Sydney Property Market Dips, But Bubble Hasn’t Burst

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Homeowners waking up today would’ve had plenty of reason to worry about the emerging cracks appearing in the Australian property market.

New figures released by Domain this morning painted a bleak picture for the state of Sydney’s property market. The data showed median house prices across the harbour city falling 3.1% in the quarter to December. That marks the worst price drop for over 20 years. And that’s without taking into account unit prices, which also fell 2.8% for the quarter.

It doesn’t make for pretty reading if you’re a homeowner in Sydney, does it? And you’d be forgiven for thinking its housing bubble was on the verge of bursting. But would that be accurate? Well, it might be…or it might not.

These figures could be completely meaningless in the grand scheme of things. That’s because it’s hard to gauge whether they point to underlying problems in the market. Or whether it’s simply a case of a temporary correction the market had to have.

When you look at property values in Sydney, you could certainly come to that conclusion. The average house still fetches a cool million. In that respect, Sydney’s property market is no different to stocks that ebb and flow regularly. Yet if the underlying strength remains in place, this might be a slight correction, and nothing more.

It’s understandable that no homeowner wants to see prices decline at any point. But we shouldn’t ignore how expensive property in Sydney remains. Recent figures from Demographia showed that Sydney has the second worse price to income ratio in the world, at 12.2. In other words, a home is worth over 12 times the average household income. At some point, prices are bound to hit a natural ceiling the market can’t sustain anymore. Maybe we’ve reached that. But that doesn’t mean the bubble has burst. Far from it.

For those of us not residing in Sydney, we have even less to worry about. The disconnect between Sydney’s market, and the rest of Australia, puts paid to any suggestion of a broader national market correction. If nothing else, most cities have already gone through their own dips in the past year. But it’s only when Sydney starts undergoing changes do we suddenly sit up and take notice.

When we look at the potential of a national housing correction, we’re really looking at two cities alone. Sydney and Melbourne are the markets which have seen the kind of ‘unsustainable’ growth that worries experts. Sydney and Melbourne shape the mood of the nation, and that won’t change anytime soon.

In general, the market becomes a lot antsier when one of the ‘big two’ suffers price drops. We start dreading the worst. In a way that we wouldn’t when we saw month after month of falling prices in Perth.

So when we look at Sydney’s 3%, we have to ask ourselves what it actually means?

Even compared to Adelaide (which saw growth of 8%), Sydney had a stellar year. In fact, no other market fared as well as the Harbour City did last year. In the context of other markets, Sydney is still growing, and it’s doing so from a much pricier base.

Now, to be fair, Sydney was almost solely responsible for the decline across the national market during the previous quarter. Its decline dragged national house prices down 0.5%. The same was true for units, which fell by 2.8% in Sydney and 1.3% across the country.

But remember, there’s no pattern to follow when we compare Sydney with the rest of the market (outside Melbourne). Figuring out what Sydney’s dip means depends on what we take the root cause to be.

If you believe market fundamentals forced prices to fall, then the bubble might really be bursting. I’m referring to supply and demand, for instance.

Yet something far simpler could be at play: confidence.

We could easily surmise that emotion has driven the market to start believing in a narrative. A narrative that, in this case, suggests the Sydney market has peaked. And that buyers might be better off waiting until prices fall even further before jumping back in.

Or even that homeowners are waiting to see whether house prices rebound first before putting their property on the market. Any number of reasons could explain why homeowners might feel this way. For much of last year, they were constantly reminded the market was overheating. They were scared into thinking the bubble could pop at any time. And they saw how banks were hurting demand by tightening lending standards.

Either way, we can’t say with any certainty Sydney’s price drop didn’t come about from a lack of confidence. Confidence is an important factor, because you can regain it as quickly as you lose it. Of course, it can also snowball and worsen. But the point remains. Confidence is different to market fundamentals. All that’s necessary to get prices moving up again is for the market to latch onto a new, more positive, narrative.

Of course, that’s easier said than done. It becomes harder to change opinion once a specific narrative sets in. Either way, we won’t have any idea if sentiment is changing until April at the earliest. That’s when the house price figures for Q1 2016 are due.

But until then, chalking this price drop down to market confidence would be wiser than calling it the start of the end. Yet it all depends on homeowners believing confidence is the key to falling prices.

We have a decent idea that it might be because of what’s happening south of the border.

When we look at Melbourne, we see that market fundamentals remain strong. The Victorian capital saw median house prices edge up 1.8% in the quarter to December. Unit prices held up nicely as well, up 1.3% for the quarter. Why is that important? Because market fundamentals are similar across both cities. And there’s nothing inherently healthier about Melbourne’s market. If anything, it’s Melbourne that has the supposed oversupply.

It’s just that Melbourne doesn’t have a confidence problem. And that’s partly because it hasn’t seen the kind of rampant growth Sydney had for so long. At least, not until recently.

If we compare the two over the past year, the performance is strikingly similar.

Even with the December blip, median prices in Sydney are still up 14.8% over the past year. Melbourne, by comparison, has grown at 14.5% over the last 12 months. So Melbourne’s still surging, even as Sydney declines.

This is where the ‘narrative’ might be catching up with Sydney. Remember that it’s only in the last couple of months that Melbourne’s annual growth has caught up with Sydney. There were months in the which Sydney prices were outpacing Melbourne by 8% for the year to date.

So maybe we could look at what’s happening now in Sydney as a necessary price adjustment. As Andrew Wilson, a senior economist at Domain, notes:

This is a sentiment-driven outcome. It’s fragile and buyers and sellers have scurried back into bunkers for the December quarter. Those that sold had to ask what the market offered at the time. It’s a question of when sentiment will turn around.

Answering that question isn’t easy though. There’s no telling when the market will shake off its wobbles. Even in the first month of 2016, there’s little sign of change on the horizon.

Take auction rates for instance. There are just 40 planned auctions in Sydney this week, half the number from this time last year. That’s well short of Melbourne’s schedule, with some 100 auctions on the cards. It’s another sign of the difference in confidence, not market fundamentals, that exists between the two markets.

The biggest concern for now is that this lack of confidence morphs into a much bigger funk. If buyers expect that prices will keep falling, you’ll see that reflected in the auction rates. So homeowners wanting to sell will be weighing up the right time to do so.

What needs to happen for Sydney property prices to recover?

Clearly, the market needs to get out of its pessimistic mood. For that to happen, a few things need to take place. Since we’re talking about confidence being the issue, these things don’t have to relate to fundamentals. It could just be a case of people feeling better about the market for no reason.

Of course, it never hurts if fundamentals look better. Higher wage growth, rising populations, rate cuts, lower lending standards…all these things help.

But it could be something even smaller that, on a short term basis, helps perk the market.

For instance, let’s say that auction clearance rates climbed higher. Auctions in Sydney are currently trending at their lowest rate in three years. Of the 12,610 auctions held in Sydney in Q4 2015, only 59.8% of properties were sold. That compared less favourably to Melbourne, which saw 67.8% auctions cleared. And that was from some 15,438 auctions in the Victorian capital.

Low clearance rates are only adding to the pessimism in the market. Yet what might help auction rates tick up is the very fact that prices are falling. Granted, prices haven’t fallen by much in real terms, that’s true. But the perception that prices are on a downward trend might spur buying activity.

Ultimately, the housing market fundamentals in Sydney remain solid. We know that because Melbourne is still growing. The December quarter can be put down to a necessary dip the market had to have just to recalibrate itself. If there is a concern about anything, it’s that this market confidence problem doesn’t outstay its welcome. And that this leads to a kind of deflationary problem in the housing market, where buyers stay on the sidelines expecting lower prices in the future.

A quick look at the rest of the Aussie property market

Outside of Sydney and Perth, the only other capital to see median house prices decline was Darwin. Despite falling 2% in Q4, Darwin’s is down by just 1% for the year. Perth saw a 0.8% drop, to bottom out at a 4.5% loss for the year. Both of these cities have seen prices fall as a result of the decline across the mining sector.

On a national front, the news was less positive for units. Brisbane saw prices fall 1.1% in the quarter, down 5.3% for the year. In Hobart, prices fell 3.3%, but were still up 7.1% for the year.

Mat Spasic,

Junior Analyst, The Daily Reckoning

PS: One factor that could help shift market sentiment would be for the Reserve Bank to cut rates again. Considering the fears over the global economy, and its effect on Australia, you wouldn’t bet against it.

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