As we head into the new year, there’s little consensus on the fate awaiting the housing market.
In recent months we’ve seen a mixture of opinion divide the market. Morgan Stanley predicted house prices crashing by 7% in 2016. Others have taken the opposite view, projecting growth instead. ANZ predicts house prices climbing by anywhere between 1.4% to 3.2% next year. SQM Research is even more bullish. It recently forecast a 3–8% increase in prices. Now Domain Group has come out with its own 2–5% growth forecast.
Between Morgan Stanley and Domain, you’re looking at a 12 percentage point swing. That’s neither helpful, nor instructive for buyers. How is anyone meant to make any sense of the market when opinion varies as much as it does?
Yet there’s an even bigger problem that gets little air time.
Between all these forecasts, why is no one asking the important question? Why are we putting so much focus on prices for one year?
We aren’t living in an era of double digit growth anymore. Which means we can’t talk about the market in isolated 12 months periods. Of course, we can, and do, regularly. But in a cooling property market, it seems self-defeating.
As medium to long term investments, you have to look at the broader picture with property. We shouldn’t fall into the trap of raising expectations for next year. Not if people can expect their investment to take a turn for the worse in 2017, 2018, or beyond.
Unlike stocks, we have some assurances when forecasting house price growth. Populations are fairly stable, which means we can account for one side of demand. We can also use other metrics, like wage growth, to make further educated guesses about future demand.
What these forecasts fail to do is help the people they’re meant to — the buyer. Instead they only raise doubts.
So when you see experts making forecasts for 2016, think about what comes after. Is the underlying rationale given reasonable? And how likely is to last beyond 2016? Unless you’re flipping houses like there’s no tomorrow, answering these questions is more important than anything.
Why Domain remains bullish on house prices in 2016
Domain’s rationale for its forecast boils down to this: investor lending will rise in 2016. The Group notes:
‘A [mortgage rate] floor will be realised. APRA will not increase rates for the investor, so where will they invest? The ignorant sniffing at 4 to 5 per cent investments with negative gearing…investors will take another look at property again next year.
‘Investors still have a strong connection to the residential market. Even with the lower 4 to 5 per cent price growth, it’s still a predictable outcome compared to other asset classes.’
With investor lending slowing this year, Domain do make a point. APRA is unlikely to push banks into forcing even higher lending rates. With investor lending edging towards APRA’s 10% recommendation, they’ll have no need.
So domain are placing their bets on investors opting for property over cash. And they’re doing so based on yield comparisons alone.
For seasoned investors, that might be enough. But how likely is that for first time investors? With lending rates rising across the board, the market is a tough sell for newer buyers. Without experience, they’d be making a big gamble investing in the market in the near future. Chances are many wouldn’t take the plunge at all.
Regardless, would any of this be enough to raise investor demand? It’s debatable.
One thing’s for certain, the odds are stacking against investors. Australia’s population growth is slowing. The population grew at just 1.4% in the year to March 2015. That’s the slowest rate of growth in over a decade. And it’s reducing demand for property across the market.
The rental market, in particular, depends on steady population growth rates. But with growth slowing, how long can attractive yields last?
Construction slowdown to drag on house prices
Another problem with forecasting price growth in 2016 is that it overlooks the glut of oversupply hitting the market in 2017 and beyond.
The housing construction boom taking place right now won’t affect the market until 2017 at the earliest. But when it does, it’ll have a significant impact on house prices. With supply rising, and demand expected to slow, the pressure will weigh on price growth.
What’s more, it should influence anyone thinking of investing in property in the short term. I’ve talked about the effects of the construction boom recently:
‘New figures from the Australia Industry Group (AIG) showed construction activity slowing in November. The Performance of Construction Index (PCI) dipped 1.4 to 50.7 points. Anything above 50 indicates expanding activity.
‘At 50.7, construction still expanded in November. And it’s managed this for the past four months in a row. But it’s expanding at a slower pace, which is the key.
‘Behind this slowdown in construction was weak house and commercial building. Housing construction fell to 48 points. As did commercial construction, down 2.7 points to 46.3. Both housing and commercial sub sectors contracted last month. Were it not for apartment construction, the entire sector would have weakened.
‘At the same time, new construction orders fell too. The PCI showed that new orders dropped below 50, to 49.8 points. This was in contrast to the previous three months, where new orders were up.
‘What this tells you is that construction activity is likely to slow in the coming months. That’s important for house prices. It should lessen the pressure, from the supply side, on dwelling prices in Q1 2016.’
Slowing housing construction should ensure rental yields remain attractive next year. What I didn’t mention there is that 200,000 new homes will rise up out of the ground across Australia in the next few years.
There simply won’t be enough demand to satisfy this housing glut.
Price growth slower, but solid
In addition to rental yields, Domain is forecasting a good year for capital gains. It expects house prices in Sydney to grow at 4% next year. That’s well down on the 17% growth rate during this calendar year.
Domain expects Melbourne to outpace Sydney next year, with prices rising by 5%. That’s also down, from 12% growth in 2015.
Elsewhere, modest growth is expected for both Brisbane and Perth. After a horror few years, Perth is expected to grow at 2% in 2016.
Of course, the longer term view doesn’t look as positive. Investing in property next year could leave buyers with ticking time bombs on their hands.
Are investors happy with one, at best two, years of okay rental yields? Maybe they are. Especially if they’re planning on dumping their investment in the next 2–3 years.
Either way, there’ll be consequences down the line.
Everything points to a housing oversupply problem. It won’t materialise next year. Or even in 2017. But investing in the housing market right now seems viable as a short term play only.
The risk of falling rental yields, and capital gains, makes it a risky asset. Especially with so many clouds hanging over the economy.
The market has done well in the past 18 months. But anything that’s falling from a cliff will eventually hit the ground. And investors would be wise to remember that.
If investors are to prop up house prices next year, we should question what they’re getting themselves into. With an expected oversupply flooding the market in the next 2–3 years, they could be setting the stage for a much larger collapse down the line.
Junior Analyst, The Daily Reckoning
PS: The Daily Reckoning’s property expert, Phillip J. Anderson, remains bullish on the market. He maintain that house prices are yet to hit their peak. And he thinks we’re at the edge of another boom that could last a decade.
Phil’s 20 years of experience as a property analyst and advisor has given him a keen sense for where the property market is, and where it’s going. He predicted a housing market crash in 2008. He also went against the mainstream in 2009, saying house prices would go on to boom this decade.
He was right on both accounts.
In a free report ‘Why Australian Property is on the Verge of a Decade Long Boom’, Phil guides you through this coming decade. He’ll show you the right time to buy property at its cheapest, and how you can use this to time your investments. To find out how to download his free report, click here.