Growth to slow further: October state of the market analysis

GUEST OBSERVATION

Market Outlook: unchanged - neutral with negative bias

• Attractiveness of renting as a preferred accommodation option continues (as at September 2014).
• Purchase affordability is still very high but declining (as at September 2014).
• Confidence in the economy is low but conditions are no longer deteriorating so rapidly (as at October 2014).
• Housing Credit Impulse has turned down, indicating change in the underlying demand for residential real estate (as at September 2014).
• Actual prices are above what could be expected based on changes in housing credit, making them sensitive to adverse changes in economic conditions (as at August 2014). 

National Real Estate Price Forecast 

Limited new data was released over the last month hence, the October 2014 report represents only a minor revision of previously released charts.

New data points were added only to the Economic Wellbeing Index and Property Price Gauge; however, both measures register almost no change on the previous month values.

In general, indicators continue to point to softer market conditions. Significant pessimism about the economy, elevated purchase costs, declining affordability and falling demand are well evident in the data.

These conditions do not indicate a crash but without a major turnaround in the indicators, prices are very unlikely to increase for much longer.

In the absence of evidence that demonstrates prices have reached their peak in the current cycle, the outlook for the property market in Australia remains neutral.

Detailed Analysis

#1 optimal accommodation choice: attraction of renting over buying is increasing

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 crossed the equilibrium line in March 2014. The September 2014 estimate points to a continuation of an upward trend for this indicator.

BRI is constructed based on the simple concept that renting and buying are substitute accommodation options, hence the optimal choice depends on which accommodation 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 the buy to rent zone gives a signal that buying costs are starting to rise faster than rental costs. So, currently, renting appears a more advantageous accommodation option than buying. 

In a market where purchasing costs are rising mainly due to price increases, the optimal point for selling the property will be when the indicator peaks, which should coincide with an interim peak in property prices. That point can be anticipated any time now, within the next 12-24 months.

 #2 purchase affordability: at a historically high level but falling

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 still at a historically high level despite the September 2014 estimate falling in value. 

This indicator explains that, relative to incomes of Australians working full time, property prices are still very affordable. There has been no significant change in the estimate since last month. 

The cost of buying a median priced property relative to average income is still lower than in late 1980s.  So, given the expectations of long-term low interest rates, there is still a lot of room for prices to move before Australian property can be considered overvalued.

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#3 perceptions about economy: negative

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. The October 2014 estimate is in negative territory and continues trending downwards. The raw measure estimate recorded a tiny increase in October 2014.

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.

The reversal of the raw measure in October, and the fact that it did not fall in the previous month significantly below June 2014 low, rise expectations that the outlook for the Australian economy may be stabilising and that perceptions will not deteriorate much further. 

Nevertheless, gloomy perspective on the future still prevails and property prices cannot be expected to advance strongly in such an environment.

 #4 demand: weakening as trend has changed

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 updated September 2014 PHCI estimate is positive but the turn downwards is now almost certain (final reading of this indicator will be confirmed next month). This is a very strong negative signal indicating change in the underlying demand for properties.

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.

A positive but declining value of PHCI indicates that credit uptake is slowing down and therefore, that the underlying demand for residential property is softening.

#5 property price expectation: growth to slow further

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 did not increase in August 2014 and continue to record value well below HPI.

The PPG is almost flat since June 2014 and changed very little since March 2014, implying that the previously experienced price growth is not sustainable and that prices are vulnerable to sudden halt at current level, or even a small reversal.

Historically, when PPG diverged from HPI over a longer term, this pattern preceded a period of increased turbulence in the Australian property market (as was the case in 2003 and 2007). The likelihood of the same scenario playing out in coming months is high if PPG does not move higher soon (for example, as in 2006 or 2013). 

# 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: State of the Property Market, April 2014. 

Arek Drozda is an independent property market analyst.