monthly growth has slowed, many markets are still recording increases and annual growth remains strong across most of the country. Perth and Darwin continue to lead, while Brisbane, Adelaide and many regional areas remain firmly in double-digit territory. Even where prices are declining, so far, falls have been modest and concentrated in the most interest rate sensitive markets.

The unit market further highlights these supply constraints. Prices have been more resilient than houses, supported by affordability pressures and first home buyer incentives. At the same time, new apartment supply remains limited, reducing the ability of this segment to provide relief. 

What we are seeing is not an easing of the housing shortage, but a shift in how it is playing out. Higher interest rates are slowing demand at the margin, which is reflected in softer price growth and declining open for inspection attendance. Buyers are becoming more cautious, but demand has not disappeared.

This cyclical slowdown is occurring against a structural shortage of housing that is now being reinforced by rising construction costs.

As a result, affordability is not improving. It is likely to worsen. Slower price growth does little to offset the fact that new housing is becoming more expensive to deliver, limiting supply and placing upward pressure on prices over time.