The hard facts about property's softening outlook

There's not much cheer in BIS Shrapnel's property outlook, with only Sydney and Brisbane set to record price growth in the next three years. But there may be a glimmer of hope for younger buyers.

With economic conditions slowing, the property market is poorly placed for price growth over the next couple of years. Recent forecasts by BIS Shrapnel provide a glimpse of what could be in the pipeline for Australian homeowners and investors.

For much of this year I have cautioned readers against becoming too optimistic regarding Australia’s property market, noting that the high level of speculation in Sydney and Melbourne is unsustainable. Combined with negative real wages, falling consumer sentiment and falling investment, it is hardly a surprise that the housing market has lost some momentum over the past few months.

I am hardly alone in my pessimism. BIS Shrapnel released their outlook for residential property yesterday and it won’t make for pretty reading for most homeowners, particularly recent buyers. But, if BIS Shrapnel is correct, the housing market may become a little more affordable for younger Australians.

I should note from the outset that forecasting the housing market is particularly difficult. When I do so I typically focus on shifts in the market’s momentum and whether growth will be strong, moderate or in decline. By comparison, BIS Shrapnel has provided estimates of the growth they expect to see over the next few years.

Over the next three years, BIS Shrapnel believes that only Sydney and Brisbane will experience house price growth after adjusting for inflation. In Sydney, prices are expected to climb over the next two years before declining in 2017, resulting in a nominal gain of 10 per cent over the three years (or a 1 per cent real gain).

Brisbane is expected to be the boom city, with BIS Shrapnel forecasting nominal growth of 17 per cent or around 8 per cent after accounting for inflation. Both Sydney and Brisbane are expected to be underpinned by tight housing supply.

The Melbourne market continues to face a number of challenges, including a subdued manufacturing sector, and property prices are expected to rise by just 8 per cent in nominal terms, which amounts to around a 1 per cent decline in real-terms.

Economic conditions in Adelaide will continue to be quite challenging and that will be reflected in their housing market. BIS Shrapnel believes that rising construction -- driven in part by the generous first home owner grant for new construction -- will combine with a soft underlying growth to produce a fairly subdued property market. They are predicting nominal growth of just 5 per cent over the next three years, or a 4 per cent decline in real terms.

Activity in Perth is expected to progressively slow over the next few years as mining investment falls sharply, impacting employment and income growth. As a result, BIS Shrapnel is forecasting that median nominal house prices will rise by just 3 per cent over the next three years, or a decline of 6 per cent after adjusting for inflation.

Finally, each of Hobart, Canberra and Darwin are expected to have nominal price growth in the order of 3 to 4 per cent, or a decline of 5 to 6 per cent after accounting for inflation.

So the big question for readers is whether this outlook is plausible. The answer is yes, particularly once you look at trends over the past decade where falling real prices have been the norm following a ‘boom’ period.

Australians may be conditioned to believe that property always goes up but that view is fairly removed from reality, with each capital city experiencing a strong cyclical element over the past decade. 

Graph for The hard facts about property's softening outlook

However, based on past growth trends BIS Shrapnel may be a little optimistic. The peak-to-trough decline for real house prices can often be quite protracted, taking more than a few years to shake out. BIS Shrapnel’s outlook would actually represent a fairly soft downturn given what we’ve seen over the past decade.

The biggest risk is probably Sydney, mainly because the current boom has been driven largely by speculative behaviour. Low interest rates have encouraged investors to bring forth their purchases and I’m concerned that investor demand may eventually become exhausted, leaving little activity to prop up the Sydney market.

I also differ with BIS Shrapnel with regards to cash rate expectations. I expect the RBA to cut rates since it is becoming increasingly obvious that the household sector will be ill-equipped to keep the economy ticking over when mining investment collapses. By comparison, BIS Shrapnel expects rates to begin rising next year.

A weaker cash rate assumption implies softer economic conditions and by extension a larger decline in property prices. But that effect is partially offset by a boost to household’s purchasing power, arising via lower interest rates, and that could reinvigorate the housing market to some extent.

BIS Shrapnel has presented a fairly weak outlook for property prices -- my outlook would be a little softer again -- but readers shouldn’t be too focused on the numbers themselves. The overriding concern should be the Australian economy, which remains quite subdued and is set to remain that way over the next few years. These are not conditions that will be conducive to strong housing activity and in that regard, readers should take BIS Shrapnel’s warnings quite seriously.

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