The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Thursday, September 30, 2010

Housing market’s soft-landing secure

In news that will doubtless please policymakers, the desired soft-landing in Australia’s housing market looks to be secure with the robust capital gains of 2009 and the first quarter of 2010 well and truly behind us.

In the month of August the seasonally-adjusted RP Data-Rismark Capital City Home Value Index fell by 0.2 per cent. On a non-seasonally adjusted basis the index remained unchanged in August. Since the housing market’s peak in May 2010, the RP Data-Rismark Capital City Home Value Index has declined by 1.2 per cent (raw and seasonally-adjusted). Over the year to end August 2010, capital city home values have risen by 8 per cent. The median dwelling price in all capital cities is $457,000 based on the three months of sales to end August.

RP Data-Rismark’s Hedonic Index leverages off Australia’s largest real estate database, which has recorded 235,799 dwelling sales in 2010 alone. The most recent (or ‘indicative’) month’s index results are typically based on up to 40-50 per cent of the final sales volumes. The index estimates may then revise as more sales data is collected over time.

In the ‘Rest of State’ markets, which cover the 40 per cent of homes not located in capital cities, the RP Data-Rismark Hedonic House Value Index was unchanged (0.0 per cent) in August (raw and seasonally-adjusted), following a 0.4 per cent seasonally-adjusted decline in July. Since the RP Data-Rismark Rest of State Index’s peak in April 2010, it has fallen by 0.5 per cent seasonally-adjusted (or 1.5 per cent in unadjusted terms).

Over the 12 months to end August 2010, house values in the Rest of State markets have appreciated by just 3.7 per cent. This undermines the myth peddled by The Economist and others that Australia’s housing market has recorded 20 per cent annualised growth rates since the end of the GFC. Accounting for all homes across Australia (ie, not just the capital cities), annualised capital growth has been in the high single-digits since December 2008 (refer also to the chart below).

Across all Australian regions, the national median dwelling price in the three months to August was $410,000, which represents a decline over the $415,000 median reported in July. (Note: medians should not be used to measure changes in value over time.) This presages a fall in the upcoming third quarter stratified median index values reported by APM and the ABS, which lag RP Data-Rismark’s results.

Rental yields across the capital cities are unsurprisingly showing signs of improvement given low vacancy rates and the freezing of capital gains. RP Data-Rismark estimate that the gross yield on capital city units is 4.9 per cent while for detached houses it is a lower 4.0 per cent.

After outperforming during 2009, home values in the top 20 per cent of suburbs ranked by price have fallen by 2.7 per cent since March 2010. This contrasts with a tiny -0.1 per cent decline in the middle 60 per cent of suburbs and a 0.1 per cent increase in the cheapest 20 per cent of suburbs. In short, 80 per cent of Australian suburbs have realised no capital growth at all since March 2010 while the top-end has corrected materially from its highs.

For some time Rismark has stated that it did not expect any further capital growth in the second half of 2010. Recent data vindicate this thesis. In the first seven months of 2010, capital city dwelling values accreted by 4.8 per cent in raw terms, which is in line with consensus expectations for disposable household income growth.

Futures market pricing for interest rates has changed dramatically over the last month, shifting from expectations of rate cuts to at least two hikes by end 2011. But following hawkish RBA remarks, economists are now predicting that we may get four to six cash rate hikes. We’ve modified our views accordingly.

If the looming resources boom combined with frisky household behaviour compel the RBA to lift its target cash rate four to six times by end 2011, we would expect to see nominal dwelling values decline modesty. This is not a bad thing. Asset prices cannot always rise—the volatile sharemarket regularly subjects investors to savage swings. As I discussed earlier in the week, since 1993 there have been five instances when the RBA has lifted the cash rate sharply. On every single occasion national capital city dwelling prices have flat-lined or declined (see chart). If the RBA aggressively raises rates, there is no reason to think 2010-11 will be any different.

We would also emphasise that borrowers applying for loans today should be prepared to service rates that are 1.5 per cent higher than what they are currently paying. They can, however, take some comfort from the fact that the peak rate is unlikely to endure for too long, and the ‘through-the-cycle’ headline mortgage rate should average between 7-8 per cent (before discounts).

To the extent that default rates and distressed sales tick-up a little during the RBA’s tightening cycle over 2010-11, attractive opportunities may present themselves to patient buyers. But investors should not budget for long-term capital gains in excess of disposable household income growth. They should also always bear in mind that gearing up amplifies the risks to which they exposed.

Where possible, home owners should use less debt and more equity.