Timing The Turnaround For Oz House Prices

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 – Morgan Stanley forecasts further Oz house price falls
 – Market presents a challenging environment for residential developers
 – Moelis more positive on housing market outlook
 – Suggests house prices are now near the bottom

By Chris Shaw

Morgan Stanley's proprietary real house price regression model has, since inception in September of 2010, accurately predicted the current weakness in prices. The model contains nine elements, which include the standard variable mortgage rate, annual population growth, employment and earnings growth, housing commencements and consumer sentiment.

At present Morgan Stanley suggests sentiment in the housing market remains mixed. Lower borrowing costs will help those with mortgages and may attract new entrants to the market, but even accounting for this the broker sees continued downside risk to house prices.

The real house price regression model supports this view, as the indication is real house prices will decline a further 12% in FY13 and 9% in FY14. This accounts for a further 75 basis points in interest rate cuts in coming months.

This implies the challenging conditions for residential developers will continue, something Morgan Stanley suggests offers real downside risk to earnings across the sector. While most of the housing price weakness is in the premium end of the market, Morgan Stanley suggests this offers little solace for developers as further margin compression across the market is likely in the current deflationary environment.

Cuts in interest rates won't be a cure all, as Morgan Stanley points out six months ago developers claimed they needed 50 basis points in cuts to boost demand. Six months and 75 basis points in cuts later and the developers still claim more cuts are needed, which suggests consumers are now more cautious. This means rate cuts won't have the same impact on demand as was the case a few years ago.

On the plus side Morgan Stanley notes further rate cuts will be a boost for affordability.

Cautious consumers suggest the market will remain difficult for developers, so Morgan Stanley retains Underweight ratings on the major names under coverage. These include Australand ((ALZ)), Stockland (SGP)) and Mirvac ((MGR)).

The issue for the broker is while yields are attractive, there remains downside risk to earnings in an environment where the bottom in prices is still unclear. Until there is greater clarity with respect to a potential recovery Morgan Stanley suggests a sustainable re-rating for the residential sector on the Australian Stock Exchange remains unlikely.

In Morgan Stanley's property universe the order of preference is Goodman Group ((GMG)), Lend Lease ((LLC)), Charter Hall Retail ((CQR)), Dexus ((DXS)), Westfield Group ((WDC)), Investa Office ((IOF)) and Commonwealth Property Office ((CPA)) as Overweight, while GPT ((GPT)), Westfield Retail ((WRT)) and CFS Retail ((CFX)) join the residential developers in terms of Underweight ratings.

Moelis is more positive on the housing market outlook than Morgan Stanley, suggesting residential prices should only fall significantly if owners are forced to sell due to an escalation in holding costs, an increase in job losses or restricted credit access.

For Moelis the residential market is holding up reasonably well in terms of pricing given the pervading negative sentiment at present. As well, affordability is improving as income growth continues, interest rates decline and prices weaken slightly.

The fundamentals that underpin residential demand remain robust according to Moelis, as unemployment is low, incomes continue to grow and population growth remain healthy. As well, the rate of supply of new dwellings remains well below long-term averages when adjusted for population growth.

For Moelis, the market is now at an inflection point where the weighted average growth of capital city house prices has fallen to a level in line with household income growth last seen in 2002. Historically, the broker notes when these measures converge house price growth tends to recommence. A further indicator the market appears near the bottom is capital city established house price growth has turned negative, which Moelis notes has only occurred three times since 1990.

The housing supply/demand impasse is still unresolved as population growth remains above new dwelling commencements but the measurement of persons per dwelling has stayed relatively constant for some time. This suggests current levels of accommodation are adequate.

There appears to be an undersupply of housing but in Moelis's view this is not as significant as some of the listed developers suggest. The expectation is longer-term demand will accelerate and the larger players in the sector should enjoy growing market share as smaller developers fall away.

Subdued consumer sentiment continues to impact on the residential market, as buyers continue to face the challenge of securing finance and are sensitive to tough labour market conditions. This is seeing prices come down and affordability improve, but Moelis suggests volumes need to normalise to show the market adjustment process has reached equilibrium.

This supports the view if there is no sharp increase in forced selling from interest rate spikes or a sudden jump in unemployment, housing values should largely hold steady or experience only modest further declines. 

Moelis suggests this is playing out now as prices reduce gradually as sellers accept lower prices and buyers get more comfortable with the view the market is now near a bottom. 

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