Pessimism threatening further price growth: July state of the market analysis

GUEST OBSERVATION

Market outlook: neutral with negative bias.

• Renting is the more attractive accommodation option over buying (as at June 2014).
• Purchase affordability is at a historically high level and steady (as at June 2014).
• Confidence in the economy continues to deteriorate (as at July 2014).
• Housing credit impulse is still growing, indicating continued demand for residential real estate (as at June 2014).
• Actual prices are above what could be expected based on housing credit growth, although only marginally but the gap is not narrowing (as at May 2014).

National Real Estate Price Forecast

Pessimism about the state of the economy is threatening further price growth, despite purchase affordability remaining at a historically high level. Subdued growth in the Property Price Gauge in the last few months is the first tangible sign of market weakness.

If this situation prolongs, it has the potential to start impacting on demand and actual prices. We can therefore expect a period of slow growth, or even stabilisation, in property prices in the September 2014 quarter.

The current price level is well supported and there is still no indication that the prices have peaked in the current cycle.

Detailed Analysis

#1 optimal accommodation choice: renting more attractive than buying

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 and continues on an upward trajectory.

This indicator 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 property prices are rising, this marks the point in time when opportunities to purchase a property at attractive prices are limited.

For those intending to sell in the current cycle, it marks a time to start preparing for the sale - the optimal point for selling the property will be when the indicator peaks, which should coincide with a peak in property prices.

If prices continue to advance, buying costs will rise further in relation to rental costs and the value of the indicator will keep growing. However, stagnant or declining prices may flatten that growth.

#2 purchase affordability: at a historically high level, unchanged from last month

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 and June 2014 estimated value has not change in relation to the previous month reading.

Relative to incomes of Australians working full time, property prices are still very affordable. Since purchase affordability is not declining at the moment, the overall support for the current price level appears to be strong. If Australia were to experience a case a mild economic turbulence, property prices would be unlikely to fall by far, if at all.

Prices have still a lot of room to move before they can be considered unaffordable despite some prominent commentators declaring that Australian property market is in a bubble.

#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. June 2014 estimate is in the negative territory and continues to fall. A more volatile raw measure is up for the second month in the row but by a very small margin.

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 are not expected to advance strongly if there is no substantial rebound in the indicator.

If this situation continues, it is also possible that growing pessimism, as implied by this indicator, may soon start to affect demand and prices of Australian properties.

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#4 demand: still strong and well underpinned with housing credit growth

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. Although the current value is revised down from previous month estimate 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.

A positive and rising value of the indicator reflects continued strong demand for residential property. Consequently, market weakness observed on RP Data daily property price index in May and early June was only short lived and prices rebounded strongly in recent weeks. This was the most probable medium term outcome as outlined in the last month’s report.

#5 property price expectation: growth to slow or possibly even 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 almost no change in May 2014. Actual prices (March 2014 House Price Index) remain above of what could be expected based on housing credit growth and the gap between PPG and HPI is not narrowing.

Although the current price level appears to be well supported, a flattening PPG points to softer property prices in the coming months. In other words, unless there is a rebound in PPG growth in June and July, actual prices, as measured by the ABS’s House Price Index, are expected to record only minimal growth in June quarter and remain flat in September quarter.

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.