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GUEST OBSERVATION
The following comment echoes a dilemma of many potential first home buyers in Australia: 
“I am in late 20s, early 30s, $150,000 household income, $200,000 in savings - what should I do? Do I buy a property and risk my cash on an asset which is said to fall in value, or do I rent and invest my money into shares?”
The numbers may differ from person to person but the concern is the same.
I dealt with the issue of <a href="finance/australian-property-prices-explained-independent-analyst/2014011367181/" target="_blank">property prices in Australia</a> and <a href="https://www.propertyobserver.com.au/residential/australian-property-prices-in-2014-and-beyond-a-peek-into-the-future/2014013167457" target="_blank">what will happen in the future</a>, so instead I would like to focus on the issue of confidence.
If we analyse Australia's current economic situation objectively, we have a <a href="https://www.propertyobserver.com.au/residential/a-roof-over-your-head-or-the-biggest-investment-you-ll-ever-make-how-should-we-treat-residential-property/2014020967655" target="_blank">six decades long history of strong growth in property prices</a>, historically low interest rates, a low unemployment level and an economic growth rate which is the envy of other developed nations. Also, it is relatively easier to finance property purchases nowadays than it was 20 years ago. In addition, there are ample examples of research demonstrating that residential property in Australia is <a href="https://www.asx.com.au/documents/resources/ASX_Report_2013.pdf" target="_blank">potentially the best investment class over the long-term</a>.
Yet, the fear of losing money, “because property prices are doomed to fall” and a pessimistic outlook are paralysing many to the extent that they are incapable of making a decision to buy a property.
Where does this fear come from? Why are we the biggest pessimists in the world despite surviving the global financial crisis quite well so far? We used to have severe recessions and other economic calamities before so, what’s different now? 
Let me digress for a moment and reflect on the “old times”, when things were viewed from another perspective.
How things used to be
Back then in the 1970s, 1980s or even 1990s, there was no talk about a possibility of property prices falling. The idea was to line up for a loan at the first opportunity and to get your first home as soon as you got your first full time job. It didn’t matter that the property had to be in a location on the city outskirts – you were buying what you could afford, and not your ultimate lifestyle.
The logic was that you pay your first property off as quickly as you can and then upgrade to something better and closer to city centre. Then do it again. And again. So that in the period of 15 to 20 years you could end up with something to enjoy for the rest of your life and which suited your lifestyle.
Your grandparents did it that way. Your parents did it that way. Everyone just followed the same routine. No questions asked. Everybody knew you cannot go wrong following this recipe.
I am generalising but it conveys the overall attitude of an older generation of Australians towards residential real estate. Now, let’s fast forward to present times.
How things are now
Parents and grandparents are no longer the role models and the primary source of wisdom. There is a new paradigm now.
Younger generations now take advice from media manufactured, faceless avatars and do-gooders on the Internet who create, either knowingly or unintentionally, the environment of fear, uncertainty and general misinformation.
This is not a criticism of a younger generation – quite the opposite. It is extremely difficult for anybody to make a decision with full confidence in such circumstances. The problem is more universal and relates to all generations living in present times. However, those of older age have those big decisions well and truly behind them while younger people have to face them now or in the near future.
The causes
It could be argued that it is the symptom of modern times that we are so overloaded with everyday tasks that are unable to find time to learn, discuss concepts and ideas with peers and elders we respect, analyse information and then make conscious decisions. Consequently, everything needs to be served on a plate for easy consumption where there is no need to exercise the brain too much.
As an example, we “do research” by skimming through news headlines and the more extreme and negative they are, the more attention they are likely to attract. We express our approval, opinions, or even protest, by clicking “Like”. And we tend to make only binary decisions: “Yes/No”, “Good/Bad”, etc. It seems there is very little time to ponder on “what if…” scenarios.
That is why media (traditional and social) and the internet in general have such a profound influence on what we think and do – they deliver snippets of information in chunks we are able to process without much effort.
The ease of dissemination of information in the digital age means there is a room for all sorts of views but what makes into a wider circulation is controversy and extreme cases.
So, we hear and read: “Property prices to fall 20%”, scratch that, 40% sounds more dramatic! But no one bothers to answer a fundamental question: "…and then what?"
Will they stay low or rebound? Is it likely that government would not intervene and would not try to prevent such a disaster? If there is intervention, what could be the impact on prices? Does this prediction have any merits after all?
It could be argued that there would be too much thinking involved to get these answers and in the fast paced digital media world there is no time for that because of editorial deadlines. The main game is headlines that attract the audience - not necessary the real story behind them.
And nobody bothers with putting caveats on such predictions either – by the following year the public will not remember “current scares” since focus will move onto the next extreme set of predictions.
A big part of the problem is how we interpret information published in the media – instead of treating those claims as a starting point for further investigation we tend to jump to a quick conclusion: “I saw it on TV so it must be right.”
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It is rather rare that a balanced and objective view of the state of affairs reaches wider audience via popular media channels – there is no incentive to publish such information simply because there is nothing sensational about it.
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Therefore, we are probably as much to blame for what is happening as the media. That is, we do not demand in-depth analysis behind the story simply because we don’t have the time to digest it. We just assume that someone must have done it diligently to come up with the conclusion, so the headlines will do just fine.
It is rather rare that a balanced and objective view of the state of affairs reaches wider audience via popular media channels – there is no incentive to publish such information simply because there is nothing sensational about it. Balanced views simply do not attract enough audience.
The effect is that only simplistic, negative, very often contentious, views propagate - leading to a widespread misinformation, like: “Property prices will fall in Australia because they have fallen everywhere else”; “We have affordability crisis because of negative gearing and speculators”; “Foreigners are causing property prices to rise”. There are a tonne of those around.
It should therefore come as no surprise that a significant proportion of would be buyers is put off making a decision.
Article continues on next page. Please click below.
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Some unexpected consequences
There is a number of quite ironic consequences resulting from all that doom, gloom and misinformation about the property market in Australia.
Firstly, it makes us vulnerable to exploitation by unscrupulous spruikers. In particular, on one hand it all leads to a perception that “property ownership is a dumb idea” (whether for living in it or earning income from it), that “everybody is losing money” and “everything is going to collapse very shortly anyway”.
On the other, it creates a fertile ground for those who claim to have a “secret formula” to “make it all magically work for us” and “to make the taxman pay for everything” - if we only spend $10,000 on a seminar and instructional videos, and some more on personal coaching.
There are plenty of people who fall for a magic of big numbers and a prospect of becoming a property mogul - despite the fact that there are no secrets to making money with property, just clever marketing.
The second consequence is that it led to emergence of new industries with a sole purpose of helping people to buy into property – from online discussion forums, dedicated blogs and property search portals profiting from advertising, through those selling specialised reports, smartphone apps, DIY property investment books and seminars, to buyer advocates and mortgage brokers offering information, tools and services for a fee. And now even financial advisers are getting on-board with advice on investment in property via self-managed superannuation funds.
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The overload of information and assistance, rather than helping in making decisions, has a totally opposite consequence – that is, more information tends to paralyse us rather than aid in making those hard decisions.
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Yet, it seems that, for many, it is harder than ever to make a decision. The overload of information and assistance, rather than helping in making decisions, has a totally opposite consequence – that is, more information tends to paralyse us rather than aid in making those hard decisions.
Not to mention that everybody demands a fair compensation for their work so, that assistance can add quite substantially to the overall cost of buying, making us even more apprehensive about making the decision.
Not many of these services existed 20 odd years ago and information was not so easy accessible either. So, the bulk of advice and assistance was coming from parents, relatives and your local bank manager – all for free.
The trust that young people had in older generations is no longer as strong for the current generation of young people. Maybe this is also due to the fact that the elders also have become confused and no longer have as strong a conviction about the merits of purchasing a property as they used to have in the past.
This is unfortunate because that trust was crucial in providing moral and emotional support for young people getting into debt for the first time. And it helped to positively reinforce the decision.
The perception that nothing can go wrong because “everybody is doing it this way”, created by decades of success stories by people they knew personally, was also very empowering.
In other words, it appears that the whole support structure that helped in making tough decisions is significantly weakened, if not entirely collapsed. There is really nobody that can be trusted anymore since those who offer assistance are there only to gain something from us (i.e. either clicks, patronage or real money for a service). The notion of “impartial advice” is somehow compromised in those circumstances as one can never be certain of true intentions behind provided information and advice. We are really on our own with those big decisions.
Social considerations that cannot be ignored
Then there are also social pressures impacting on the decision whether to buy a property or not. In the 21st century fun, globetrotting, gadgets, extreme sports, celebrity status, etc. “symbols of good and joyful life” are valued much higher than debt on a property located somewhere on the city's outskirts. Committing to owning a property early in life would mean sacrifices (i.e. less of the fun things) and would undermine rather than enhance the status of individuals in the eyes of their peers. So, at young age the choice is easy – don’t buy.
By the time people are ready to settle and start a family (which happens much later in life than in the past) they have already got used to the convenience of living in the city but they are overwhelmed by the amount of money required to continue that lifestyle as a family unit (either renting or buying, which requires taking on a substantial debt). This is when the anxiety about the future really kicks in.
The fact that Australia has not really experience economic hardship since early 1990s means that many of younger people also do not know what to expect when the hard times do come, adding to the anxiety and multiplying the fear factor (ie. because of the unknown).
This is a point in life when headlines like “property prices are overvalued by 40%” or “there is housing affordability crisis in Australia” are becoming a drawcard for this demographic group because it helps them to cope with the anxiety by reinforcing the fact they are not alone in this predicament.
However, these are not the real reasons why they are unable to buy - it is all primarily about the mindset.
A simple solution
The reality is that things are never black and white as they are over-simplified by media for the purpose of easy consumption. What we mostly hear in the media are opinions and not indisputable facts based on evidence – even those expressed by experts.
So, this fear is not substantiated with a valid reason. It is just a consequence of not knowing what to believe in, as well as not having the adequate knowledge to objectively assess what others are purporting to be the “ultimate truth”.
The only way to overcome this paralysis it is to get to know the facts. And this requires making the effort of starting to think for yourself.
The bottom line is that one cannot outsource thinking because there is a big price to pay at a later date. 
End note
I did use many generalisations in this article to emphasise the important issues underpinning the problem but, of course, there are many exceptions, as current property sales statistics show. There are many first home buyers that are making the decision to buy right now.
It all boils down to a mental state of having a confidence in the decision you make. It requires knowledge and conviction that this knowledge is not tainted.
It takes effort and lots of thinking before you can get into that mental state. So, taking time to think should be as important as attending the gym or undertaking other routine activities of your daily life. Sorting out finances to buy a property is the easy part.
There are no right or wrong decisions. However, since there are consequences of each decision, there will be those decisions that one can live with and those that will be regretted until the end of one’s life.
The key is to be mentally prepared to bear those unpleasant consequences when you make a decision which produces an outcome that is not in your favour.
This is the only secret one really needs to know to make a decision whether to buy or not to buy a property at present time. Affordability has nothing to do with it - it is all about the confidence.
Arek Drozda is an independent analyst who has worked in the public and private sectors for over 20 years in business development, data analysis and in building geographic information systems.
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Crisis of confidence or crisis of affordability?

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“Since FY 2000, at the macro level, rents have not been able to cover costs (mortgage, maintenance, rates) and policy has produced a country of loss-making landlords who rely upon negative gearing.” Chief Economist of a large international financial organisaton.
The above statement echoes a common perception about the merits of property investment in Australia. Similar views are shared by many prominent and respectable social, economic and finance commentators and hance, get a lot of circulation in the media. Since media has big influence on public opinion, such views get absorbed by wide sectors of the community without much scrutiny as to their merit. The result is that we end up in a situation where there is a widespread misunderstanding about residential property investment.
Let me try to clarify this misunderstanding by explaining how income losses originate in the early years of residential real estate investments and what implications it has for the returns on such investments. In other words, why “losses” and “profits” can go hand in hand in property investment - and why it is not a misnomer as you may expect at first…
 
1. Property investors are price takers and, as individuals, have minimal impact on the market.
As much as investors would like to buy cheap to make big profits from day one, they are not the only buyers in the market. Hence, they have to pay prices that the market dictates. Investors also compete for tenants so, incomes from letting of residential properties are influenced by prevailing rental market conditions.
To illustrate the point, imagine you could buy a property for $500K, pay 5% in interest on 100% of the value of the property plus $5K in oncosts (i.e. $30K p.a. in total) and rent it for $40K p.a. (8% gross yield) to make a profit before tax of $10K. That property would also grow in value by 3% p.a.
So $0, nil, zip, zilch, nothing invested up front (apart from a promise to the lender to repay debts in due course or if something goes wrong) and a starting profit of $25K (comprising $10K cash and $15K in capital). There is only one question to ask - how many such properties would you like? You could probably stop working with 10, make most of your dreams come through with 20, and live a multimillionaire lifestyle with 30…
Let’s introduce a twist to this scenario and say, your cousin would like to do the same… and other members of your family, and your friends, and their family and friends… Suddenly, there would be a little bit more competition for the properties you intend to buy. So, how much such investment would be worth to you? Would you pay $600K for the property to earn “only” $20K p.a. (i.e. paying $35K p.a. in total costs and earning $5K net from rent and $15K in capital gains on original value of $500K)? Or maybe $700K would still be a good deal?
And let’s consider this case from a renter’s perspective. If it costs $40K p.a. to rent, would it be worth to buy the place for $600K and pay $35K p.a. in total costs and having an opportunity of making extra $15K p.a. in capital gains? Would paying $700K for the property be still a good deal?
The point is that prices at which properties change hands are the outcome of a complex set of circumstances, leading to individual decisions of buyers and sellers - the participants in the process, who collectively make the market. By default, since there can be only one buyer per property (whether a single person or a team), the price is usually the highest offer from all interested parties and is inevitably influenced by the cost of renting of comparable premises.
The following section explains how paying market prices works out for investors in the long run…
 
2. Long term returns on non-leveraged property investments match returns on share portfolios
<a href="https://www.asx.com.au/documents/resources/ASX_Report_2013.pdf" target="_blank">Exhibit 5,7 &amp;8</a>
If you accept conclusions of <a href="https://www.propertyobserver.com.au/residential/more-liquid-shares-just-outperform-property-over-last-20-years-if-you-dont-mind-the-volatility-rismark-study/2013081963840" target="_blank">studies on returns from shares and non-leveraged residential property</a>, both these investment classes deliver comparable results over a long term. As an example, according to RP Data, on average, property delivered gross rental yields of 3.6 to 7.8% p.a. (based on 1996 to 2013 data series) and capital appreciation of anywhere between 4 to 13% p.a. (2001-2011 data series) - results vary by State and type of property. These are<a href="https://www.urban.com.au/property-observer" target="_blank"> quite respectable returns</a> and reflect <a href="https://www.propertyobserver.com.au/residential/the-two-speed-decade-for-home-value-growth-tim-lawless/2012021553403" target="_blank">relatively low risk of this investment class</a>.
In other words, investors who bought properties with cash, or who paid off the initial loan, are consistently generating positive returns form their investments. So, labelling property investors “loss making landlords” is rather unfair generalisation.
The next section explains implications of a prospect of stable long term returns for the risk appetite of property investors…
 
 
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3. Low volatility creates opportunities for higher leverage
Since cash purchases of residential real estate are very rare, due to sums involved and difficulties in acquiring fractional ownership of a property, such investments are usually made with borrowed money. Buying an asset with borrowed money is called leverage, or gearing, and both owner occupiers and investors can take advantage of it.
Volatility in property prices is relatively low, especially on the down side. So, it is quite common for investors to buy residential properties with loans of up to 100% of purchase price plus full cost of purchase expenses (in such cases lenders take additional security over other unencumbered assets of the investor). The last six decades of persistent growth in property prices created expectations that this upward trend will continue in the future which gives borrowers and lenders confidence to enter into arrangements that are otherwise considered very risky (<a href="https://www.propertyobserver.com.au/residential/should-you-invest-in-shares-or-property-tim-lawless/2012110757682" target="_blank">e.g. for share portfolios</a>).
By applying maximum leverage to investments that already deliver positive returns investors have the opportunity to turn respectable profits into more substantial ones. However, the leverage comes at a cost in the initial stages of the investment when interest payments are not fully covered by income from rent. As borrowed money is paid off and/or rental incomes grow, those losses are eliminated.
The next section explains how those small losses can deliver big returns over time…
 
4.  Losses are actually additional capital injections that make leverage possible
Explanation of this step requires applying unconventional approach to account for profits. In short, the logic goes like this: the loan is required to secure possession of an income producing asset and it has an annual cost which initially is not covered by income from that asset (the reasons are explained in point 1 above). The annual operating loss (regardless whether reduced by negative gearing or not) and/ or investor’s contribution to the purchase price are considered capital outlays for the investment - not the purchase price of the asset. It therefore follows that these real cash outlays are what should be used in calculations of investor’s true returns.
To illustrate, a $500K apartment bought last year in Sydney with 100% loan (so, no cash outlay) that increased in value by say, 10% over the last 12 months (so, $50K gain) but generated $10K after-tax loss (i.e. which is actual cash invested), delivered in reality 500% return to the investor (of course net returns will be less due to capital gains tax and other costs if property is sold).
And it works in a very similarly way for owner occupiers. For example, a property purchased with 10% deposit that doubles in value (i.e. 100% return on purchase price) in reality is a 1,000% gross return on the original cash investment (for net return figure all costs of owning that property over the period would have to be deducted).
Of course, it is needless to say that the less leverage applied, the more those returns will approximate normal returns (as outlined in point 2 above). Also, that both property owners and investors can lose equally big if their bet on rising property prices goes the other way and properties decrease in value over time.
I am first to admit that this method of accounting for profits is controversial and can be criticised on a number of grounds. More importantly, this information taken out of context and in hands of unscrupulous peddles of “make zillions in property” seminars can be outright dangerous. However, it does not change the fact that for home owners and investors alike it is the real, hard cash that counts at the end of the day, not paper profits calculated for tax or other accounting purposes.  This method has its merits as it shows true net cash position after disposal costs, relevant taxes and debts are accounted for. It also demonstrates that even small increase in property prices can lead to substantial returns for property owners. There is no “black magic” or “secret formula” involved – this is simply how leverage works.
And to conclude…
 
5. Government or taxation policies have nothing to do with it
As I explained in my previous article <a href="https://www.propertyobserver.com.au/news/let-s-get-the-facts-straight-negative-gearing-benefits-less-well-off-investors-more-than-it-does-the-rich/2013111266324/Page-1" target="_blank">“Negative Gearing: The three facts that will challenge your assumptions”</a>, there is very little about negative gearing that would allow drawing a conclusion that landlords in Australia have to rely on it exclusively to make their property investments viable. There are no other government policies that would directly contribute to the viability of property investing either. Residential property as an investment class has its own merits - for owner occupiers as well as investors, with or without negative gearing, with or without leverage.
Majority of Australians already participate in this class of investment, either as owner occupiers and/or investors. We are not a nation of gullible property speculators, sinking money into dubious assets - but it takes some financial acumen to understand it. Off-the-caff comments, sensationalising selective aspects of property ownership or investing, without explaining the context, will not help those who are unable to participate in the Australian Dream. Promoting basic financial education is more pragmatic and would be more considerate...
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Arek Drozda is an independent analyst who has worked in the public and private sectors for over 20 years in business development, data analysis and in building geographic information systems.
 
 
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Putting property investment losses into perspective

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In my previous article, '<a href="https://www.propertyobserver.com.au/finance/australian-property-prices-explained-independent-analyst/2014011367181" target="_blank">Australian property prices explained</a>', I presented a chart that provided very accurate narrative on what has happened in the Australian property marketover the last three decades.  

It is safe to conclude that the same concept which allowed for the description of the past with such accuracy, should also be able to provide a reasonable guidance for the future.  
Of course, predicting exactly what will happen in 2014 and beyond is a tall order. Life is known to create such a variety of unanticipated scenarios that the reality will almost certainly play out differently to what everybody expects.  
Therefore, I prefer to think about the future in terms of a range of possible outcomes and likely probabilities of occurrence rather than as a single, definite result.  
The real benefit of such an approach is knowing how changes in economic conditions can potentially affect the outcome - not in picking the exact end result in advance.  
Since changes in some economic factors will have more profound effects than others, if you can identify in advance what are they, you can watch out for the tell-tale signs that a particular scenario is playing out – and act accordingly.  
You only need to be right about the direction property prices are heading to be able to benefit.
Please consider what follows with caution - in the “what if” category, rather than a certainty.  
Based on the income capacity of working Australians, residential property in this country is not overpriced and prices are far from bubble territory.  
The proof is in relative changes in the cost of buying over the last 27 years, which has been significantly below the relative changes in personal incomes over that time. Below is a slightly different representation of that information to highlight this point. 
<img src="/images/stories/2014/01/31/arek_jan_31_one.jpg" width="470" height="299" alt="arek_jan_31_one">
By rearranging the data we can create a chart that shows how much more property prices could increase at present and still be considered affordable (in relation to current incomes and as benchmarked to 1986). 
<img src="/images/stories/2014/01/31/arek_jan_31_two.jpg" width="470" height="301" alt="arek_jan_31_two">
The above chart indicates that current property prices are potentially undervalued by as much as 45%. Of course, this does not mean that prices will immediately move by this much but the potential for a substantial jump is there.  
Yet another perspective using the same underlying data reveals that conditions are now starting to resemble those in 2009. Although affordability in 2009 was not as extreme as in late 1990’s, it nevertheless led to a substantial price increase in 2010.
<img src="/images/stories/2014/01/31/arek_jan_31_three.png" width="470" height="277" alt="arek_jan_31_three">
Therefore, as history shows, if interest rates remain mostly unchanged and incomes keep growing, we can anticipate a significant jump in property prices in coming years.  
The increase could either be a rapid advancement of 10-20%, or even 30%, in the next 12-24 months if the 'good times' perspective prevails or, if pessimism dominates, it could result in an even more substantial jump but in the more distant future.  
Of course, this scenario can only play out on the proviso that there are no unexpected shocks applied to the system, such as a major international conflict, another economic calamity in the region, another collapse of world financial system, or a major natural disaster – to mention a few obvious cases.  
In terms of further outlook, if the relationship between costs of buying, incomes, rents and prices hold in the future, and the current rate of income growth continues, then it can be estimated that from now to the end of 2023 property prices could grow by as much as 140% under a historically low interest rate scenario (i.e. 5% per annum), or as little as 20% under a high interest rate scenario (i.e. 10% per annum).  
Under a more probable scenario of slower growth in incomes and interest rates averaging 7% per annum over the next decade, prices can still be expected to grow by 60% in the next 10 years.  
A much gloomier future is also possible but the probability of this scenario is rather small at this point in time.  
That is, a 40% drop in property prices is possible in the next decade but it would take extreme economic conditions for this scenario to play out. In particular, mortgage rates would have to persist at close to 20% per annum for a good part of the decade and income growth would have to drop to 2% per annum to bring prices down by this much.  
In conclusion, the outlook for property prices in Australia is positive - unless of course the world encounters another economic disaster of a magnitude that is hard to even imagine.  
Some insist that the next big event is 'just around the corner' so, it would be wise to keep an eye for the tell-tale signs of possible troubles brewing somewhere in the world but there is no obvious reason to panic just yet.    
Arek Drozda is an independent analyst who has worked in the public and private sectors for over 20 years in business development, data analysis and in building geographic information systems.
You can contact Arek on <a target="_blank" href="https://twitter.com/arekdrozda">Twitter</a>.
 
 
 
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Australian property prices in 2014 and beyond - a peek into the future

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Since property prices started to rise again a key question that comes to mind is – what about the bubble? Are we there yet or far from it? Opinions are many but I prefer to deal with facts and figures so, let’s examine the evidence…
Firstly, we have to define the “price bubble”. As it turns out, even this simple task is not without some challenges due to a variety of perspectives on the issue. Therefore, let’s settle on a simple and succinct <a target="_blank" href="https://en.wikipedia.org/wiki/Economic_bubble">definition from Wikipedia</a> which explains price bubble as “trade in high volumes at prices that are considerably at variance with intrinsic values".
So, according to this definition, the first precondition of a bubble is “trade in high volumes”. Since I do not have access to property sales data for the last few decades, the best proxy of this information is the number of mortgages issued by financial institutions, as published by the Australian Bureau of Statistics. This data series goes back to 1975 and is presented on the chart below. The red line on the chart is a 12 month moving average of monthly volumes of loans for purchase of established dwellings, new dwellings as well as for construction of dwellings. Loans classified as refinancing are excluded.
The spikes in volume can be clearly identified in 1984, 1988, 1994, 2003 and 2007. Volumes were also elevated in 2009 and are up in 2013 from a very low base but these appear so far to be “reactions” in a downtrend hence, rather unlikely candidates for a bubble.
 <img src="/images/stories/2013/12/03/total_dwellings_financed.png" alt="total_dwellings_financed" height="236" width="470">
The second precondition for the existence of a bubble is that “prices are considerably at variance with intrinsic values”. The definition of an “intrinsic value” is a much bigger problem. So again, let’s opt for something simple and widely used by economists. In particular, the most common approach to determine the intrinsic value of properties is to calculate price to household disposable income ratio, or price to rent ratio, and compare present and historical values. The second measure is my preference since there are long term data series readily available which makes construction of this indicator much easier. However, both those measures should show a very similar result.
I set the ratio of house price to rent as 1 for 1975, which is the start of housing mortgage data but I also calculated the ratio back to 1950’s - to a point in time when modern and unregulated post World War II housing market began in Australia.
Read more over page
 
 


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 <img src="/images/stories/2013/12/03/House_prices_to_rents.png" alt="House_prices_to_rents" height="288" width="470">
Looking at the above chart we can immediately identify a problem – the line only rises and it never fell back to or below 1950 level. The ratio first jumped in early 1950’s, then in mid 1970’s, again in late 1980’s and in early 2000’s, peaking so far in 2010. In other words, it implies that prices are “at variance to intrinsic value” continuously for 60 years now… Yet, despite that implied long lasting exuberance, property prices in <country-region>Australia</country-region> fluctuate periodically – they advance and then they pause or fall slightly, then they advance again to a higher level.
It means that this popular measure of intrinsic value is rather insensitive to short term variations in market conditions and therefore should probably be only applied in analysis spanning many decades or even centuries. In other words, simple measures like price to rent ratio, are rather inadequate for a shorter and medium term analysis, relevant to a person’s lifespan.  A more responsive measure is needed in order to determine whether prices are exuberant or not. I will explore this further in my next article.
For now, the only conclusion that can be drawn is that, according to our original definition, if we accept that 1950 is an appropriate starting reference point and that prices to rents ratio is an appropriate measure of a variance to intrinsic value, Australian property is in a very long term bubble that peaked so far in 2007 (the point of the highest volume of loans and high ratio of prices to rents) and that this bubble is currently deflating.
However, there is more that should be said. In particular, it is an awfully long term bubble and it may take an awfully long time to deflate, if at all. It is not out of the question that what we observe on the second chart is a reflection of ongoing structural changes in the housing market – therefore, that the chart indicates what the current intrinsic value is and not the variance from a historic intrinsic value, as this information is commonly interpreted. If what we observe is indeed the result of long term structural changes in the market, this “bubble” could as well inflate to even bigger proportions, as it happened in 1950s, 1970s, 1980s and in 2000s.
I will leave you with an interesting question to ponder about - what would it take to completely deflate this bubble and bring ratio of prices to rents down, back to 1950’s level? It would involve a serious modelling exercise to come up with a range of scenarios that could deliver that outcome but, as an illustration, prices would have to halve from current levels and, at the same time, rents would have to double to get us close to that result in the next 20 years. How likely it is to happen without a catastrophic economic shock or a drastic government intervention is not difficult to guess.
 
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Arek Drozda is an independent analyst who has worked in the public and private sectors for over 20 years in business development, data analysis and in building geographic information systems.
 
 
 
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The analyst in search of a property bubble: Arek Drozda

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Many people express the opinion that residential property is first and foremost a shelter and therefore should only be considered from a social perspective. Many believe that it is a given right of every citizen of this country to have a roof over the head – rather than as a financial asset that can potentially make money for its owners.
Although it seems like a righteous position to hold, it cannot be denied that, in addition to offering a physical protection from the elements, residential property is, and always has been, an attractive investment option.
The old saying “property is the biggest investments one will ever make” has not been coined without reason. Besides, even when people say they are buying a “home and not an investment” they do not necessarily equate this statement with not making any money on their purchase in the future.
It would therefore be more pragmatic to consider residential real estate as “long-term accommodation” rather than just a “shelter”. It is both a  roof over the head, as well as a money making asset.
Property ownership is quite popular in <country-region>Australia</country-region>. According to the Australian Bureau of Statistics, as at August 2011, 67% of all residential dwellings were owner occupied. Although this proportion is slightly down since the previous Census in 2006, it has remained relatively unchanged for the past 50 years.
Those Australians who had a stake in residential property did quite well over the last six decades, as the following chart demonstrates.
 <img alt="seven_decades_of_prices" src="/images/stories/2014/02/10/seven_decades_of_prices.png" height="261" width="470">
Source: Based on ABS data and Stapledon 2007
Returns varied from decade to decade as property prices rose at different paces, but they have always remained positive. So will property owners be seventh time lucky? Chances are they will, given the <a href="https://www.propertyobserver.com.au/residential/australian-property-prices-in-2014-and-beyond-a-peek-into-the-future/2014013167457" target="_blank">past history of property prices in this country</a> .
What the above chart does not show is that property owners also had an opportunity to make substantial savings in the ongoing costs of accommodation (i.e. rent) once they had paid off their initial loan. This increased the actual returns to owners quite substantially.
The following chart compares estimated total returns on residential property from capital appreciation and reinvestment of imputed rents, which is conceptually equivalent to S&amp;P/ASX 200 Accumulation Index.
 <img alt="property_vs_shares" src="/images/stories/2014/02/10/property_vs_shares.png" height="275" width="470">
 
Sources: based on ASX and ABS data
The chart indicates that, over the long run, returns from residential real estate match returns from share market investments. This conclusion is also supported by a study undertaken by Russel Investments and published by the Australian Stock Exchange, the <a href="https://www.asx.com.au/documents/resources/ASX_Report_2013.pdf" target="_blank">Long-term Investing Report, July 2013.</a>
It is important to stress that residential property is a long term investment option – it delivers, but requires patience. Consequently, this means it can be outperformed over a short-term by other types of investments.
Take gold for example:
 <img alt="property_prices_vs_gold" src="/images/stories/2014/02/10/property_prices_vs_gold.png" height="299" width="470">
Sources: based on ABS and Perth Mint data
Over the long run, residential property outperformed gold. However, over a short-term, those investors who piled into gold in 2005 would have experienced a much greater rate of return than property owners - even after the 2012 and 2013 falls in gold price are factored in.
 <img alt="property_prices_vs_gold_short_term" src="/images/stories/2014/02/10/property_prices_vs_gold_short_term.png" height="299" width="470">
Sources: based on ABS and Perth Mint data
Just a note of caution: Do not take the above comment literaraly – property owners could still come on top, despite the proportionately smaller increases in prices compared to gold because of the leverage that is usually applied when buying a property.
For example, a $100,000 cash investment in gold in 2005 would now be worth $250,000 (i.e. $150,000 increase). That amount invested in the right property worth $400,000 in 2005 (i.e. as 25% deposit) would deliver by now $200,000 extra in owner’s equity.
There is one more reason why property should be treated as an investment. In particular, if you believe in the merits of diversification, individuals should always aim to spread their wealth across a wide range of assets to minimise financial risk.
Residential property is an asset class with proven long-term security, hence should be considered as a part of well diversified financial portfolio.
All working Australians already participate in local and overseas stock markets, various cash instruments and/or commercial property market via the superannuation funds they belong to. However, these funds do not invest in residential property.
Dixon Advisory was the first Australian company to offer individuals the opportunity to invest in residential property in the <country-region>USA</country-region> via its <country-region>US</country-region> Masters Residential Property Fund, but not in Australian property. So, diversification into Australian residential real estate is only possible via direct investment in your own home or in the investment property (as an individual or via self-managed super fund).
All in all, residential property is an investment regardless of whether it can be morally justified, or whether those buying the property do it with full consciousness of this fact or not. It is simply because the returns are too good and too consistent to treat it otherwise.
The social aspect of housing, that is, as an “affordable shelter”, is very important and should be widely debated. However, in my opinion, the issue stands a much better chance of being addressed properly with tailored solutions aimed at assisting specific sections of the community; rather than with Robin Hood like polices advocated by some commentators, that can potentially destroy the investment value of property in Australia.
Residential property constitutes a significant part of the wealth of this nation. There is merit in the aspiration to own a property as a way of building and accumulating wealth, and therefore, there is a good reason to keep the 'Australian dream' alive.
Undermining this aspiration and shaking confidence of Australians in property will not end well – either fif it leads to destruction of national wealth, or for those who are persuaded to opt out of participation if history continues unchanged. 
Arek Drozda is an independent analyst who has worked in the public and private sectors for over 20 years in business development, data analysis and in building geographic information systems.
 
<hr>
 RELATED ARTICLES BY AREK DROZDA:
<a target="_blank" href="/property-observer">Putting property investment losses into perspective</a>
<a target="_blank" href="/property-observer"></a><a target="_blank" href="https://www.propertyobserver.com.au/finance/australian-property-prices-explained-independent-analyst/2014011367181">Australian property prices explained</a>
 
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An investment or just a roof over your head: How should we treat residential property?

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Anybody who follows the property market in <country-region>Australia</country-region> is familiar with Steve Keen, an economist who made a daring prediction that our property prices will fall as much as 40% sometime before 2023. How this prediction came about is subject to various interpretations, nevertheless, the “40% drop” forecast has been repeated so many times over the years, and by so many, that it has almost become a part of Australian folklore.
I have to admit that when I first came across Steve Keen’s prediction I treated it with a fair dose of scepticism since I could not find corroborating evidence for such a substantial fall in prices using indicators from my own analytical toolkit.
I had a particular issue with the somewhat overly simplistic assumption that 'whatever happened in the <country-region>US</country-region> has to happen here because we are no different'. I had an alternative perspective on this as, a decade or so earlier, I had undertaken some analysis of the 1980s housing crisis in the <country-region>US</country-region> and clearly, the events played out quite differently in <country-region>Australia</country-region>.
However, there was one bit of theory that underpinned Keen’s conclusions which attracted my further interest. In particular, at the core of Keen’s argument is a concept that “aggregate demand equals GDP plus the change in debt” (emphasis mine).
Since debt is equivalent to cash in your pocket and 'money makes the world go round', it therefore seems a logical proposition to look into changes in debt levels as a way of gauging what is happening in a wider economy.
Keen devised an indicator called the <a target="_blank" href="https://www.debtdeflation.com/blogs/2011/08/28/updated-credit-accelerators/">Credit Accelerator</a> to forecast the effect of changes in debt levels on GDP. It is conceptually similar to Credit Impulse proposed by Biggs, Myer, Pick in <a target="_blank" href="https://www.banccentraldecatalunya.ch/wordpress/wp-content/uploads/2013/Biblioteca_ERC/2013Oktober/11102013/BankOfNetherlands-Working%20paper%20218_tcm46-220409.pdf">their analytical paper</a> published in July 2009.
Briefly on Credit Impulse, as it is important for the interpretation of the graph presented below: the original theory was the result of an attempt to find a possible explanation for credit-less recoveries where GDP starts to grow with no growth in stock of credit. The authors found the evidence that a mere slowdown in the speed of debt reduction (i.e. in deleveraging) had a positive effect on the overall economy.
In simple terms, when the Credit Impulse indicator starts to point upwards while in negative territory, it is a positive sign that things are improving. The opposite should also hold true; that is, when it starts to point down while in positive territory - it is a negative sign meaning things are deteriorating.
So by substituting total debt with just housing debt, one can potentially gain insight specifically into the property market.
However, it is debatable whether Credit Impulse/ Credit Accelerator are still meaningful in this context. And there are also some issues with refinancing not being able to be isolated from the total value of housing debt which potentially clouds the picture. Nevertheless, a comparison of Credit Impulse (constructed with housing debt data) to the 12-month rate of change in the established house price index indicates quite a good correlation between the two data series, as illustrated on the following chart.
<img src="/images/stories/2014/02/17/arek_feb_1_7_one.png" width="470" height="320" alt="arek_feb_1_7_one">
Source: Based on ABS and RBA data
I am using an adaptation of the Biggs, Myer, Pick version of the algorithm, hence there may be discrepancies between Keen's and my version of the graph.
It is worth noting that correlation between the two data series is particularly strong over the last five years (for those statistically inclined, correlation coefficient is 0.88 but drops to 0.64 for the entire series). That would imply there is merit in using the Credit Impulse concept for monitoring the state of the property market in <country-region>Australia</country-region>.
The potential benefit of this indicator is twofold: it offers a timely insight into the dynamics of the property market – better than quarterly established house price data from the ABS. And secondly, perhaps more importantly, it can provide an early indication of impending changes in the direction of property prices.
As the above graph demonstrates, the theory behind Steve Keen’s original prediction appears sound - although it is not entirely clear to me whether Keen had actually been using his Credit Accelerator indicator when he made his prediction or not (Biggs, Myer, Pick paper was published much later). However, let’s examine how this indicator should have been interpreted if it was in existence.
Article continues on next page. Please click below.
 
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To be frank, it would have been a frightening experience to stare at this graph in 2007 and 2008, hearing about all the financial collapses happening throughout the world and not knowing the depth it could all fall to.
Based on these factors alone, a prediction of significant declines in house prices would have been well justified back then. However, since the magnitude of the likely decline cannot be derived directly from the Credit Impulse indicator, I assume there must have been other factors that allowed Keen to make the estimate of 40% drop in prices, because otherwise it would have been just a presumption.
By the same token, when the Credit Impulse started to point upwards in March 2009, and kept rising in the following quarters, it gave an indication that things were likely to improve. However, this message was not conveyed to the wider audience. So, again, one can only assume that there must have been other compelling factors that led Keen to persist with his earlier conclusion.
The whole situation repeated again in 2010 (i.e. in June Credit Impulse indicated a possible reversal in the growth of property prices) and in 2012 (when the Credit Impulse started to point upwards again, indicating the likely end to price decreases).
By then Keen had been regularly publishing commentary on his Credit Accelerator indicator, so the experience from the earlier 2008-2009 episode should have helped with a more accurate interpretation of what was happening. However, throughout that time, Keen had insisted that there were only two likely options for property prices: a US-like scenario where prices fall rapidly, or <a target="_blank" href="https://www.propertyobserver.com.au/residential/house-prices-will-fall-in-a-slow-bleed-fashion-steve-keen/2013060662034">Japan-like scenario of a “slow melt”</a> over the <a target="_blank" href="https://www.propertyobserver.com.au/residential/property-prices-to-fall-20-by-2013-year-s-end-steve-keen/2011101952000">next decade or so</a>.
Again, this call was made most likely because of other factors which, to my best knowledge, remain unspecified (that is, if we leave aside the two simplistic assumptions Steve Keen made that '<a target="_blank" href="https://www.debtdeflation.com/blogs/2012/01/28/economics-in-the-age-of-deleveraging/">Australian private debt is high and therefore it will deleverage</a>' and that 'Australia is like the US so the same has to happen here as well').
It was only much later, when a third scenario started to play out and property prices actually recorded some gains, that Steve conceded prices <a target="_blank" href="https://www.debtdeflation.com/blogs/2013/11/13/i-will-be-wrong-on-house-prices/">“may go up for a while”</a>. However, the media did not pick up on this comment with the same zeal as on the previous doom scenario. How unfortunate.
All in all, in 2008 Keen had an important message to tell and that message was broadcast to a wide audience. Media played a very important role in publicising his warning. That is how I and many others became aware of his views.
However, not many took the effort to understand what was really behind the “40% price drop” headline. The majority bought into this scenario without any further thought.
Many still hold to this view despite prices reaching new heights and despite the fact that the indicator that is at the core of the original prediction is showing that property prices will grow further. However, the positive message is not being reported by the media.
To be fair, there is a small possibility that the “40% price drop” prediction may come true in the next decade (the timeframe nominated by Steve Keen). We can only wait and see. However, if it happens, without additional evidence from Steve on what kept him convinced that the original scenario is still to play out, it will be difficult to accept that it was all <a target="_blank" href="https://www.propertyobserver.com.au/residential/australian-property-prices-in-2014-and-beyond-a-peek-into-the-future/2014013167457">predictable as far back as 2008</a>.
One thing is almost certain though. Based on the past performance, the Credit Impulse should give a warning when the current price trend is about to reverse. For now, let’s just enjoy the ride to the next top, however long, or short, it will be.
Arek Drozda is an independent analyst who has worked in the public and private sectors for over 20 years in business development, data analysis and in building geographic information systems.
UPDATE: In repsonse to this article Steve Keen wrote a reply, which you are able to view here: <a href="https://www.propertyobserver.com.au/economy/clarifying-my-40-drop-call-and-what-s-still-driving-housing-prices-up/2014021867863" target="_blank">Clarifying my 40% price drop call and the factors still driving housing prices up: Steve Keen</a>
 
 
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Revisiting Steve Keen’s 40% property price fall prediction

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GUEST OBSERVATION
Residential property is <a href="https://www.propertyobserver.com.au/residential/a-roof-over-your-head-or-the-biggest-investment-you-ll-ever-make-how-should-we-treat-residential-property/2014020967655" target="_blank">considered an investment class</a> and, as such, it is subject to market cycles where prices fluctuate over time.
Being aware of the stage of the market cycle can help in timing purchase and sale decisions.
However, it is rather difficult to gauge the state of the market and its future direction by examining only historical prices, even if these are reported on a daily basis - as is the case with RP Data's Home Value Index. Periods of rises and falls in prices are of different durations and subsequent movements can have very different magnitudes.
Frankly speaking, the dynamics of the Australian real estate market are very little understood despite its value exceeding more than threefold the capitalisation of all companies listed on the Australian Securities Exchange. Financial institutions are not investing in it directly hence long term research on performance and cycles is almost non-existent, or at least not available to the public. 
True, we do have various, raw measures of price movement, reports on auction clearance rates, vacancy rates, intentions to buy, asking prices, or various affordability indexes but these were developed primarily in support of valuation or risk management activities of lenders and insurers, or for the purpose of economic modelling, and not necessarily to help in decision making by individuals. Besides, each of these measures on its own gives only a partial picture of the market.
Traders in shares, bonds, currencies and similar financial instruments have developed a myriad of secondary “technical indicators” to aid in recognition of prevailing market cycles and trends. There are no such indicators available for buyers and sellers of residential properties.
The only thing that comes close to a true market gauge is the concept of a “property clock” but it tends to be very subjective and readings often differ from one commentator to another. In other words, we are missing a truly analytical perspective on the state of the property market.
To address the lack of consistent, long term analytical measures that help understand the state of property market in Australia, I have compiled a set of unique indicators which I would like to share with you on a regular basis.
The aim of this first set of indicators is to provide a broad perspective on the national property market as a whole. Peculiarities of local markets will be assessed with another set of indicators which I intend to publish at a later date.
About the Indicators
The first two indicators in the set (buy-rent indicator and purchase affordability indicator) provide objective measures of relative attractiveness of residential real estate to prospective buyers. In other words, whether there is a potential incentive, “value” if you like, for prospective buyers to consider buying a property or not.
The third indicator, economic wellbeing indicator, reflects perceptions of Australians about the economy. Since people are more inclined to commit to a substantial purchase if they have a positive outlook on the economy, this indicator evaluates the likelihood of people committing to property purchases.
The fourth indicator, private housing credit impulse, measures what people are actually doing. That is, whether perceptions about the value of owning a property and outlook on the economy translate to actual purchases or not.
The fifth indicator, property prices gauge, aims to forecast how the collective actions of buyers will likely impact property prices and whether actual change in prices is proportionate to the volume of money flowing into the property market at any given time.
Actual prices feed back into the value proposition, as reflected in the first two indicators, which closes the information loop. This is the minimum set of indicators that allows drawing a definite conclusion on the overall state of the property market now and in the recent past.
The indicators are calculated back to mid 1980’s and where possible I publish them with a reference to the change in prices of established houses (as reported by the Australian Bureau of Statistics) to show how well they reflect the reality over time. I will provide my interpretation of the latest results, a bit more extensively than usual in this first edition, but please feel free to derive and share your own conclusions via comments.
A short explanation of some conventions to help in interpreting the information:
<ul>
<li>
Market outlook can be: positive, positive with negative bias, neutral with positive bias, neutral, neutral with negative bias, negative with positive bias and negative 
</li>
<li>
Charts are labelled as:
</li>
</ul>
Estimate – if data estimates are used in calculations of the latest measure,
Preliminary – if mix of actual and estimated data is used to calculate the current measure, and
Final – where all inputs are actual data.
Caveat
The information is provided in good faith and does not constitute financial advice. Use with caution and at own risk.
Arek's April state of the market summary is on the following pages. Please click below. 
<hr class="system-pagebreak">
Summary
Market outlook: positive with negative bias
 
<ul>
<li>Current conditions favour purchasing over renting but change in trend is imminent (as at December 2013) </li>
<li>Purchase affordability is at a historically high level and has most likely reached its peak (as at December 2013) </li>
<li>Confidence in the economy has started to deteriorate in recent months but is still positive (as at March 2014) </li>
<li>Housing credit is growing strongly, indicating healthy demand (as at March 2014) </li>
<li>Actual prices are slightly ahead of what could be expected based on housing credit growth (as at February 2014)</li>
</ul>
 
National real estate price forecast
Conditions are supportive of further growth in prices in June 2014 quarter and beyond, however increasing pessimism about the economy indicates a possible slowdown in the pace of that growth.
#1 Optimal accommodation choice: Buying more advantageous than renting
<img src="/images/2014/04/28/BRI_April2014.png" alt="">
The Buy-Rent Indicator (BRI) identifies how cost of buying is changing in relation to cost of renting.
BRI bottomed in June 2012 (indicating the lowest point in the current cycle) and it has been rising consistently since then. Although still in buy-territory, the indicator is fast approaching the equilibrium line.
This indicator is constructed based on a simple concept that renting and buying are substitute accommodation options, hence the optimal choice depends on which cost is rising in relation to the other.
BRI in “buy zone” implies that the cost of buying a property has either declined more or risen less, in percentage terms, than cost of renting, therefore making this accommodation option more attractive.
The practical use of this indicator is for identifying market cycles and for timing purchase and sale decisions. In particular, market cycles can be determined by identifying peaks or troughs on the graph (for example, the last two peaks were in March 2008 and June 2010 - and coincide with peaks in national property price indexes).
The crossing of the indicator from rent to buy zone gives a signal that costs of buying started to decline, or at least are rising less than costs of renting.
For those intending to buy in the current cycle the optimal point for making a purchase is when the indicator crosses into buy territory, if the decline is driven by falling interest rates. However, if the fall is caused primarily by falling prices the optimal point is when the indicator turns up, confirming that purchasing costs have bottomed in the current cycle.
The crossing of the indicator from buy to rent zone (which is now approaching) gives a signal that buying costs are rising faster than rental costs.
In the market where property prices are rising, this marks the point in time when opportunities to purchase a property at attractive prices may be all but exhausted in the current cycle. Prices are expected to continue on the upward trajectory from this point onwards which will cause buying costs to rise further.
For those intending to sell in the current cycle, the crossover marks the optimal point if costs of buying are rising due to changes in interest rates. If buying costs are rising primarily due to price increases, the optimal point for selling will be when the indicator peaks, which should coincide with a peak in property prices.
Please note, this indicator can be calculated only on a quarterly basis and is therefore lagging (the latest reading is for December 2013). That is, the confirmation of the cycle peak or trough can be delayed for up to six months.
#2 Purchase affordability: At historically high level, started to decline 
 <img src="/images/2014/04/28/PAI_April2014.png" alt="">
The Purchase Affordability Indicator (PAI) compares changes in the annual cost of buying to changes in average full time adult income, therefore it identifies how purchase affordability has changed over time.
PAI is at historically high level, comparable to that reached in 2009 or 1994, but has recorded a decline in December 2013 from a peak reached in September 2013.
This indicator explains the reason why prices have been growing so strongly. That is, relative to incomes of Australians working full-time, property prices are still very affordable (in the past 30 years purchase affordability was only better between September 1996 and December 2002).
PAI is a lagging indicator and the latest available reading is for December 2013. This indicator will continue to decline if cost of buying grows faster than adult full time incomes. However, prices have still a lot of room to move before they reach an overpriced territory.
Article continues on next page. Please click below.
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#3 Perceptions about economy: Outlook is positive but conditions are deteriorating
<img src="/images/2014/04/28/EWI_April2014.png" alt=""> 
The Economic Wellbeing Index (EWI) is designed to reflect general perceptions of Australians about the current economic conditions.
The EWI is in positive territory but has been declining since June 2013.
A more volatile raw measure of the index is trending up again but only after it recorded significant falls in the previous four months and crossed over into the negative territory.
Declining EWI indicates that perception of Australians about the state of economy started to change to less upbeat since mid-2013 but overall, it is still positive.
The key premise behind this indicator is that people are generally less inclined to make big purchases when they are worried about the state of the economy. This has certainly been a pattern in the past – every time the index crossed into the negative territory, property prices either declined or reduced the rate of growth.
The index is still positive so there should be still plenty of positively thinking buyers and property prices are not likely to decline however, increased uncertainty should take some heat off the market.
The EWI is updated monthly and therefore it offers quite timely insight into the perceptions about the state of economy.
#4 Demand: Housing credit continue to grow
 <img src="/images/2014/04/28/PHCI_April2014.png" alt="">
The Private Housing Credit Impulse (PHCI) provides an indication of the level of buyer activity in the residential property market in Australia, hence it reflects underlying demand for properties.
The March 2014 estimate is positive and reached its highest value since December 2011.
Positive and rising value of the indicator reflects continued strong demand for residential property.
The practical use of this indicator is to provide early warning about impending changes in housing credit uptake, and hence, changes in the underlying demand for residential property.
The most significant signals are when the indicator turns up after bottoming in the negative territory or when it turns down after peaking in a positive territory - since these indicate major trend reversal points.
PHCI bottomed in December 2011 when the decline in the rate of quarterly growth in mortgage finance reached the lowest level and started to improve (i.e. when mortgage finance started accelerating again). This trend was immediately reflected by the reduction in the rate of declines in property prices.
As more money started to flow into the property market, it coincided with a pick up in residential property prices from December 2012 onwards. The demand for property has been rising ever since, with a minor slowdown in June 2013 quarter.
The indicator is currently close to a level at which it turned down on two previous occasions - the September 2006 peak, after which credit declined significantly in a lead up to the Global Financial Crisis (which also coincided with a period of severe purchase unaffordability), and in June 2010 when property prices reached another peak, induced by post GFC stimulus.
In contrast to those previous occasions, property is now much more affordable than in 2006 and demand for residential property seems to be real (rather than induced with incentives, as in 2010), so there is a strong momentum for mortgage credit to continue to rise. However, there could be a temporary slowdown in the strength of that rise as a result of self-imposed credit restraints due to economic uncertainty.
It is important to note that, although this indicator is reported in quarterly intervals, it is derived on a monthly basis. In other words, it is initially calculated based on estimated values which are subject to subsequent revision once actual data becomes available. Hence, the latest quarterly reading can change from one month to the next.
#5 Property price expectation: Values are rising and are close to the level of actual prices
 <img src="/images/2014/04/28/PPG_April2014.png" alt="">
The Property Prices Gauge (PPG) is a proxy of a property price index. It becomes a leading indicator when combined with House Price Index (HPI).
PPG continues on the upward trajectory after a temporary slowdown between March and July 2013. The value of the indicator is close to the value of establish house price index.
Expected and actual prices are relatively close now, although were at variance for a while. This indicates that recent price rises are now in line with underlying demand and are not the result of a mad rush to buy.
PPG is calculated from credit related statistics and is not dependent on any reported property price data. It provides a good indication of the magnitude and future direction of the actual price movement.
The most significant signals from this indicator are when it diverges from actual prices - it points to either underlying strength or weakness of the market.
For example, it provided ample warning about 2008 price falls - almost a year in advance, and then signalled strength of a subsequent recovery. Post-June 2010, it provided evidence that the market was stronger than actual price falls indicated and again, signalled market recovery since March 2012.
The index is calculated on a monthly basis but house price data can only be updated in quarterly intervals.
You can <a href="component/googlecse?q=arek+drozda" target="_blank">read more of Arek Drozda's pieces here</a>.
AREK DROZDA is an independent analyst who has worked in the public and private sectors for over 20 years in business development, data analysis and in building geographic information systems. 
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Buying more advantageous than renting, yet change imminent: April 2014 state of the market analysis

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GUEST OBSERVATION
Summary
Market outlook: unchanged - positive with negative bias
<ul>
<li>Buying and renting costs are changing at the same pace giving no preference to either option (as at March 2014).</li>
<li>Purchase affordability is at a historically high level but the downward trend is now apparent (as at March 2014).</li>
<li>Confidence in the economy has deteriorated further and is close to crossing into negative territory (as at May 2014).</li>
<li>Housing credit is growing strongly, indicating healthy demand (as at March 2014).</li>
<li>Actual prices are above of what could be expected based on housing credit growth but margin is reasonable (as at March 2014).</li>
</ul>
National Real Estate Price Forecast
Unchanged: conditions are supportive of further growth in prices in June 2014 quarter and beyond, however declining optimism about the economy indicates a possible slowdown in the pace of that growth.
#1 optimal accommodation choice: buying and renting costs are balanced
 <img src="/images/2014/05/20/BRI_May2014.png" alt="">
The Buy-Rent Indicator (BRI) identifies how cost of buying is changing in relation to cost of renting.
BRI bottomed in June ’12 (indicating the lowest point in the current cycle) and it has been rising consistently since then. The indicator has now reached the equilibrium line.
This indicator is constructed based on a simple concept that renting and buying are substitute accommodation options, hence the optimal choice depends on which cost is rising in relation to the other. The practical use of this indicator is for identifying market cycles and for timing purchase and sale decisions.
The crossing of the indicator from buy to rent zone gives a signal that buying costs are starting to rise faster than rental costs.
In the market where property prices are rising, this marks the point in time when opportunities to purchase a property at attractive prices may be all but exhausted in the current cycle. Prices are expected to continue on the upward trajectory from this point onwards which will cause buying costs to rise further.
#2 purchase affordability: at historically high level but declining 
 <img src="/images/2014/05/20/PAI_May2014.png" alt="">
The Purchase Affordability Indicator (PAI) compares changes in the annual cost of buying to changes in average full time adult income, therefore it identifies how purchase affordability has changed over time.
PAI is at historically high level, comparable to that reached in 2009 or 1994, but is steadily declining from a peak reached in September 2013.
This indicator explains that, relative to incomes of Australians working full time, property prices are still very affordable. In the past 30 years purchase affordability was only better between September 1996 and December 2002.
Prices have still a lot of room to move before they can be considered unaffordable.
Article continues on next page. Please click below.
<hr class="system-pagebreak">
#3 perceptions about economy: conditions are deteriorating
<img src="/images/2014/05/20/EWI_May2014.png" alt=""> 
The Economic Wellbeing Index (EWI) is designed to reflect general perceptions of Australians about the current economic conditions.
The EWI is falling since June 2013 and has almost reached a crossover line.
The key premise behind this indicator is that people are generally less inclined to make big purchases when they are worried about the state of the economy.
EWI fallings towards neutral line indicates that perceptions of Australians about the state of economy are deteriorating but have not yet turned negative. Increased uncertainty about the economy can result in more sluggish demand for residential properties.
#4 demand: housing credit continue to grow
 <img src="/images/2014/05/20/PHCI_May2014.png" alt="">
The Private Housing Credit Impulse (PHCI) provides an indication of the level of buyer activity in the residential property market in Australia, hence it reflects underlying demand for properties.
The preliminary March 2014 PHCI is positive and reached its highest value since December 2011. Consequently, property prices continue to record higher values.
The practical use of this indicator is to provide early warning about impending changes in housing credit uptake, and hence, changes in the underlying demand for residential property.
Positive and rising value of the indicator reflects continued strong demand for residential property.
#5 property price expectation: values are rising and are close to the level of actual prices
<img src="/images/2014/05/20/PPG_May2014.png" alt="">
The Property Prices Gauge (PPG) is a proxy of a property price index. It becomes a leading indicator when combined with House Price Index (HPI).
PPG continues on the upward trajectory after a temporary slowdown between March and July 2013. The value of the indicator is close to the value of establish house price index.
Actual prices are above of what could be expected based on housing credit growth but not too far ahead. Therefore, current price level is well supported. 
For more extended description of individual measures and how to apply this information please refer to the first report in this series: <a href="/expert-insights/buying/30639-state-of-the-property-market-april-2014?limitstart=0" target="_blank">State of the Property Market, April 2014</a>. 
Caveat: The information is provided in good faith and does not constitute financial advice. Use with caution and at own risk.
AREK DROZDA is an independent analyst who has worked in the public and private sectors for over 20 years in business development, data analysis and in building geographic information systems. 
You can <a href="component/googlecse?q=arek+drozda" target="_blank">read more of Arek Drozda's pieces here</a>.
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Further price growth likely, though pace may slow: May 2014 state of the market analysis

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GUEST OBSERVATION
Market Outlook: downgraded to neutral
<ul>
<li>Renting has just become more attractive accommodation option than buying (as at June 2014).</li>
<li>Purchase affordability is at a historically high level but the downward trend is now apparent (as at March 2014).</li>
<li>Confidence in the economy has just turned negative (as at June 2014).</li>
<li>Housing credit impulse is still growing, indicating continued demand for residential real estate (as at June 2014).</li>
<li>Actual prices are above what could be expected based on housing credit growth but only marginally (as at April 2014).</li>
</ul>
National Real Estate Price Forecast
Growing pessimism about the state of the economy has the potential to start impacting on demand.
We can therefore expect a period of slower growth, or even stabilisation, in property prices in June and September 2014 quarters.
There is no indication as yet that the prices have peaked in the current cycle so, the slowdown may only be temporary.
Detailed Analysis
#1 optimal accommodation choice: renting more attractive than buying
<img src="/images/2014/06/23/BRI_June2014.png" alt=""> 
The Buy-Rent Indicator (BRI) identifies how cost of buying is changing in relation to cost of renting.
BRI bottomed in June 2012 (indicating the lowest point in the current cycle) and it has been rising consistently since then. The indicator has just crossed the equilibrium line.
This indicator is constructed based on a simple concept that renting and buying are substitute accommodation options, hence the optimal choice depends on which cost is rising in relation to the other. The practical use of this indicator is for identifying market cycles and for timing purchase and sale decisions.
The crossing of the indicator from buy to rent zone gives a signal that buying costs are starting to rise faster than rental costs.
In the market where property prices are rising, this marks the point in time when opportunities to purchase a property at attractive prices may be all but exhausted in the current cycle. Prices are expected to continue on the upward trajectory from this point onwards which will cause buying costs to rise further in relation to rental costs.
#2 purchase affordability: at a historically high level but declining
 <img src="/images/2014/06/23/PAI_June2014.png" alt="">
The Purchase Affordability Indicator (PAI) compares changes in the annual cost of buying to changes in average full time adult income, therefore it identifies how purchase affordability has changed over time.
PAI is at historically high level, comparable to that reached in 2009 or 1994, but is steadily declining from a peak reached in September 2013.
This indicator explains that, relative to incomes of Australians working full time, property prices are still very affordable. In the past 30 years purchase affordability was only better between September 1996 and December 2002.
Prices have still a lot of room to move before they can be considered unaffordable.
Article continues on the next page. Please click below.
<hr class="system-pagebreak">
#3 perceptions about economy: have just turned negative
 <img src="/images/2014/06/23/EWI_June2014.png" alt="">
The Economic Wellbeing Index (EWI) is designed to reflect general perceptions of Australians about the current economic conditions.
The EWI is falling since June 2013. June 2014 estimate has crossed over into the negative territory. A more volatile raw measure is slightly up comparing to May 2014 but is still well within the negative territory.
The key premise behind this indicator is that people are generally less inclined to make big purchases when they are worried about the state of the economy.
EWI crossing a neutral line indicates that perceptions of Australians about the state of economy deteriorated to the point that can now be considered negative. In the past this coincided with a rapid slowdown in price growth (with one exception in late 2005) or even with price falls (as it happened in 2008 and 2010). If there is no strong rebound in the indicator, growing pessimism will soon start to affect demand and prices of Australian properties.
#4 demand: still strong and well underpinned with housing credit growth
 <img src="/images/2014/06/23/PHCI_June2014.png" alt="">
The Private Housing Credit Impulse (PHCI) provides an indication of the level of buyer activity in the residential property market in Australia, hence it reflects underlying demand for properties.
The June 2014 PHCI estimate is positive and the value of the indicator is at its highest since December 2011.
The June value of PHCI is subject to revision over the next two months but it would take a significant decline in growth of housing credit to reverse the current trend.
The practical use of this indicator is to provide early warning about impending changes in housing credit uptake, and hence, changes in the underlying demand for residential property.
Positive and rising value of the indicator reflects continued strong demand for residential property. Consequently, despite reports of recent falls in daily property price index, actual prices on a national level are not expected to decline in June quarter and the likelihood of falls in September quarter is also very minimal at this stage.
#5 property price expectation: growth to slow or possibly even flatten
 <img src="/images/2014/06/23/PPG_June2014.png" alt="">
The Property Prices Gauge (PPG) is a proxy of a property price index. It becomes a leading indicator when combined with House Price Index (HPI).
PPG has risen in April 2014 however, the rate of growth is slowing. Actual prices (March 2014 House Price Index) are above of what could be expected based on housing credit growth but the gap between PPG and HPI is narrowing.
Although the current price level appears to be well supported, weaker PPG growth points to softer property prices in the coming months. In other words, prices may stabilise for a while or, if they keep growing, the rate of growth should be more modest than in the last few quarters. 
Caveat
The information is provided in good faith and does not constitute financial advice. Use with caution and at own risk.
Background information
For more extended description of individual measures and how to apply this information please refer to the first report in this series: <a href="/expert-insights/buying/30639-state-of-the-property-market-april-2014" target="_blank">State of the Property Market, April 2014</a>. 
Arek Drozda is an independent property market analyst.
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Arek Drozda

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