The mightiest of Australia’s bullhawks (half housing bull, half rate hawk), Christopher Joye, today published his latest assessment of house prices at Business Spectator. Let’s take a look:
A lot of fuss is being made about house prices doing, well, nothing. For the record, this is the outcome we have correctly predicted since early 2010.
Year-on-year, Aussie dwelling prices have not budged (off by -0.6 per cent, to be precise). In the first quarter of this year, they have not moved at all, either in raw or actual value terms (-0.4 per cent). Seasonally-adjusted, the first quarter has been noticeably weaker, down about 2 per cent. But this seasonally-adjusted data is simply a ‘relativity’, adjusted to reflect conditions that normally prevail at this time. Actual house prices are not down 2 per cent. On the contrary, they are flat.
Taking a quick trip down memory lane, we can find a number of appearances in the media last year by Mr Joye. On March 5, 2010, Mr Joye appeared on the Switzer program. At the time, house price growth had begun to slow after the FHOG mini-boom and Mr Joye argued that prices would “cool” in 2010 from the double digit growth rates that they showed at that time. Not quite a prediction of flattening prices but fair enough, I suppose.
But by June last year, when appearing on Alan Kohler’s other media outlet, the ABC, Mr Joye had this to say:
Well Alan, we saw disposable household incomes rise by 11.5 per cent in the 2009 calendar year. Unsurprisingly house prices rose by 11.8 per cent. And there’s an extremely strong relationship between purchasing power and house prices.
This year disposable incomes are forecast to rise by 4 or 5 per cent and we’ve seen 4 or 5 per cent growth in house prices already.
So I think our view is that we’re going to see single digit growth – modest, measured growth. We’ve been saying this for the last six months and it would not surprise me at all if asset prices in the housing market specifically tracked sideways for some time yet.
That’s a pretty clear prediction of modest growth don’t you think? Even allowing for the delicate bit of arse covering at the end.
To confirm our sense that that is what Mr Joye meant, we can also examine what other members of the “we” that made the prediction said at the time. Presumably, Mr Joye is referring to other members of the R.P.Data/Rismark team. The two are separate companies but it’s a fair conclusion to draw given that the two collaborate on Hedonic House Price Index (and I apologise if I have this wrong). On 18 June 2010, RP Data Managing director, Tim Lawless, wrote on the company blog that:
Our view is that home value growth is likely to moderate, tracking household income growth which is likely to be circa 5 per cent over the coming year.
It don’t think it unreasonable to conclude that Mr Joye and his colleagues (the “we”) are engaged in a little historical revisionism here.
Let’s get on with the article:
Year-on-year, Aussie dwelling prices have not budged (off by -0.6 per cent, to be precise). In the first quarter of this year, they have not moved at all, either in raw or actual value terms (-0.4 per cent). Seasonally-adjusted, the first quarter has been noticeably weaker, down about 2 per cent. But this seasonally-adjusted data is simply a ‘relativity’, adjusted to reflect conditions that normally prevail at this time. Actual house prices are not down 2 per cent. On the contrary, they are flat.
Having said that, I would not be in the least bit concerned if they were. If the doomsayers on the domestic economy are right, rates are not going anywhere (I obviously don’t agree with them). Recent data arguably lend weight to this view, with a run of soft outcomes across housing finance, employment, wages, and retail spending in the past couple of weeks. In the event the RBA does pull its finger off the rates trigger, we will get mild nominal house price growth over 2011, which will likely underperform inflation (i.e., real house price declines, as we have seen for the last year or so).
On whether prices are falling or stable, I’ll let you decide by taking a look at Mr Joye’s own chart of seasonally adjusted quarterly prices released today:
Looks pretty straight forward to me. Moreover, later in the day, Mr Joye published a defense of the importance of his own seasonally adjusted measure:
RP Data produce seasonally-adjusted index results precisely because it is a proven empirical fact (documented by both the RBA and ourselves) that Australian house price movements are highly seasonal, as they are elsewhere around the world.
On the RBA, contrary to Mr Joye, I don’t reckon interest rates will rise anywhere near the pace, nor to the degree, that the bullhawks (Joye, Bloxham, Carr) have campaigned for. To my mind, the RBA has created (intentionally or not) a panic about rate rises, and would no doubt be pleased with the effect that this is having on consumer confidence. As Mr Joye points out, this has caused a serious weakening in almost all economic indicators this year (including, now, house prices). The RBA may still have to raise rates again once this year to underline the seriousness of its intent but that would likely be enough to keep a lid on the consumer, if needed. A weak consumer and housing (flat rather than falling I hazard to suggest) is what the RBA wants to see, as it has said on many occasions, to make room for the commodities sector to grow.
Mr Joye turns this pretty straight forward point on its head. He contends that in the event that rates don’t rise, housing will. The truth is in fact the opposite, as made clear by Mr Joye’s own repeated calls for dramatic and immediate rate hikes. If house price growth resumes the likelihood is that consumer confidence will rebound and the RBA will instantly raise rates to stamp it out. To repeat, in order to make room for resource sector growth.
Mr Joye’s continues with his scenarios:
If rates do rise 2-3 times this year (as we expect in our central case), nominal dwelling prices will go nowhere or retrench modestly (eg, 0-5 per cent, year-on-year), depending on the exact number of hikes. That’s not a bad thing at all. The underlying demand and supply fundamentals are very strong. Australia’s dwelling price-to-income ratio and rent-to-price ratios will keep on improving, which is a great thing for future buyers. The labour market is close to fully employed, and household income growth has been robust. The only thing that will change any of this is something the RBA controls: interest rates.
On the general point here, that it’s good that house prices are slipping, I agree. The more specific contention about the degree of house price falls in the event of a rampant RBA is a judgement. Let’s just say that Mr Joye is more than living up to his bullish reputation.
I must also note that the supply/demand fundamentals that Mr Joye mentions are right now headed in the opposite direction to what he describes. The stock of unsold homes is growing monthly and is up 68% year on year. Melbourne especially looks worrying. A sundry point is that Mr Joye seems unable to grasp that it is not only the supply side of the equation that is flexible. Demand too is elastic and any number of things could suddenly reduce the number of Australians wanting to buy homes.
Back to Mr Joye:
No growth in house prices, or some small declines, is a handy reminder that no asset-class is a one-way bet, as Glenn Stevens presciently pointed out at the start of last year. To be sure, anyone defaulting on a home loan with a, say, 7.6 per cent mortgage rate (i.e., assuming another two rate hikes added to the current 7.1 per cent discounted rate), should arguably not have a home loan in the first place. Of course, there will be those folks who get unlucky, and lose jobs in industries that are not benefiting from the resources-led expansion. Those facing these regrettable circumstances will have to make the transition to rental accommodation.
The housing market’s fundamentals will likely continue to solidify as household formation-driven demand escalates via better-than-expected population growth combined with weak very new supply coming online. Indeed, new building approvals have consistently underperformed economist expectations for years. There’s a relatively simple explanation: with up to a quarter of the cost of a new house in NSW absorbed by local, state and federal government taxes and charges, developers have found it hard to bring new product online at prices significantly below the market clearing level. Many claim it is hard to produce a new free standing home in NSW for much less than $550,000. This in turn means their expected returns are both low and risky. As a consequence, we are not seeing much capital invested in the supply-side of the housing market.
When interest rates do eventually fall, as they do in every cycle, there will be an enormous affordability dividend dropped onto Australia’s housing market, which will likely trigger healthy upward movements in prices (e.g., in late 2012-14) as the market signals to builders that they need to get into gear and start constructing more housing. In the interim, the RBA is going to be left to deal with significant rental inflation care of our low vacancy rates (chart via Citi). So while property owners are not getting much capital growth, their total returns are holding ground via better income growth.
Despite the confident tone, there are mighty assumptions at work here. First, Mr Joye is clearly addressing investors when discussing rental returns. What he doesn’t mention, however, is that the gross national rental yield is 4.9%. That is sort of competitive with the risk-free bank deposit rate of 6% per annum (I suppose). But is it really? As former Reserve Bank of New Zealand board member, Terry Fadgen, argued recently:
Consider the yields currently available from housing. The data for the latest quarter shows gross rental yields in Australia are now 4.9% pa. On an $800,000 house that’s $39,200 of gross cash-flow. From that we need to make a deduction for rates, property taxes, insurance, and maintenance. Let’s call that $8,000 all up, which is generous to the investment case. So that’s $31,200 net cash per annum assuming that the property is fully let at all times and before any allowance for management and letting fees. Adding an allowance for these costs and some rental downtime takes the cash yield to around $25,000 pa representing a yield of 3% on the investment. You can easily generate a lower number.
I have been a supporter of the ‘house prices will plateau’ theory. I still hold that the most likely outcome is a slow melt with much of the damage in real terms. But in doing so, I do not deny that risks to that outcome exist. To my mind, the main risk is the fact that 66% of Australian property investors are negatively geared. This VERY large group is not making a return if prices stay flat (let alone falling). It is losing money hand over fist. Any lengthy stalling of house prices risks these investors bailing out en masse. The theory therefore relies upon the assumption that investors will not sell into the losses. Given the forces arrayed against housing in this cycle, I contend that that is to assume that investors will remain irrationally attached to their houses.
Mr Joye concludes:
And if worst comes to worst, and the Chindia story implodes, or the global economy has a repeat of the 2007-08 episode, the RBA will very likely slash interest rates, with the chief beneficiary being the housing sector, just as it was during the last crisis.
In summary, there is much ado about nothing here.
That sounds good in theory. But again, Mr Joye is not sharing the full picture with you. Take, for instance, the news just yesterday that Moody’s has downgraded the big four banks. In the press release that explained the move, Moody’s drew several unsettling correlations:
Moody’s also notes that Australia has heavy investment needs, and so is likely to continue to run a sustained balance of payments deficit, which is likely in turn to perpetuate the banking sector’s requirement for offshore funding.
Furthermore, with the domestic economy increasingly biased to the commodity sector, terms of trade that are exceptionally favorable by historical standards, and high asset prices, there is a potential for confidence shocks to impact the banks’ access to funding.
During the recent crisis, the banks demonstrated that natural economic stabilizers do permit them to adjust their funding mix. Nevertheless, the downgrade reflects Moody’s concern that — in a less liquid and more volatile post-crisis world– the banks’ sensitivity to market conditions is better reflected at the new rating level.
I don’t know about you, but to me that sounds rather like a threat to downgrade the banks in the event of a commodities crash. The implications of that, of course, are that just as the RBA seeks to cut interest rates, the banks funding costs will rise, perhaps dramatically. That, in turn, will mean that they are unable to pass on the interest rate cuts in some measure. How much? I don’t know. Do you?
Mr Joye would probably counter that at that point the government would simply step in and guarantee the bank’s wholesale funding. But would that work again? If “the Chindia story implodes” then the Budget will instantaneously find itself in deep deficit. It may be the case that the guarantee would work if the downturn was short-lived. But there will be many demands on the Budget through automatic stabilisers as the economy enters recession. And if the “implosion” lasted, it not clear to me that the Budget could be used to bail out the bank and housing complex a second time.
In my view, this article shows a bullhawk wearing distinctly rose-coloured glasses.
