The property data that can help you get a better deal

New research indicates auction results can be used to predict future dwelling prices, providing buyers with valuable insight about whether auction or private treaty is their best bet for a bargain.

The Reserve Bank of Australia has kept fairly tight-lipped about the housing market this year, with officials offering a few minor comments but generally steering clear of saying anything controversial. But housing is clearly on the central bank's mind -- three research papers on property have been released this year alone -- and its research team has taken important steps in understanding Australia’s $5 trillion property sector.

Back in July the bank released a paper -- written by economists Ryan Fox and Peter Tulip -- which, among other things, basically said that Australian property is significantly overvalued unless capital growth replicates its performance over the past sixty years (The great Australian housing rip-off, July 15).

The paper released last Friday is not as controversial and certainly won’t get the same press coverage but it’s definitely an interesting read. The new work -- authored by economists David Genesove and James Hansen  --  explores the interplay between auctions, private treaties and house prices.

It finds that auction prices “can be used to predict both private-treaty and average dwelling prices” and including auction prices in models can reduce the forecasting error for Melbourne and Sydney house prices by 10 per cent and 18 per cent, respectively. Private-treaty prices offer no such insight into future prices.

That’s nothing to sneeze at, particularly when you consider the importance of housing to bank balance sheets, household wealth and the broader Australian economy.

The results are fairly remarkable -- a sentiment shared by the authors -- since auctions accounted for just 12 per cent of Sydney property sales and 17 per cent of Melbourne sales between 1993 and 2012. The number of auctions is typically too low in the other capital cities to be included in this type of analysis.

Graph for The property data that can help you get a better deal

So what’s going on here? How can such a small segment of the market offer such insight into future prices?

To start with we should consider what happens at an auction. An auction gathers together potential buyers and the final sale price typically incorporates some information from every buyer who makes a bid during the auction. Buyers dynamically alter their valuation of the property based on the bidding of other people.

A private-treaty sale, by comparison, is the complete opposite: in a simple bilateral purchase, the only available information comes from the buyer and the seller. A private-treaty sale is a little like a blind auction with a single bid and it’s hardly surprising that the final price may not reflect the fair value of the property.

According to the researchers, an auction places a relatively higher weight on buyers’ valuations. Beyond setting the reserve, the seller is largely irrelevant to the final price. By comparison, for a private-treaty it is the relative bargaining strength of the buyer and seller that determines the sale price.

By virtue of better reflecting available information, an auction is more likely to result in a price that reflects the prevailing fair value of the property. An auction is also less likely to be affected -- positively or negatively -- by temporary or transitory factors that may affect the price in a private treaty.

Although this goes beyond the scope of the paper, the research implies that buyers and sellers should take a different approach depending on the state of the property market.

During a boom, sellers should take advantage of auctions since they will incorporate the higher price expectations more quickly than a private sale. But when prices begin to decline, a seller may end up better off by avoiding auctions altogether.

The opposite is true for buyers. When prices are rising rapidly, a private-treaty sale is your best bet to get a bargain. When a correction arrives, the downward shift in expectations will be felt in auction markets long before private sellers are willing to compromise on their expectations.

Finally, I’ve no doubt that market analysts will be particularly interested by the RBA’s findings. Unfortunately, taking advantage of their research requires a little more effort than simply taking the median or mean auction price from the weekly reports from Australian Property Monitors or RP Data.

The RBA used a complicated hedonic process -- which controls for monthly changes in household characteristics such as the number of bedrooms and bathrooms, size of the dwelling and its postcode -- to model the average auction price. That won’t be possible for the average real estate agent or market analyst but it is the type of data that RP Data could potentially produce if there was enough interest.

Reporting on the auction market is often misleading -- the media has a nasty habit of focusing on hugely unreliable preliminary estimates of the auction clearance rate -- but the market itself contains a treasure trove of information on housing market conditions.

Despite accounting for a tiny share of total property sales, average auction prices can be a useful leading indicator and forecasting tool for house prices in Sydney and Melbourne. By comparison, private treaties -- which account for between 80 and 90 per cent of the market in our two largest cities -- offer no such insight. 

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