What's happening with residential property?

Residential property has enjoyed an amazing run over the past 10 years, with prices for established houses in Australian capitals increasing by an average of 91%, equivalent to a 6.8% compound annual growth rate. This level of price appreciation has significantly outstripped the corresponding growth in earnings of 55.2%, leaving Australian housing as some of the least affordable in the world. This is reinforced by Demographia International’s recent 8th Housing Affordability Survey, where Sydney and Melbourne ranked as the third and fourth least affordable cities in the world after Hong Kong and Vancouver, and Adelaide, Perth and Brisbane were only just behind, ranked 6th, 10th and 11th respectively.


Setting aside the low level of land releases and Australians slightly irrational love affair with owning their own home, logic tells us Australian house prices are significantly overvalued, and potentially in bubble territory. We are seeing clear signs the spectacular rise in prices over the past 10 years is slowly starting to unwind, with Melbourne, Brisbane and Adelaide prices all declining by in excess of 6% in the year to December 2011. We would not be surprised to see further softness in residential property, with declines of up to 10% over the coming two years a distinct possibility. But, we believe there are some fundamentals preventing the full scale capitulation in property values that occurred in the US and Ireland. These fundamentals comprise Australia’s low unemployment rate, rising rents, supply shortage and an increasing demand backlog. This demand backlog is evident in the low level of building approvals, which due to lead times in completion is unlikely to materially add to housing stock in the in the coming two years. 


The two Reserve Bank rate cuts in late 2011 have to date not been enough to halt the decline in residential property prices and the impact of any further monetary easing is likely to be watered down by the banks not passing on rate cuts in full. With building approvals at relatively low levels, demand pressures will continue to build, however we look for evidence of improving affordability before upgrading our near-term earnings outlook for the residential developers.