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."

Tuesday, December 7, 2010

Australian Housing Market’s Valuation Improves…Further Deflation Forecast over 2010-11

In good news for prospective home owners, the valuation of Australia’s housing market has improved over the third quarter of 2010. And there is more deflation likely to come.

Drawing on the September quarter ABS National Accounts data combined with Australia’s most comprehensive residential sales database, which captures 100 per cent of all home sales across the country, Rismark finds that Australia’s dwelling price-to-disposable household income ratio has fallen from 4.6 times in June to 4.4 times in September 2010.

Subject to the course of interest rates, Rismark projects that disposable household incomes will continue to grow more rapidly than dwelling prices over the next 6-12 months.

In the 12 months to September 2010, disposable incomes per Australian household rose by 6.8 per cent while the cost of the median dwelling across all Australian regions increased by 6.6 per cent. Australian disposable household incomes have also out-run median dwelling prices over the preceding three years with compound annual growth rates of 5.0 per cent and 4.2 per cent, respectively.

Since September 2003, which roughly coincides with the end of the last housing boom, the cost of housing and incomes have moved almost exactly in lock-step. In particular, the compound annual growth rate in the median Australian dwelling price has been 6.5 per cent compared with 6.3 per cent annual growth in disposable incomes per household.

Australia’s dwelling price-to-income ratio in the September quarter is exactly in line with its average of 4.4 times since the end of the last cycle seven years ago. On this basis, there appears to be little evidence that housing market valuations have become more stretched in recent years, as is commonly claimed.

Unlike other estimates, Rismark’s national dwelling price-to-disposable household income ratio includes:

*Dwellings across all Australian regions (not just capital cities);
*All property types (not just detached houses); and
*The ABS’s quarterly National Accounts measure of average disposable household incomes (not just average weekly earnings), which captures income earned from all areas (eg, labour and investments) and reflects the fact that there is typically more than one income earner per household.

Rismark’s preferred ratio also compares average dwelling prices with average disposable incomes on a per household basis.

The chart below illustrates the change in Rismark’s national dwelling price-to-disposable household income ratio since 1993. For completeness, this analysis compares both average and median dwelling prices across all metro and non-metro regions with average Australian disposable incomes per household.

Rismark estimates that the national median dwelling price based on sales in all regions throughout Australia, and encompassing all detached houses, semis, terraces and units, fell from $418,000 to $405,000 between June and September 2010. The average* dwelling price also declined from $447,994 to $432,954 during this same period.

Rismark has documented a remarkably robust and statistically significant relationship between Australian housing costs and disposable household incomes since 1993 (on a per household basis). The chart below highlights this relationship.

There has only been a brief period between 2000 and 2003 during which Australian dwelling prices have outpaced disposable incomes. Rismark and Australia’s central bank, the RBA, believe this reflects the once-off valuation impact of the structural downward shift in inflation and nominal interest rate expectations after the RBA established a credible inflation-targeting regime in the late 1990s (this regime was practically implemented in 1993 but did not fully anchor long-term inflation expectations until the latter half of the decade).

To demonstrate this point, the next chart depicts the change in Australia’s headline variable mortgage rate since 1980. Observe how the ‘level’ of mortgage rates did not stabilise until the early 2000s. It was presumably around this time that Australian home buyers had greater confidence that the future path of interest rates would remain relatively stable around a much lower 6-8 per cent average rate compared to the far higher rates that prevailed in the 1980s and early 1990s.

Because of the boom in the prices of Australia’s key commodity exports, such as iron ore and coal, the nation is benefiting from a large income shock. This is reflected in the striking differential in the real gross national income (GNI) and real gross domestic product (GDP) growth rates over the last year. In the 12 months to September 2010 real GNI rose by 7.2 per cent compared with just 2.7 per cent growth in real GDP (see chart). The RBA believes that this positive income shock is more likely than not to persist for a number of years as China and India continue to undergo their steel-intensive urbanisation processes.

Rismark’s analysis draws on Australia’s largest residential sales database, which is supplied by RP Data and captures 100 per cent of all homes sales transacted across the country. In total, RP Data has more than 150 million real estate records and spends over $9 million each year collecting new data.

The income proxy employed in the analysis above is the ABS National Accounts disposable household income estimate before interest payments and excluding unincorporated enterprises divided by the total number of households. It represents the total disposable wage and investment income generated by all members of the household and should not be confused with simpler estimates of average wages or median incomes.

On an annual basis, one can quantify the impact of excluding the ‘net imputed owner-occupied rents’ that the ABS includes in its National Accounts numbers. Rismark estimates that in the September quarter this would have reduced average disposable income per household from $98,859 to $90,476. Regrettably, the ABS’s Survey of Income and Housing measure of median disposable household income is not produced on a regular basis (the last available estimates were surveyed between August 2007 and June 2008).

*The ‘trimmed mean’ is similar to the measure used by the RBA when estimating inflation. A simple average results in very volatile estimates due to extreme outliers that may reflect occasional valuer general data entry errors. The trimming process results in the truncation of only the top and bottom 5 per cent of prices within the price distribution