Debunking Bullish Calls On Oz House Prices

This story features STOCKLAND, and other companies. For more info SHARE ANALYSIS: SGP

 – Australian housing prices justifiable
 – Assumed housing shortage may not be accurate 
 – Outlook is for modest house price growth rather than boom or bust
 – Expectations for aggressive easing in rate cycle may be overly optimistic

By Chris Shaw

The RP Data-Rismark house price index yesterday showed a 1% average gain in national prices in June, with the RBA cuts assumed as the driver, but economists do not necessarily share industry assumptions of a return to rapidly rising Australian house prices.

Australian house prices are consistently regarded as overvalued, but analysis by BA Merrill Lynch suggests the current price level in the housing market can be justified by household income growth and the increased ability to leverage that has become evident over the past 20 years.

When Australia's solid economic performance is added to a history of prudent lending by the banks and the strong position of household balance sheets at present, BA-ML's view is a sustained sharp fall in house prices is in fact unlikely. 

While house prices in Australia have declined over the past 18 months, BA-ML suggests this is due to decreased appetite for debt among Australian households. This suggests it is unlikely to be the beginning of a sustained sharp fall in prices.

Looking at the market over the past 10 years or so, BA-ML notes Australian house prices rose by 142% from 2000 then eased by 7% from the peak late in 2010. Since 2000 Australian mortgage rates have settled at an average of 6.5%, which compares to an average of 11% in the 1980s and 1990s. This fall means households have the same interest servicing burden on a higher amount of debt.

From 2000 to now income growth in Australia has averaged 7.5% annually, which is up from an average of 4.5% in the 1990s. This has allowed for increased leverage of rising income levels, which has pushed up house prices over the past decade. 

Assuming incomes and interest rates are the key long-term drivers of prices, BA-ML suggests booms in medium Australian house prices are now a thing of the past. This reflects the fact the structural decrease in interest rates has now occurred and won't happen again. As well, the peaking in the terms of trade and falling nominal GDP growth rates suggests Australia is at the end of the period of higher than average household income growth. 

For BA-ML this suggests trend house price growth in coming years should be 3-4% annually, rather than the 9.5% enjoyed between 2000-2010. While this suggests no boom in house prices, BA-ML points out it also implies no bust in the market as lower unemployment and still solid economic growth will support household incomes and so housing prices.

One factor that has supported the argument of further gains in house prices is the suggestion of a shortage of supply in the market, but Morgan Stanley's view is the market is in fact in oversupply, on paper at least.

According to Morgan Stanley, while the recent Census data suggested an estimated housing shortage of 228,000 units in 2011, this assessment is based on flawed data as supply and household estimates have also been over-stated. If adjustments for these overestimates are made, the implied undersupply of 228,000 units becomes an oversupply of 341,000 units. 

The other question assessed by Morgan Stanley is if the market is actually undersupplied, then why are house prices continuing to decline? This brings into the equation factors such as prices, affordability and the willingness of households to leverage up, which are regarded as bigger drivers of actual demand than simply population demand and construction levels.

In Morgan Stanley's view, households and individuals adjust their living style to fit their financial position. If this is the case, the argument of a housing shortage supporting volumes or prices is difficult to believe. 

Looking forward, Morgan Stanley's view is house price growth in real terms over the next decade will be meaningfully lower than in the past decade. Medium-term the outlook is for flat to negative growth in real terms as wage growth outpaces price growth, while Morgan Stanley sees little risk of a housing crash scenario as this would require broad based unemployment as a driver and this is considered unlikely.

With respect to the impact on investment options in the housing sector, Morgan Stanley retains a cautious view. The broker remains Underweight on stocks with meaningful residential exposure, which includes Stockland ((SGP)), Mirvac ((MGR)) and Australand ((ALZ)). By way of comparison, the FNArena database shows Sentiment Indicator readings for these three companies of 0.7 for Australand, 0.6 for Mirvac and 0.4 for Stockland.

Heading into the July Reserve Bank of Australia (RBA) meeting, Macquarie notes the expectation is for no change in official interest rates following the 75 basis points in cuts delivered across the May and June meetings. 

What the meeting should show is how the Australian housing market is performing post the 50 basis point cut in May in particular. As Macquarie notes, in a typical pre-GFC cycle, a lowering of the cash rate boosts consumer confidence. 

This provides a rapid boost to the housing market as households take advantage of lower rates and buy property. This has not occurred over the past two months however, as Macquarie notes consumer sentiment has hardly changed and auction clearance rates remain soft despite the rate cuts.

This implies the rate cuts have done little to improve domestic economic conditions, something Macquarie expects will be confirmed by data due to be released this week. A weak economy but one that is not falling off a cliff would be in line with RBA expectations, leading Macquarie to suggest the RBA may look to keep the cash rate more restrictive than would otherwise be the case to force productivity growth within the economy.

Given this, Macquarie suggests the current market pricing for an aggressive easing in the interest rate cycle is likely to be prove to be too enthusiastic. 

 Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms