Growth slowing but no sign that cycle has peaked: June state of the market analysis

GUEST OBSERVATION

Market Outlook: downgraded to neutral

• Renting has just become more attractive accommodation option than buying (as at June 2014).
• Purchase affordability is at a historically high level but the downward trend is now apparent (as at March 2014).
• Confidence in the economy has just turned negative (as at June 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 but only marginally (as at April 2014).

National Real Estate Price Forecast

Growing pessimism about the state of the economy has the potential to start impacting on demand.

We can therefore expect a period of slower growth, or even stabilisation, in property prices in June and September 2014 quarters.

There is no indication as yet that the prices have peaked in the current cycle so, the slowdown may only be temporary.

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 has just crossed the equilibrium line.

This indicator is constructed based on a simple concept that renting and buying are substitute accommodation options, hence the optimal choice depends on which 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 the market where property prices are rising, this marks the point in time when opportunities to purchase a property at attractive prices may be all but exhausted in the current cycle. Prices are expected to continue on the upward trajectory from this point onwards which will cause buying costs to rise further in relation to rental costs.

#2 purchase affordability: at a historically high level but declining

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, comparable to that reached in 2009 or 1994, but is steadily declining from a peak reached in September 2013.

This indicator explains that, relative to incomes of Australians working full time, property prices are still very affordable. In the past 30 years purchase affordability was only better between September 1996 and December 2002.

Prices have still a lot of room to move before they can be considered unaffordable.

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#3 perceptions about economy: have just turned 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 has crossed over into the negative territory. A more volatile raw measure is slightly up comparing to May 2014 but is still well within the negative territory.

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.

EWI crossing a neutral line indicates that perceptions of Australians about the state of economy deteriorated to the point that can now be considered negative. In the past this coincided with a rapid slowdown in price growth (with one exception in late 2005) or even with price falls (as it happened in 2008 and 2010). If there is no strong rebound in the indicator, growing pessimism will soon start to affect demand and prices of Australian properties.

#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 over the next two months but 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.

Positive and rising value of the indicator reflects continued strong demand for residential property. Consequently, despite reports of recent falls in daily property price index, actual prices on a national level are not expected to decline in June quarter and the likelihood of falls in September quarter is also very minimal at this stage.

#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 has risen in April 2014 however, the rate of growth is slowing. Actual prices (March 2014 House Price Index) are above of what could be expected based on housing credit growth but the gap between PPG and HPI is narrowing.

Although the current price level appears to be well supported, weaker PPG growth points to softer property prices in the coming months. In other words, prices may stabilise for a while or, if they keep growing, the rate of growth should be more modest than in the last few quarters. 

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.