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All is not as it appears

I remain optimistic about the potential total returns from good investments in housing but there is a converging set of circumstances which mean that we need to be well-researched before we make our investments and we need to take particular care about our debt level.

We are entering a period where we must be in control of our long term decision making process. It is clear to me that if we invest correctly and in the right area we are going to do very well indeed but the investment will probably not be in the traditionally accepted good investment areas.

If you pick up any newspaper today you could be forgiven for believing that a housing “boom” is taking place. We have TV programmes being taken out of “old boxes” and given life again based on this positive view. On the surface when looking at aggregate numbers it does look as if we are in the midst of a very strong market growth phase and some areas are certainly doing well.

Many of our newspaper reporters and property “expert” commentators have not previously reported on or seen a market where auction clearance rates and aggregate capital growth numbers are as strong as they are now. This naturally, will lead them to be particularly optimistic.

Our Reserve Bank is not receiving disaggregated numbers and hence is probably not aware that there are sections of this market which are losing value or doing very poorly. Further, there has been in a number of their reports, discussions about high auction clearance rates and suggestions that these have been taken into consideration in their decision making process.

I would caution that while auction clearance rates do tell us something about market conditions they do not tell us (with the exception of Victoria) what the total market activity is. We should not read too much into them and all should remember that in most markets less than 20% of all sales go to auction and the lower cost properties have a very low tendency to be auctioned.

Further, clearance rates in the 70% range are not reflective of anything other than a normal market. A “boom” market will see consistent clearance rates of better than 85%.

res - changing lending margins may 2010.jpg

I am left wondering if the Reserve Bank had in its possession all the information that I have, whether it would be so aggressively moving interest rates up.

This is occurring also at a time when our Banks are lifting their lending margins due to their increasing cost of funds. (See Table 1 ‘Changing Lending Margins’). The margin has not been as high for about 15 years. The net result is that our home loan interest rate is quickly placing home borrowers in a highly stressed situation and this is having an impact. Yes, there was a need for the RBA to adjust rates but I fear the magnitude and speed of increase has been too large and too rapid.

So what do the March numbers tell us?

Table 2 March Results

res table may 2010.jpg

On an aggregate basis all capital cities other than Brisbane generally presented home owners with an increase in wealth. Where we have all the positive hype and median increases, there would be few if any suburbs where the median house price was falling in value. The only city in Australia where there is no suburb which is falling in value is Melbourne but some cities are in fact doing quite poorly.

For example, in Brisbane in the last quarter, with more than 53% of all suburbs losing value, while in Sydney more than 20% again lost value.

In our current quarterly Residex Reports for March for each state (to be released this month) there is a listing, suburb by suburb of the last quarter’s result and from this the picture is very clear. Our young families are again suffering. Interest rate increases and the reduction of the First Home Owners Grant are having an impact but the activity in the middle segment of the market is clouding the picture. For example, from the 53% of Brisbane’s suburbs that lost value, 83% have a lower median value than the overall for Brisbane. That is to say, in a more general way, that growth is only being experienced in areas where people are better off than Mr and Mrs Average.

If you look just at the aggregate numbers for the quarter as presented in Table 2 March Results you would have little realisation that so many families are loosing wealth. They too probably are unaware of what is happening other than it is getting tough for them to avoid defaulting on their mortgage.

res - percent suburbs in loss may 2010.jpg

In Graph 1 ‘Percentage Suburbs in Loss’ we display at a decile level the percentage of suburbs in each decile which are in loss. 0.1 is the lowest cost decile while 1 is the highest cost decile. That is 0.1 represents the suburbs which are the lowest 10% of the market and 1 represents the suburbs which are the highest 10% of the market and the Y axis is the percentage of suburbs in the decile which is in loss for the quarter. This graph does take a little effort to understand but it is eventually worth the effort. Melbourne does not feature in the graph simply because it does not have any suburbs in loss (last quarter). Clearly, in each city there is a tendency for the lowest cost suburbs to be the worst affected. These suburbs are where we will find our first home owners and those who have upgraded once. In these low-cost suburbs where one finds the lowest level of equity and highest loan to equity ratios; our most at risk borrowers as home loan interest rates increase.

For a number of months now I have been indicating that the peak of the growth in July 2009 had passed and the markets are now slowing naturally and commenced this process for most markets in Australia before the RBA made its first move on interest rates (October 2009). See Graph 2 ‘Australia House Price Growth’.

res - aust houe price growth may 2010.jpg

However, in both Sydney and Melbourne it was not until they moved that these markets started to slow. Basically this is the problem the RBA has. We have, in particular Melbourne which may be overheating while other states are just behaving normally. The reason is immigration and supply issues.

In the last 12 months to end September, Victoria had a net overseas immigration equal to 1.53% of its population while NSW and Qld had a significantly lower intake of approximately 1.3% of total population. On the surface while the difference is clear the immigration impact is higher than these numbers indicate simply because Melbourne takes 75% of Victoria’s overseas arrivals while Sydney only takes 63% and Brisbane only takes 45% of its state’s intake. Hence the probable basic reason why we see the lowest rates of growth in Brisbane is that demand there will not be as high as fewer arrivals need immediate housing in this city.

To state the obvious; interest rate increases have a dampening effect because they reduce affordability and hence demand. It is the high unaffordability which has kept house prices in Sydney from growing significantly during recent years.

Hence, in my view Melbourne will correct itself without more intervention from the RBA. Currently, if you have a typical household income and a 20% deposit it takes 49.10% of gross household income (based on ABS Census numbers adjusted for changes in average weekly wages) and a very slightly higher number for Sydney being 49.12%. This suggests to me that the exuberance in the Melbourne market will soon slow naturally, particularly given the stricter lending criteria of the banks.

There is little risk of a bubble in other states forming given the position which is being evidenced above. Further hikes in interest rates could significantly increase the chance of bringing about the correction in the housing market which Australia has to date avoided. The real risk for Melbourne is that further interest rate increases can lead to defaults very soon after a period of high growth where many will have paid a higher price for a property than they should have.

This is an abbreviated version of the monthly market update provided by John Edwards of Residex. To read the full market commentary subscribe to their newsletter at  www.residex.com.au

John Edwards is a director of Residex, a leading Australian research organisation providing quality information on the real estate market to government, financial institutions, valuers, real estate agents, accountants, solicitors and individuals. Go to www.residex.com.au



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About

John is Consulting Analyst for Onthehouse, Australia’s most comprehensive real estate portal, and Founder of Residex, a leading Australian research organisation providing quality information on the real estate market to government, financial institutions, valuers, real estate agents, accountants, solicitors and the general public. Visit www.OnTheHouse.com.au


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