Market set to tip in favour of buyers: November 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 December 2014).
  
  
• Purchase affordability is still very high but declining (as at December 2014).
  
  
• Confidence in the economy is low but conditions are not deteriorating (as at November 2014).
  
  
• Housing Credit Impulse points again to a strong demand for real estate (as at September 2014).
  
  
• Prices are vulnerable at current levels, but can be sustained if flow of funds into the market continues (as at September 2014).

National Real Estate Price Forecast

The latest set of statistics paints a more positive picture than initial estimates and preliminary results indicated just a month ago.

In particular, we can see a small improvement in perception about the economy (but this is not yet reflected in the main indicator, only by a row measure), the actual demand for properties turned out to be much stronger than originally anticipated and there was a small but important lift in Property Price Gauge, indicating a notable increase in the flow of funds into the market.

The rebound in several indicators and the fact that prices are still very affordable, signal that the market remains relatively strong.

However, we will have to wait a few more months for confirmation if the rebound in the indicators is a sign of a return to fast paced growth in prices or just a late sprout of activity that will soon subside.

Without this confirmation, the overall outlook for the Australian property market remains at a neutral level and unchanged from previous month.

Detailed Analysis

#1 optimal accommodation choice: renting still the more favourable option

The Buy-Rent Indicator (BRI) identifies how cost of buying is changing in relation to cost of renting.

The September 2014 BRI final value is higher than in previous quarter, confirming that buying costs are growing faster than rental costs. However, the first estimate of BRI for December 2014 quarter points to a likely reversal of this trend.

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 BRI shows that renting is currently still a more attractive option than buying. The reversal of the direction of the indicator is a result of the recent slowdown in the growth of national property prices and hence, the slowdown in the growth of purchasing costs. At the same time, the rental costs continue to increase at a steady pace.

In a market where purchasing costs are rising primarily due to price increases, the optimal point for selling a property is when the indicator peaks and then starts to decline.

Based on the previous behaviour of this indicator, the peak of the current cycle is anticipated to happen before the end of 2016.

If the currently observed change in trend is confirmed in the next few months, it would indicate that the fast price growth phase of the cycle has ended. The December 2014 quarter will therefore mark the end of the “seller market” and the beginning of “buyer market” conditions.

#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.

The December 2014 PAI estimate points to a continued, gradual decline of the indicator.

This indicator explains that, relative to incomes of Australians working full time, property prices are still very affordable.

Since the cost of buying a median priced property relative to average income is significantly lower than in the late 1980s, there is still a lot of room for prices to move before Australian real estate can be considered overvalued. 

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#3 perceptions about economy: still 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 November 2014 preliminary value is in negative territory and continues trending downwards. The raw measure recorded a small rise for the second consecutive month.

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 a small uptick in November 2014 are positive signs, giving hope that perception about the Australian economy has started to improve, or at least, that it is not deteriorating any further.

However, the overall outlook for the economy is still fairly negative and property prices cannot be expected to advance strongly in such an environment.

#4 demand: much stronger than indicated by original estimates

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 preliminary reading is much stronger than the last month’s estimate and this latest update did not confirm the previously reported reversal in the direction of the indicator. That is, the PHCI value has actually increased, not declined. However, the increase is very small.

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.

Housing credit data for September 2014 was very strong which impacted on the overall result for the quarter.

It implies that, after an initial slowdown in July and August, buyers have returned in force in the last month of the quarter. Therefore, the underlying demand for residential property is actually much stronger than initial estimates suggested.

Nevertheless, the increase in PHCI is only marginal which does not give confidence that this high level of demand can continue unabated beyond the December quarter.

#5 property price expectation: further growth possible but at risk

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 increased slightly in September 2014, more than in the previous several months, but the indicator continues to lag well below HPI.

A noticeable increase in the value of the PPG points to a possible resumption of an upward trend after several months of relatively flat results. While it is a positive sign, there would need to be a much stronger upward movement in the indicator in the coming months to confirm that the flow of money into the market is substantial enough to support further growth in prices.

Otherwise, the previously experienced rate of price growth is not sustainable and prices will be vulnerable to a sudden halt at the current level.

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.