What’s ahead for our proeprty markets over the next few years?
Sure there have been some wild predictions form the usual property pessimists and even some bizarre ones recently from overseas doomsayers.
Last week respected Moody’s Analytics, a leader in risk measurement and management, and CoreLogic, Australia’s leading property data, forecast that home value growth will likely slow across Australia in 2016, following two years of exceptional home value appreciation and double-digit growth in many areas.
This forecast is based on the new CoreLogic-Moody’s Analytics Australian Forecast Home Value Index, launched today, which provides a quarterly projection of the trend of residential home values across the country over the next 10 years. Forecasts are updated monthly to help market participants identify opportunities and manage risk exposures.
They don’t see a property armageddon ahead
Instead they see accommodative policy, robust rental growth, and a recovering labour market are expected to support valuations over the medium term.
Mining regions, including Perth, the rest of Western Australia, and Darwin, are likely to have downbeat results over the near to medium term.
No price declines are expected in Adelaide, although price growth will underperform the rest of the country for the near to medium term.
The slow transition from mining investment Australia’s economy continues to rebalance away from mining-led investment.
Mining investment has dropped 38% since mid-2013—an annualized $37 billion loss in investment activity, equivalent to 2.3% of GDP—with no trough in sight.
Chart 1: Mining Industry Slumps
High global supplies of commodities have pushed down export prices and weighed on national incomes, and the terms of trade have fallen by one-third since 2011 (see Chart 1).
Unemployment in the mining state of Western Australia rose to 6.4% in the fourth quarter of 2015, up from 3.7% in mid-2012.
Nationwide, unemployment was 5.8% in the fourth quarter, up from 4.9% in 2011.
The relatively small deterioration in employment conditions nationwide may explain why households have been remarkably sanguine about economic conditions:
The Westpac- Melbourne Institute Index of Consumer Confidence has fluctuated between mild pessimism and mild optimism over the past few years (see Chart 2).
That the economy has not succumbed to recession so far is a testament to resilient Australian households, which have bolstered the economy through higher spending, helped by savings built up since 2009.
Household savings—disposable income minus consumption—averaged 9.3% of disposable income in 2009-2013.
Since then, households have dipped into their savings a little—by the end of 2015, the household savings rate had fallen to 8%, representing an additional $3 billion a quarter of spending— and this has blunted the effects of weaker employment conditions (see Chart 3).
Chart 2: Consumers Remain Upbeat
Chart 3: Households Have Savings Buffer
Chart 4: Households Offset Mining Slump
Despite the fall in trade and the decline in Australian export prices, disposable incomes increased a solid, if unspectacular, 2.8% year over year from 2013 to 2015, a cumulative increase of 9%.
This development enabled household expenditure to support the economy, which expanded around 2.3% y/y over 2013-2015 (see Chart 4).
Accommodative policy settings are also abetting the transition away from mining and towards consumption.
The Reserve Bank of Australia has lowered the cash rate by a cumulative 275 basis points since 2011.
This action has lifted credit growth, which was rising 6.8% y/y by December 2015.
Housing has been the biggest recipient of this extra lending and is now receiving 60% of total credit (see Chart 5).
From 2012 to mid-2015, most housing-related lending was for investment purposes, but since then housing investment loans have fallen sharply, while lending for owner-occupiers has surged, most likely a result of macroprudential guidance from the RBA and the Australian Prudential Regulation Authority.
Chart 5: Housing Loans Surge
Strong credit growth—coupled with steady income growth—has kept the housing sector buoyant.
Dwelling prices nationwide rose close to one-third from 2012 to January 2016.
Price growth has been strongest in Sydney and Melbourne.
Building approvals and housing construction have risen to match demand, and this situation has worked to improve employment conditions.
These recent trends make the outlook for housing even more important to the outlook for the broader economy.
With the RBA and APRA maintaining their controls on housing investment lending, and with the drag on national income from low commodity prices persisting, the near- and medium-term outlook for housing is a little more subdued.
Broadly speaking, slower income growth and the anticipated rise in supply when the current tranche of construction is completed will cool house price appreciation nationwide in 2016.
Offsetting this trend are the low cost of borrowing and improving employment conditions.
Moody’s Analytics expects nationwide house values to rise just 1.1% year on year in the third quarter of 2016, down from a peak 10.8% gain in the third quarter of 2015, before a gradual recovery as the economy returns to trend growth.
Of course, this hides considerable regional variation
Table 1: Hedonic HVI Forecasts
Chart 6: Sydney and Melbourne
Chart 7: Perth and Rest of Western Australia
Prices to fall in Sydney in 2016, glut to hit Melbourne for three years
Sydney’s housing market is forecast to cool in 2016, a small recovery in prices in January (0.5% m/m) notwithstanding.
From current levels, Sydney dwelling prices are expected to decline 0.6% by the third quarter, a 2.6% drop from the peak reached in October 2015, before recovering thereafter.
This recovery is predicated on higher income and rental growth and slower growth in housing supply.
Disposable incomes are tipped to fall 0.6% y/y in the second quarter before steadily climbing to 3.6% growth by early 2018.
Similarly, rental growth will slow to 0.9% y/y in the fourth quarter of 2016 and then recover to 1.5% y/y by early 2018.
Slower supply growth—building approvals spiked 61% y/y in the third quarter of 2015, but growth slowed to 8.3% y/y by the first quarter of 2016—is also expected to underpin a recovery in price growth from 2017.
Over the medium to long term (2018 through 2025), Moody’s Analytics expects Sydney house values to rise 4.9% a year in nominal terms versus a 7.3% annual increase over the period from 1982 to the present (see Chart 6).
House price growth in Melbourne is outpacing Sydney’s so far in 2016, and that will remain the case for the rest of the year.
That said, the big gains are over.
Melbourne dwelling prices are expected to rise an additional 2.3% from current valuations through mid-2017.
Thereafter, however, prices are expected to decline on average 0.2% every quarter until early 2019, falling below current valuations.
Dwelling prices will then recover to current valuations in 2020.
It should be noted that this will be in nominal terms; prices in real, inflation-adjusted terms in 2020 are expected to still be lower than current real valuations.
Melbourne’s performance is mostly the result of high building supply.
A cumulative 252,000 dwellings were approved over 2012- 2015 versus 208,000 in Sydney.
Robust rental growth of 2.7% y/y through the forecast period will keep prices from falling further.
Mining areas to endure more pain
Battered by the slowdown in mining activity, house prices in Perth and the rest of Western Australia declined in 2015.
This trend will continue in 2016.
Low commodity prices, coupled with falling incomes and rising unemployment, are the key drivers of the housing slump in the west.
Perth house prices fell 2.7% y/y in the first quarter of 2016 and are expected to fall 2.5% from peak to trough in the second quarter of 2016.
Unlike in Melbourne, prices will mount a modest recovery, rising 4.8% in 2017 after a 0.1% decline for 2016.
This comes as a result of lower supply growth—building approvals fell 18% y/y in the third quarter of 2015—and continued population growth (Perth has Australia’s fastest population growth outside of Sydney and Melbourne).
Conditions for the rest of Western Australia are less positive.
House prices declined 6.4% y/y in the fourth quarter of 2015 and are expected to decline 7% more in 2016 before a small recovery in 2017 (see Chart 7).
Valuations are expected to fall 10.7% from their peak in 2014 to their trough in late 2016.
House price growth in Queensland will be subdued through 2016, but prices will not decline.
Brisbane’s housing market will maintain its out performance relative to the rest of Australia.
Valuations are expected to rise 4.2% for 2016, helped by good rental growth and relatively strong employment conditions in Brisbane.
But slower employment growth in the rest of Queensland will weigh on its housing market, with values forecast to rise just 1.7% in 2016 following a subdued 1.8% gain in 2015.
House prices in Darwin’s volatile market will likely decline further.
They dropped by 3.3% y/y in the first quarter of 2016 and are expected to decline an additional 3.7% in the second.
Falling rents, likely a 2.1% decline for 2016, will push house prices down 1.7% in 2016, compounding a 2.5% decline in 2015.
Strong market in ACT, underperforming Adelaide
Housing markets in the Australian Capital Territory and Hobart are set for robust growth.
Incomes in the ACT fell 9% from 2013 to the middle of 2015 as fiscal austerity cut government officials’ incomes, but they have been growing moderately since.
Moody’s Analytics forecasts a steady recovery in incomes through 2017 to historical trends.
Chart 8: Other Capital Cities
Chart 9: Rest of State Regions
Therefore, ACT house values are expected to rise 5.3% in 2016 after a dismal 1.9% gain in 2015 (see Chart 8).
House prices in South Australia tend to be volatile.
They declined from 2011 to 2013, possibly because of the decline in manufacturing across the state.
Structural changes in South Australia’s industries mean that income growth is likely to underperform that of the rest of the country.
Thus, house price growth will likely similarly underperform, expanding by just 0.3% in 2016 and 2.8% in 2017.
Steady gains in service sector employment should ensure a stable, albeit unexciting, market (see Chart 9).
Which markets are overvalued?
The Moody’s Analytics error-correction structural approach to modeling housing dynamics also provides a way to estimate a fundamental value of housing, based on incomes, rents, and the employment-to-population
Deviations from this trend represent estimates of over- or undervaluation.
Chart 10: Over-/Undervaluation
It should be noted that estimates of overvaluation do not necessarily imply expectations of house value declines and vice versa.
Although the error-correction framework assumes that house values will revert to fundamental values, the path will not be straightforward.
Estimates of fundamental house values will change over time as forecasts of income growth, interest rates and rental growth change, and that could raise or lower the fundamental value of housing to meet actual valuations.
For example, Sydney dwelling prices surged 55% from 2000 to 2005.
Prices exceeded the Moody’s Analytics estimate of fundamental value and were 38% overvalued by late 2003.
This did not mean that prices were to fall 38%, although they did decline by 6.4% from early 2004 to late 2005.
House prices moved closer to fundamental value because the fundamental value of houses in Sydney rose 20.4% from 2000 to 2005,driven by strong income growth,which rose by one-third over the period.
As of February 2016, house prices nationwide are 5.9% overvalued relative to fundamental values (see Chart 10).
The biggest driver of this overvaluation is the housing market in Melbourne, which is more than 23% above the Moody’s Analytics estimate of fundamental value.
House values in Melbourne have appreciated far beyond what income and rental growth suggest is appropriate.
This underlines the Moody’s Analytics forecast that Melbourne’s housing market is set for a period of near-stagnation while incomes, rents, and the employment market catch up with actual housing values.
House prices in Sydney are closer to fair value than Melbourne’s, although they are still 9.5% overvalued in aggregate.
This smaller estimate of overvaluation is the result of Sydney’s stronger employment market.
Expectations of stronger fundamental drivers can mitigate current over- or undervaluation.
For example, although the ACT housing market is considered 14% overvalued based on current fundamentals, expectations that incomes will rise based on freer government spending means that fundamental values are
expected to catch up to current values.
The CoreLogic-Moody’s Analytics hedonic HVI model can also illustrate the effects of hypothetical shocks.
One presumption is that Australia’s housing market is supported by the low interest rate environment, the implication being that higher interest rates would hurt housing valuations.
Chart 11: Higher Rates, Lower Valuations
To test this, Moody’s Analytics ran the model with an assumption that the RBA cash rate would jump to 4.5% in the second quarter of 2016 from its current 2%.
As expected, higher interest rates lower fundamental valuations.
Table 2: House Price Valuation Relative to Fundamentals
This has the effect of raising the degree of overvaluation in house prices (see Table 2).
If the cash rate rose to 4.5%, Sydney house prices would be considered close to 20% overvalued.
House prices nationally would be considered 14.2% overvalued.
Price growth would slow sharply, and house prices under normalised interest rates would languish around 4.5% below baseline levels (see Chart 11).