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Perspectives on Australian House Prices

March 2013

Key Points:
Residential price developments in the capital cities have been relatively weak over the past three years. Periods of weak prices have tended to coincide with reduced levels of transactions in the market turnover is much stronger during episodes of price growth. Over the past decade, transaction volumes in the capital city markets have steadily declined. The relationship between house prices and earnings is currently close to its long term level, suggesting that any significant price movements are unlikely. The relationship between mortgage repayments and earnings also suggests that the market is in a relatively steady state.

Due to the uncertainty currently present in the Australian housing market, it is useful to review the state of the market with a view to establishing the likely future direction of prices. Price developments are very important in housing markets for a number of reasons. Periods of rising prices tend to be accompanied by stronger turnover in the market, larger numbers of sales and more urgency in the behaviour of both buyers and sellers. Strengthening prices fulfil an important signalling function, indicating to home builders that a relative shortage exists and that more building is required. Conversely, periods of falling home prices are characterised by greater uncertainty and hesitance on behalf of market participants, with both buyers and sellers becoming more reluctant to close sales. Overall market turnover tends to weaken. For prospective purchasers in particular, falling prices provide an incentive to sit out of the market and wait in the expectation that prices will drop further. For home builders, building projects may be curtailed, postponed or even cancelled. The chart below summarises developments in house prices and the number of house transactions between 2002 and 2012 across the state capital cities. The last couple of years have been marked by weak price developments. Price growth had been strong for most of the decade prior to the Global Financial Crisis (GFC). In its aftermath, prices fell markedly over the course of around one year before recovering strongly in mid-2009 and reaching a new peak in 2010. Prices have drifted downward since then, although an increase of 1.6 per cent occurred in the final quarter of 2012.
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HIA Economics Group Research Note March 2013 Perspectives on Australian House Prices

House prices and sales volumes in Capital Cities


Source: ABS 10% 70,000

8%

60,000

6%

50,000

4%

40,000

2%

30,000

0%

20,000

-2%

10,000

-4%

Sep-11

Jun-07

Jun-03

Jun-04

Jun-05

Jun-06

Jun-08

Jun-09

Jun-10

Jun-11

Mar-03

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Jun-12

Sep-12

Dec-02

Dec-03

Dec-04

Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Dec-10

Dec-11

Price Change (qoq) % (LHS)

Sales Volume (RHS)

As we noted above, the relationship between prices and market activity tends to be strong. The chart above clearly shows how sales volumes for houses tend to rise as price growth strengthens and how weaker price developments coincide with fewer market transactions. At times of rising prices, buyers are keen to close sales more quickly in order to limit their exposure to further price rises. Over the past decade, the number of transactions has been on a gradually downward trend. In 2002, around 240,000 transactions occurred. This was substantially higher than for the year ended June 2012, when around 160,000 sales were recorded.

House price and income relationship Measuring the relationship between home prices and other measures of economic activity can sometimes shed light on possible future developments in the sector. For example, it is often proposed that the relationship between household income on the one hand and home prices on the other will tend to remain largely stable over time, with home prices tending to be a fairly stable multiple of household incomes. One of the implications of this is that any significant deviations from the ratio means that house prices are out of line with household incomes. In turn, this may act as a precursor to significant movements in price which will restore the long run relationship.
House Prices as multiple of Earnings
Source: RP Data; ABS

7.0 6.5 6.0 5.5

5.0
4.5 4.0 3.5 3.0 2.5 2.0

Nov-1999

Dec-12
Nov-2012
Nov-2011

Mar-04

Mar-05

Mar-06

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

Nov-1990

Nov-1991

Nov-1992

Nov-1993

Nov-1994

Nov-1995

Nov-1996

Nov-1997

Nov-1998

Nov-2000

Nov-2001

Nov-2002

Nov-2003

Nov-2004

Nov-2005

Nov-2006

Nov-2007

Nov-2008

Nov-2009

Mar-12

AUS

Period Average

Nov-2010

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HIA Economics Group Research Note March 2013 Perspectives on Australian House Prices

The chart above shows the ratio between median house prices in earnings over the same period. Ideally, the household disposable earnings in the ratio as this is the ultimate determinant of the ability availability dictates that the ABS Average Weekly Earnings series disposable income.

Australia since 1990 and average income should be used instead of to pay for housing. However, data is used as a proxy for household

It is worth bearing in mind that this approximation assumes that there is only one earner per household. In reality there are numerous multiple earner households. Our calculation also ignores the role of non-earned income sources such as investment income. The overall effect of these factors means that our calculated ratios are likely to be higher than what they would be if household disposable income were used instead. The more important implication of this is that the ratio is likely to overestimate the likelihood of excessive prices affecting the market. It is very important to bear this in mind when interpreting results of our analysis. On average, house prices have been a multiple of about 4.5 times average annual earnings (as shown by the grey line). Over the last decade, the ratio has been consistently higher than this, particularly around early 2008 and again in mid-2010. Price falls followed in both cases and the ratio currently stands at about 5.7. This is higher than the long term average, but the gap is not of hugely significant magnitude. Accordingly, the most likely scenario is that prices will remain largely stable with no sizeable upward or downward movement taking place.

House prices and mortgage costs Examining the relationship between mortgage repayments and earnings also provides interesting insights into potential price developments. Mortgage repayments represent a powerful indicator as they incorporate prevailing house prices and interest rates into one measure. When taken as a proportion of earnings, a useful perspective on house purchase affordability is provided. Economic theory holds that the relationship between mortgage servicing costs and household income should remain largely stable over time and that any significant deviation from its long term tendency may indicate imbalance. The figure below illustrates the relationship between average mortgage repayments and earnings over a 23 year period between 1990 and 2012. It is worth noting that this is a notional measure which calculates what the repayment would be in a particular month for a house bought in that month, where the purchase is fully funded by a standard variable rate mortgage. This form of calculation accounts for the interest foregone on any savings funds used by the owners to purchase the property. It is also worth noting that our calculation assumes that households are single earners and so the effect of multiple earner households is ignored. This means that our metric probably overestimates the mortgage payment burden.
Mortgage Repayments as % of Earnings
Source: RP Data; ABS; RBA

65% 60% 55% 50% 45% 40% 35% 30% 25% 20%

Nov-1993

Nov-1990

Nov-1991

Nov-1992

Nov-1994

Nov-1995

Nov-1996

Nov-1997

Nov-1998

Nov-1999

Nov-2000

Nov-2001

Nov-2002

Nov-2003

Nov-2004

Nov-2005

Nov-2006

Nov-2007

Nov-2008

Nov-2009

Nov-2010

Nov-2011

AUS

Average

Nov-2012

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HIA Economics Group Research Note March 2013 Perspectives on Australian House Prices

The chart shows how since 1990, average mortgage repayments have accounted for about 40 per cent of earnings. There has been considerable fluctuation around this figure. The ratio bottomed out during the late 1990s, with brisk growth in house prices following. These rises combined with interest hikes brought the ratio to a peak in mid-2008. Falling house prices and sharp interest rate cuts then caused the ratio to fall considerably. Currently, the ratio is slightly above its long term average. This suggests that the relationship between earnings, interest rates and house prices is balanced and consistent with stability in the market. Accordingly, any large price swings are probably unlikely in the near future. Overall, the analysis presented here indicates that the Australian housing market is relatively weak by historical standards in terms of transaction volumes and anaemic price growth over recent months. This state of affairs underlines one of the key features of housing markets generally, whereby low levels of transaction and turnover tend to accompany periods of subdued prices. Consequently, the return of sustainable price growth to the market would add welcome fuel to activity in the residential construction sector. Our analysis also sought to establish whether any significant price movements were likely in the market going forward. The relationship between earnings and house prices is broadly consistent with its long term tendency which suggests that any significant movement in prices is unlikely. This is corroborated by our comparison of mortgage repayments and earnings, which are also in line with the long term trend.

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