Residential Property Prices - the medium term perspective

The press seeks to make headlines. It does this by sensationalist reporting.This Bulletin provides some longer term data that sit above the day to day headlines.

The following graph is put together by ANZ bank from ABS data. It shows that residential property prices, in general, have not fallen in any significant or prolonged way since the series commenced over 40 years ago.

This does not mean that individual home prices never fall: this can occur in the same way that an individual share price can fall while the stock market generally is rising. It means that, on average, across Australia, home prices have not fallen except very briefly and by small amounts. This is in striking contrast to investments in equities and managed funds that show very sharp and prolonged falls from time to time.

In particular, general housing prices did not fall singnificantly during the five recessions since the 1960s (see graph). Nor did they fall during previous oil crises, the Asian crisis, the tech-wreck of 2000, 17% home loan rates, the US savings & loan crisis of 1985, the US junk bond crisis, the stock market crash of 1987 (among others), the Enron crisis, Y2K, the Australian commercial property crises of the 1970s and 1980s, or any other crisis highlighted by that the doom and gloomers.

So why are some people talking down residential property now?We believe there are several related reasons.

One is that some are not aware of (or forget) history, and feel that if other asset classes crash, then so must general house prices, even though this has not happened in Australia.

Others point to difficulties encountered overseas, and feel that if other countries suffer then so must Australia. However, Australia is unique in that it is in the midst of an export boom that will continue for some time, and compared to the US has a very sound home lending regime.

Negative views are fuelled by some fund managers, particularly those who have recently overseen very large falls in the value of the assets they manage. They fear that disgruntled investors might further reduce fund manager income by shifting assets away from managed funds and into historically less volatile and high growth residential property.

Investors are vulnerable to negative reports because right now consumer sentiment is very low (see graph below).

Another negative is that the press and governments have sensationialised the fact that interest rates and inflation are higher than in recent years. However, as the graphs show below, they have both been very much higher without leading to a reduction in overall home prices. Further, Reserve Bank forecasts are that inflation will fall below 3% during 2010.And the RBA also stated on 5 August that "scope to move towards a less restrictive stance of monetary policy in the period ahead is increasing".

We believe that the economic fundamentals support a rise in home prices, particularly in areas that have strong reason to be attractive investments. The reason is that population growth is increasing the demand for homes, and supply is not keeping up.The next ANZ graph predicts a dwelling shortfall of 200,000 by 2009. This is driving rental vacancies to record lows of about 1%, or less than one week per year.

More than half of this excess demand is in NSW (over 80,000) and Queensland (about 40,000).

We believe it inevitable that this combination of undersupply of homes, and record low vacancies, will see rents and home prices continue to rise, particularly in areas with strong fundamental support.Impetus will strengthen further when interest rates start to fall and consumer confidence improves.

While the possibility of economic slowing can never be ruled out, the first chart we saw shows that not one of the last five recessions over the last half century caused any significant fall in overall residential home prices. Talk of slowdown also needs to be considered in light of our low unemployment, the export boom, the recent tax cuts, and the fact that all governments are well placed to provide support should this be required. The following graph from the Reserve Bank shows that all government sectors are in very good shape.

This situation of sound economic fundamentals for residential property, but very weak consumer sentiment, is unusual. It provides opportunity to acquire quality property at prices and on terms that are unlikely to be available once sentiment and fundamentals align. Population growth will not stop: it is currently at record levels. Excess demand for dwellings will not stop for some years at least. Rents are forecast to continue rising. Construction costs will continue to rise. Inflation and interest rates are forecast to fall. Unlike other asset classes, sound residential investment property has consistently overcome all obstacles for the last half century (and more).

Of course, some residential areas will weaken, as always occurs. But overall, we expect the general market to be sound, as it has been for decades. And we believe that selected areas will perform very well indeed. The weak sentiment creates opportunities to buy well.