House prices: Has the first domino fallen?

Whether you think the economy desperately needs rebalancing through lower rates and a lower dollar to avoid a recession, or not, I think there is one thing everyone can agree. The broad spread of available data suggests that record low interest rates aren’t having much of an effect  (See my note of 24 May: Has Monetary Policy lost its oomph?) . Indeed the NAB business survey on Tuesday showed that despite the 200bp worth of easing and a 12% slump in the dollar, business conditions got worse in June.

Now we have to remember that it’s very rare to see a slow and orderly change in any market dynamic. It doesn’t work that way and readers may remember the experience of 2009. One minute we’re all talking about a recession, and the GFC is still very much in play. The next thing you know house prices shoot up 20% in the space of a few quarters. And that’s exactly what happened.

We’re not at that point obviously, and recent house price data shows that the average dwelling price growth for the 8 major cities was just 0.2% in the June quarter . This included a 1.9% monthly gain in June, and only managed to offset a 1.7% fall over April and May (according to RP Data Rismark). That’s not great, but it’s not bad.                                                                                                                                                                                                                                                                                                                                                                                                                                              It Gets you thinking though. I mean when we look abroad and see some of the results in the US and more recently in the UK, the housing market in both of these countries is bouncing back  - and with gusto in the US. Sure, the US experienced some serious house price falls, but those figures are distorted by foreclosure sales which instantly went out at discounts of 30-50% - before the haggling began. Now we find that many of the major cities are recording double digit house price growth, some the fastest on record, maybe that reflects in part dwindling foreclosure sales, but it’s very good momentum considering the US had a housing bubble in the true sense. Price and construction.  With no major headwinds in Australia (interest rates at record lows, low debt levels, two-thirds of households with no meaningful debt, low unemployment rate) it must only be a question of time before our market too undergoes its own renaissance - confidence the only headwind.

In that regard, I’m left wondering if maybe the first domino has fallen.

Chart 1: Major capital city house prices

Click to enlarge

Source: Australian Bureau of Statistics

Consider the backdrop. House prices in general, and apart from that spurt in 2009-10, haven’t done much over the last four years or so.  In fact on average they’ve fallen a bit. You can see that in chart 1 above, which also shows things on a longer time frame - the last decade or so. Very strong growth in Perth, basically doubled, which is the same in Hobart and Darwin. Then for Melbourne they’re up about 1.9 times with increases of a similar magnitude in Brisbane and Adelaide. Sydney meanwhile lags, with prices up just 1.3 times. So for the decade you’re looking at gains of only 3% or so per year in Sydney while the other cities have had gains varying from 8-17%. Double annual digit growth in Perth, Darwin and Hobart.

For the larger cities that’s actually quite subdued house price growth when you consider that disposable incomes over that period have doubled, or increased at an annual rate of about 10% per year. Income growth has exceed house price growth in nearly all the major cities except Hobart. Darwin and Perth.  Now this is just over the last decade and many people would point out that over an even longer time period, say 15-20 years, prices have out-run income growth but a significant margin and this is true. But keep in mind there was a significant structural shift which drove that - the move to a lower interest rate environment.  Interest rates have been markedly lower and access to debt markedly easier which has allowed structural shift in the amount of debt that people can accumulate and service.  Noting that one-off structural shift, the important point is that house prices have been running below income growth for about a decade.

Take Sydney’s market for instance. It’s shown a solid bounce in prices for the June quarter - up 1.2% - with a 2.7% increase in June alone. That’s consistent with what we are seeing in auction clearance rates - up around the 77% mark which is well above the national average of 64%. To that, I’ve got my own personal anecdote to add: now I’m very wary of using personal anecdote to extrapolate a national trend but my personal experience is consistent with the national aggregate data.

Living in Sydney and having just purchased another property, I’ve got first-hand account of how this market is changing. My observation is that that there has been a fairly rapid lift in prices over the last year - over the last six months in particular. We watched that momentum build. Too frequently we were looking at sales results in our catchment and just shaking our heads each time - at the prices. But it gets to the point when you’re doing that each time, that you have to reassess your estimate of fair value. And we had to do that by a good 10-15%. What we thought were one-off prices paid by emotional buyers ended up being reflective of the actual market. Many properties weren’t even lasting a week before selling pre-auction.   And this is in a market with no confidence. What’s it going to be like when confidence comes back in full?

There is no doubt that it’s an emerging sellers’ market, at least in Sydney, and I don’t think that’s going to really change too soon. Indeed it’s likely to get worse when confidence picks up. Consider that there isn’t a lot of stock at the moment and as Alvin Pontoh wrote in a good piece last week (Housing recovery around the corner), that’s unlikely to change too much in the near-term. Even with a pick-up in housing construction as indicated by approvals, it’s just not enough.  Demand however is growing as the auction clearance rates show. I’ve attended many this year and they’ been well attended and very well bid. And why not? Interest rates are at record lows.

Moreover I can’t really see this being an isolated event in my catchment. Sydney has certainly underperformed, but it’s not the only city to have income growth exceed house price growth - it's a national trend and that should mean house prices should accelerate at least to match income growth if not to exceed it.