Market conditions continue to weaken: September state of the market analysis

GUEST OBSERVATION

Market Outlook: unchanged - neutral with negative bias

• Attractiveness of renting as a preferred accommodation option has further increased (as at September 2014).
• Purchase affordability is still very high but declining - it provides support for prices at the current level (as at June 2014).
• Confidence in the economy continues to deteriorate with no signs of improvement (as at September 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 July 2014). 

National Real Estate Price Forecast

The latest indicators provide further evidence of weakening market conditions.  

The pessimism about the economy and the rising purchase costs that detract potential buyers from the market have started to impact on overall demand.

Purchase affordability is deteriorating but it still remains high, providing support for the current price level. Nevertheless, prices are quite vulnerable at present and the prospect of further strong growth is rather limited - and conditional on the return of optimism.

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. The scenario of subdued market conditions, leading to no or small growth in prices, remains the most probable outcome for September and December quarters. 

#1 optimal accommodation choice: attraction of renting 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 buy to rent zone gives a signal that buying costs are starting to rise faster than rental costs.

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.

As outlined in the last report, we are already two years into the current cycle.  The longest uptrend in the last 30 years was 3.5 years in duration, hence current cycle peak in property prices can be expected before the end on 2015.

Unless, of course, this cycle turns into an exceptionally long one - for example, due to historically high purchase affordability, if confidence in the economy improves.

All in all, fast moving prices from this point onwards can lead to a quite dramatic reduction in the demand for properties and, in effect, shorten the overall cycle.

Stagnating or slowly growing prices, which seems to be the more likely scenario, can potentially limit the negative impact on demand as growth in buying costs will be offset to a large degree by rising rental costs. This can delay the peak and extend the duration of the overall cycle.

 #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.

The cost of buying a median priced property relative to average income is now 26.1% lower than it was in 1986. 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 and deteriorating

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 September 2014 estimate is in the negative territory and continues trending downwards.

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.

Actual prices cannot be expected to advance strongly in an environment where a gloomy outlook on the future prevails.

If there is no substantial change in perceptions about the economy, market conditions will be rather soft for the reminder of the spring selling season.

A scenario of subdued market conditions, flagged in earlier reports, has already started to play out in real time - RP Data’s daily price index for five capital cities shows that prices have fallen in mid September from the peak reached at the end of August.

#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 September 2014 PHCI estimate is positive but the indicator has just turned south. This is a very strong negative signal indicating change in the underlying demand for properties. The September value of PHCI is subject to final revision.

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 or flatten

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 recorded a small increase in July 2014 but remains well below HPI.

The PPG is rising but not very strongly. Hence, the support for the current price level is weakening and, as outlined in the last report, this situation can make prices quite vulnerable.

In other words, the fact that PPG cannot move closer to the current HPI level can only imply an underlying weakness in the market and hence, greater uncertainty about the future direction of property prices.

We can already see some tangible evidence of that weakness. In particular, last weekend RP Data reported a reduction in auction clearance rates and their daily index of 5 capital city prices recorded a small decline.

Arek Drozda is an independent property market analyst.

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.