The fallacy of property market predictions

If there is one thing I have learned over the years it is to try avoiding making too many near-term predictions, because they are so often hopelessly wrong.

In mid-2011, for example, due to a mirage of inflation we believed that interest rates were heading higher (they were cut repeatedly by 175bps).

In the past few weeks we heard that the stock market “party” was over (the Dow immediately strapped on the after-burners and ripped upwards to all-time highs) and that the Aussie dollar was about to break below parity (cue instantaneous rebound)…

We can produce every chart and technical signal under the sun, but the best that most of us can really hope for is to identify prevailing trends to see whether we can learn anything worthwhile from them.

I noted earlier that RP Data’s property price index has seen prices moving up for the past 9 months.

Today, I’m going to look at a few macro trends to see whether we can establish what might happen in the housing market over the coming months.

 1. Auction clearance rates

Source: rpdata.com.au

Not quite at boom-time levels just yet, but not too far away in some cities. And the trend has clearly been up as the effect of the aforementioned interest rate cuts and low fixed-interest yields flow through in full.Clearance rates in Sydney and Melbourne have been very strong in recent weeks.
Resurgent clearance rates can lead to something of a self-fulfilling herd mentality, of course. Higher auction clearance rates may lead to panic buying and a FOMO (fear of missing out) rally, which in turn leads to more buyers diving which can and appreciating sales prices. Auction clearance rates are to some extent impacted by…
2. Low interest rates

Source: asx.com.au

The cash rate was kept on hold at just 3.00% yesterday, but the yield curve continues to show that rates could yet fall to record lows of 2.75% or below. The inversion of the curve was flattened a little by the solid GDP result.

But inflation still appears benign and affords the RBA room to cut should further easing be deemed necessary, and the non-mining sectors of the economy remain indisputably weak.

My fair-natured buddy Catherine Cashmore has written recently about the tenuous link between interest rates and dwelling prices.

The dropping of interest rates close to the ‘zero-bound’ is indicative of a sick or a weakened economy and by no means do low rates ensure higher dwelling prices (as evidenced in many countries employing a ZIRP in recent years). Indeed, the converse may often hold true – interest rates are sometimes high when inflation is high and property prices are flying.

 However, it would be accurate to say that in some cases lower rates and cheap credit can stimulate demand and lead to higher prices. In Australia, notes RP Data, close to 60% of apartments are owned by investors, in part due to the capital city entry prices thereof being lower than those of houses.
Capital city apartments close to the media’s beloved median price are likely to be a more interest rate sensitive sector than certain other sectors of property markets.

Notably with regards to interest rates, if both stock valuations and dwelling prices continue to appreciate at the rate they have been over the past three quarters, it is likely that this would preclude further interest rate cuts in this cycle.

But whether or not the cash rate falls lower, mortgage rates are already at very low levels and bank competition for business could potentially see them decline yet further via out-of-cycle cuts. Continuing demand for property is partly being fuelled by…

3. Population growth

We are experiencing very strong in the four major capital cities and this is forecast to be so by the ABS for more than four decades into the future:

To deal with the rapidly growing population, Australia needs strong…

4. Dwelling construction and approvals

It is hoped that construction will pick up to plug the gap left by the forthcoming (imminent?) peak in mining investment. Any dramatic such increase has not yet transpired, which in itself could maintain an effective lid on interest rates.

Approvals for apartments have increased year-on-year (although they have declined in some parts over recent months), but are still some way short of where they might be. In any case, approvals don’t solve the problem of …

 5.  New house sales

These have picked up a little over the last couple of months but as measured on a historical basis, new house sales figures are diabolical, particularly in states such as New South Wales (rolling annual figures down from ~40,000 at the turn of the century to just ~10,000 according the HIA).

New house sales in other states such as Queensland, South Australia and Victoria are also desperately weak.

Why is this? Presumably largely due to the prohibitive cost of new dwellings and particularly houses.

Many homebuyers and many investors have identified that existing dwellings may offer superior ‘value’ and thus are likely to be drawn towards the limited supply of existing stock. Choked supply and high demand results in low vacancy rates in existing dwellings, and further to…

6. Expensive rents

Rent levels vary depending on the city or region, but in many areas of low vacancy rates rents have been blasting ahead of inflation for years now. Higher rents can cause those leasing to consider buying, and the first thing they are likely to consider is…


7. Affordability

Ah, “affordability”: one simple little word which is always guaranteed to generate a headline, and one which commonly attracts no little vitriol. It is well known that, just as in most of the world’s major cities, house prices in the popular suburbs of Australia’s main capital cities are not “affordable” on just about any metric you may care to mention. That is not something which is likely to change any time soon (or, in fact, ever).

 

With mortgage rates now available from an incredibly low 4.79%, however, apartment prices are (generally) relatively affordable in terms of today’s repayments (“the best affordability in a decade!” we are reliably informed).

This may or may not continue to be the case as and when interest rate easing cycle reverses, but that particular ‘can’ is likely to be kicked well down the road.

Take the example of Australia’s most expensive metropolis: Sydney. RP Data records the median apartment price in that city as having jumped by around 5% in the past 12 months to $475,000. With low-rate mortgages so freely available and buyers clamouring for a choked supply of quality apartments, is it any wonder?

Even if you hold an 80% mortgage against a median priced apartment in Australia’s most expensive city, the interest component on, say, a mortgage charged at 5.00%, has fallen to just $19,000 per annum.

 I don’t have a comprehensive data set to substantiate the following point, but my own experience tells me that, in these heady days of rat-wheel capitalism, Sydney’s aspirational inner suburbs have a proliferation of two-income households which fuels higher prices.

Trends to look out for…

Interest rates (and correspondingly, mortgage rates) look set to stay close to record lows for quite some time to come yet. Watch out for high auction clearance rates causing an increase in the price of properties close to the median price over the coming months.

This may eventuate is hot sectors of the market such as Sydney’s Inner West or in parts of Perth, but is unlikely where there are a glut of apartments such as in the ACT.

Strong price growth will only occur in areas where demand is outstripping supply.If rising prices do eventuate then the RBA may soon be forced to pull the handbrake/take away the punchbowl/insert clumsy metaphor here…



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Pete Wargent

About

Pete Wargent is a Chartered Accountant, Chartered Secretary and has a Financial Planning Diploma. He’s achieved financial freedom at the age of 33 - as detailed in his book ‘Get a Financial Grip – A Simple Plan for Financial Freedom’. Pete now manages his investment portfolio, travels and works as a consultant in the finance industry from time to time. Visit his blog


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