Written by Leading Australian Property Market Analyst, John Lindeman.
Despite the obvious importance of accurate methods in property market forecasting, the industry is rife with ineffective and even inaccurate prediction methods.
What investors don’t know is that they have all the tools they need to make accurate predictions at their disposal. The only trick is to get rid of the unreliable ones and to use the credible ones effectively.
FABLE: PAST PERFORMANCE IS A GOOD INDICATOR OF THE FUTURE
First, let’s take a look at some prediction methods which investors are likely to come across. Most of these involve relying on the past to predict the future. These includes the following:
The property market cycle of endlessly recurring booms and busts
The long-term growth notion that housing prices double every eight years or so
The extended no growth theory claiming that an extended period of no growth means that prices are overdue for a rise
The hot spots idea that recent high growth is a good indicator of more growth to come
The reason these methods of prediction may fail (apart from their obvious contradictions with each other) is because past performance is not a good indicator of future performance. That’s as far as the housing market is concerned. This is because the conditions that caused price and rent changes in the past are very likely to be different in future.
There are only a few key dynamics which dictate changes in housing prices and rents. These apply equally to cities, regions or individual suburbs. These key dynamics are:
Population growth and change
The availability, cost, and need for finance
The relative surplus or shortage of suitable housing stock
Even when the rate of population growth and availability of finance are identical to some previous point in time, the impact on housing prices or rents will be completely different the next time around if the housing stock situation is also dissimilar to what it was before.
Figure 1 demonstrates how the changing relationship between these dynamics results in different housing price and rent movements.
It’s also becoming increasingly difficult to know who to rely on when some ‘experts’ are discredited by hidden agendas or receive kickbacks, knock-ons, commissions and finder’s fees for pointing unwary investors in the “right” direction.
Other commentators who claim to provide independent information may link the housing market’s future performance to intangibles such as unaffordability, interest rates, economic performance, unemployment, infrastructure or even consumer confidence.
FABLE: THE FUTURE WILL BE THE SAME AS THE PAST
No matter which of these dynamics (if any) is right, the fact is that the future of our housing market will be very different to its recent past. This is because, during the last 7 years, we’ve endured some of the most exceptional climatic, social, economic and financial changes in our history as a nation. These changes are extremely unlikely to occur together again.
Figure 2 shows the weather extremes that we recently experienced, each having a significant but different impact on housing markets.
At the same time, our economic performance swung back from a mining-induced boom in 2006/07 to several near recessions and hesitant recoveries (Figure 3).
During the last 7 years, we also moved from an easy money market with a proliferation of non-bank lenders, to severe cuts in housing finance in mid-2008. This was followed by a mini housing boom in 2009 fed by the Rudd government’s First Home Owner Grant initiatives and other spending programs.
The housing finance environment then contracted once again. But as Figure 4 indicates, housing finance is resuming a much more modest growth trend being once again back in the safe but cautious hands of the Big 4 banks.
Another dynamic, just as crucial for our housing markets, is the topsy-turvy way our federal government has tinkered with overseas migration levels. The Rudd government maintained high rates of overseas migration even after the GFC hit our shores, on the premise that overseas arrivals create more jobs than they take up.
Figure 5 shows that reductions in their numbers didn’t occur until 2009 but were then quite extreme when they kicked in. Of most significance for the housing market is that the huge migrant cut-back of 32% in 2010 was followed by the largest annual percentage increase of overseas arrivals in recent history – a jump of 40% last year (2012).
Because of our reliance on overseas migration for population growth, our annual population growth rate has lurched around from 1.9% in late 2008 to only 1.1% by early 2011. It then went back up to 1.7%.
This dynamic alone goes a long way to explaining why Melbourne, where overseas arrival reductions were most severe had a unit rental market surplus while Perth, where there were no such reductions, had a unit rental market shortage.
Analysing these significant climatic, social, political and economic changes helps us to understand why the housing market has performed in the way that it has, but because such a unique combination of events is highly unlikely to ever occur again, they also teach us that relying on the recent past to point the way forward is futile.
FABLE: PREDICTING THE FUTURE IS EASY
The difference between making a prediction and a prophecy is to know just how far into the future we can actually see with some certainty. No one could have accurately predicted the housing market’s performance in 2008/09 without also anticipating the climatic changes that occurred, the onset of the GFC and our government’s response to the crisis, plus the changes in housing lending and overseas migration that took place.
This is why long-term prediction is difficult because even with the benefit of the most accurate prediction methods, the further into the future that we attempt to predict, the greater is the likelihood of unanticipated events occurring which will throw our forecasts into disarray.
No matter how good our explanations, short-term forecasts are likely to be more accurate than long -term ones. Luckily, the housing market is on our side because prices and rents can move substantially in relatively short periods of time, and they do so in accordance with easy to understand supply and demand principles.
The secret to unlocking the housing market’s future is to understand that housing is a commodity that we buy and sell. Yet we don’t usually think of housing as a commodity. We normally don’t buy our homes as investments but for other reasons. Homes provide us with security and comfort, a place to raise a family or retire to. Another reason that we don’t think of housing as a commodity is that it doesn’t seem to behave like one. Its behaviour clearly confounds even the most studious analysts. Why is this so?
FACT: THERE ARE TWO HOUSING MARKETS, NOT ONE
Housing behaves differently from other commodities because there are in effect, two housing markets. Figure 6 shows them as a buyer and seller price controlled market of 10,000,000 residential dwellings. Within it is a smaller private renter controlled market.
These two markets can behave very differently in accordance with the changing relationship between demand and supply for properties in each.
Demand for housing can flow into either market, so that when housing finance is tight or costly, rental demand increases and the rental market grows in size and value. Oppositely, if housing finance is cheap and freely available, buyer demand rises and the renter market declines and rents may fall.
Because most suburbs have a combination of both rented and owner-occupied dwellings, prices may rise while rents will fall in some suburbs, while in others both rents and prices may rise or fall or rents can rise while prices fall.
While each of these markets has its own dynamics of demand, they’re connected because households move from one to the other, starting out as renters and then usually becoming buyers and sellers. This means that there needs to be a constant supply of properties for them to purchase in the buyer/seller market.
As they leave the renter market, there also needs to be a constant supply of new renting households to keep up the rental demand. If we remember that renter demand controls the renter market, while buyers and sellers control the price market, we can unravel the mysteries of why the market behaves as it does and make some meaningful predictions.
FACT: RENTER TRENDS REVEAL THE FUTURE OF THE RENTER MARKET
The source of population growth indicates which housing markets we need to look at for future price or rent growth. We’ve undergone a large increase in overseas arrivals. These new ready-made households almost always need to rent for some years before they become established. They do so in older, cheaper suburbs with ethnic similarities close to transport and employment. This means that many major middle distance metropolitan suburbs will experience growing rental demand, but not all. The pressure on rents will be greatest where there are already rental shortages and where these are growing. This applies equally to any renter market, such as new inner urban unit development precincts or mining towns and ports.
If you notice that unit or house rents in a suburb are rising dramatically and the number of rental vacancies declining, you may also notice that the rental yield is growing. Not only can this simple analysis reveal positively geared rental suburbs for you, but also uncover areas with potential for price growth.
This is because rent growth in rental markets always precedes the price rises that take place when investors notice the high yield and start jostling to buy properties. To get in before they do, you need to move your analysis across to the buyer/seller market and also track the buyer trends occurring in your selected suburbs.
FACT: BUYER TRENDS REVEAL THE FUTURE OF THE BUYER/SELLER MARKET
Although most of the housing market is a buyer/seller market, there are different groups of buyers, such as first home buyers, upgraders, final home buyers, and retirees. There are also locations where you will find higher concentrations of such buyers and you can identify these by where they are located, such as seaside retiree markets, recovering rural areas, or by median prices, such as first home buyer suburbs, or upgrader areas.
The key dynamics shown above in this article indicate that banks are cautiously lending more to upgrading households so that buyer demand is likely to grow most in well-established suburbs for homes around their suburb’s median prices.
To find them before the growth kicks in, you can use two indicators; the suburb’s median price for units or houses and the number of units or houses listed for sale in the suburb on any major real estate listing site. By keeping a record of these two figures, you will pick up any trends that indicate growing or decreasing purchase demand.
When doing this analysis, be wary of small numbers, especially in areas with low stock numbers as these can be subject to high volatility. Maintain your analysis on a regular basis, and wait until a clear trend emerges before undertaking further research. Most important of all, be as fully informed as possible. Rely on facts rather than on fables to forecast the future, because while the housing market behaves in predictable ways it remains a mystery to many.
Australian National Accounts 5206.0, ABS Housing Finance Australia 5609.0, ABS Australian Demographic Statistics 3101.0, ABS