Sunday, April 12, 2015

Australian Property Market: Secular & Cyclical Trends

Barry Ritholtz recently framed secular markets this way, “The simplest way to think of secular markets is as longer eras driven by overriding dynamics that define the period either positively or negatively”. Wikipedia says a a secular market is a long term trending lasting up to 25 years which consists of a series of primary trends, "A secular bear market consists of smaller bull markets and larger bear markets; a secular bull market consists of larger bull markets and smaller bear markets."

However you want to define it, property in Australia over the last 20-30 years has been in a secular bull trend, not only in nominal prices, but also measured by real increases. Consider the rise in land values compared with GDP (via Prosper, Soos):

A measure of real house prices (via Prosper, Soos):

Or perhaps the most commonly observed, dwelling price to income ratio (via Christopher Joye / UBS):

Some argue that price to income ratios at current levels are not sustainable, but as the chart above shows (at least on a nation-wide basis), the current price to income ratio has levitated within a relatively tight range (4.5-5.5) for well over a decade now.

Price enablers and drivers have included an increase in dual income households, low interest rates, easier lending practices (high LVR loans), tax policies (including the restoration of negative gearing after a brief hiatus, introduction of GST and the Capital Gains Tax discount), strong income growth stemming from a resources boom and mining investment, government incentives (such as the First Home Owners Grant & Boost), supply constraints, strong population growth and more recently investment in residential property by foreign buyers. There is no one cause, but rather the overriding dynamics have resulted in prices in Australia becoming some of the least affordable in the world.

While some of these factors may change (housing affordability is becoming more politicised, especially in Sydney where prices are being driven excessively higher by an influx of investors), some of the changes that have occurred over the decades are unlikely to reverse course and I think those holding out for a significant crash in prices Australia wide (e.g. where we see price to income ratios return to the level seen in the early 1990s) will be disappointed.

It's likely we are nearing the top of the latest growth spurt (at least on a national measure), see this chart from RP Data which visualises the cyclical trend.

But the national rolling annual change doesn't give us a full picture of the performance of all capitals which makeup the series.

I expect that Sydney and Melbourne may be nearing major cyclical peaks (i.e. within the next 12 months). Sydney is showing many signs of rampant speculation that were similarly observable at the 2003 peak (e.g. investor loans reaching record nominal levels and as a % of all lending). Sydney's cyclical peak in 2003 saw prices decline and ultimately 5 years of lower/stagnant prices.

Perth has seen the cyclical climb higher that I predicted from mid 2012 ('Perth Property on Cusp of Price Growth?'), however a sharp drop off in mining investment (the 'capex cliff') and falling commodity prices are likely to take the wind out of the sails going forward (as I speculated might happen).

Adelaide is still playing out as expected with muted price growth given the underwhelming economic conditions ('What's next for Adelaide property prices?'). Despite the recent growth prices in Adelaide (at a capital city level) are only around the same as the last cyclical peak in 2010 and in some suburbs I am watching are similar to those seen in 2008/2009.

I expect growth to rollover to the downside (lower level or negative growth) as reality bites with the closure of the Holden factory, some major infrastructure projects come to an end (such as the new Royal Adelaide Hospital) and with a lack of good economic news in the pipeline. However, I think the next couple of years may provide a buying opportunity in Adelaide, the ability to lock in lower interest rates, with yields at a more reasonable level than the eastern states and prices which will potentially be little higher than they were 6-7 years prior, it's likely to be enough to coax me back into the property market (for the first time since the peak in 2010 when I sold).

That said I will be approaching the market cautiously and looking for opportunities where downside risk is limited if Australia faces recession or continued weak economic conditions.

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