NSW Excerpt from the 2014 January Market report

Sydney has sent investors’ hearts racing with an incredible run of price growth over 2013, but will it last?

Can’t everybody just agree?

As Australia’s biggest state, both in population and economy, opinion has been divided on NSW’s future. Most property forecasters have been more bullish than bearish, but the bears haven’t been in hibernation either. Then there’s been a certain section of the real estate profession that has been so bullish that its talk has been more on the side of the stuff that bull extremities produce.

Overseas commentators haven’t been shy of throwing in a comment or two either. Usually it has involved terms such as “bubble” and “trouble”, words that conveniently rhyme, no doubt, but say little about what is actually going to happen to those poor souls who throw their money into a NSW investment property.

There’s only one thing everybody has been agreeing on: Sydney property prices are going to continue to grow over 2014. What’s in dispute is for how long and to what extent.

The middle-of-the-road forecast is perhaps best represented by the opinions of a handful of property pundits, and they just happen to work for Australia’s most reputable property research organisations.

One of them is Andrew Wilson, senior economist at Australian Property Monitors (APM). Wilson says Sydney is likely to see two more quarters of house price growth, but he expects the market to become a lot more subdued by June.

“A shortage of property has been keeping the Sydney market ticking over, and that’s why rents are high and there is always that consistent underlying demand for property. But prices are not only a product of demand; they are also determined by a financial capacity to borrow.”

Wilson says that the Sydney economy has seen benign wages growth and that has kept city properties largely unaffordable for a big segment of the buying market, despite the low interest rate environment. This means that there’s a strong cap on how high prices can grow. If they grow too much, activity will stifle, slowing growth in values down.

“I’m not sure where big forecasts like 20% growth [in 2014] are coming from, but if that occurred the Sydney median house price would become $900,000. That says it all, doesn’t it? It’s not going to happen,” Wilson says.

Reining in a similar forecast is RP Data analyst Cameron Kusher. Kusher believes that a factor often left out of Sydney property forecasts is how seasonal many of the city’s markets are. Growth tends to occur over specific times of the year, which means that strong activity in recent quarters is unlikely to last. Kusher is also sceptical of the Sydney market’s high entry point.

“Sydney will probably start to see some affordability constraints coming onto the market fairly shortly,” says Kusher.

“The last few growth phases haven’t tended to be all that long. There’s strong growth over a short period, then it peters out.

“I think we will probably start to see that possibly happening in the second quarter, and it will really just come down to affordability hindering people from getting into the market.”

Affordability and economic issues aside, other factors will have a say in how the market performs as a whole.

Easily the most important is the number of properties released on to the market (supply) and the underlying demand for them from the buying public.

Supply and demand factors

1. Interest rates and demand
Historically, Sydney and Melbourne have tended to benefit the most from periods when interest rates have been low, because together they account for roughly half of Australian capital city residents. The current market is no exception, but there’s a catch.

Usually, low interest rates encourage activity from first home buyers and upgraders – the segment of the buyer base most concerned with affordability – but that hasn’t been the case in Sydney.

QBE LMI’s Australian Housing Outlook 2013–2016 report indicates that while homebuyer and upgrader activity has increased a little since 2012, the market has been led by investors.

Rob Mellor, managing director of BIS Shrapnel, who had a key hand in putting together the report, says that first home buyers have been largely absent from the established housing market. This he attributes to the scrapping of homebuyer incentives and grants.

“Nationally, first home buyer demand is down, while investor activity is up, but it is concentrated heavily in NSW,” Mellor says.

This explains the findings of the QBE LMI report, which shows the current upturn in the Sydney market is being driven by growth in markets popular with investors. Those markets are almost exclusively in the inner city.

The report’s numbers show just how wide the gulf between city regions has been. Since mid-2012, Sydney’s inner suburbs have seen a 13.7% growth in values and middle-ring suburbs 8.5% growth, while outer regions, the areas where first home buyers tend to buy, have only seen 3.1% growth.

APM’s Andrew Wilson says that high investor activity should be considered within an environment in which there is strong capital growth that will outpace any growth in rental yields. In fact, Wilson says rental yields are likely to go down as prices continue to grow, and this may become something of a deterrent for new investors to get into the market.

And if the investors go, the impetus behind much of Sydney’s strong growth might go too.

“We are already starting to see falling yields in Sydney. Once yields start to fall below 4%, it is going to become less and less attractive for new investors to purchase in the Sydney market,” Wilson says.

2. Massive under supply
Despite Sydney’s low first home buyer activity and property prices that are already galaxies ahead of other capital cities (Sydney’s median house price of $635,000 is $90,000 more than Canberra, $115,000 more than Perth and $145,000 more than Melbourne), growth in values has continued to come largely because the city faces a massive under supply of property.

“Massive” may sound sensationalised, but the numbers don’t lie. ABS building activity figures currently have NSW – not just Sydney – at just under 50,000 dwellings short of underlying demand.

While building activity has stepped up in response to this, it is still falling short of what NSW residents will require by 2016. Dwelling commencements over 2012/13 were just below the 40,000 mark and it is not surprising in this environment that the state’s supply problems will only get worse.

BIS Shrapnel forecasts NSW’s dwelling deficiency to hit over 55,000 properties by 2015. By 2016 it will drop back down to just over 50,000 – an improvement on 2015 levels but still higher than it is at the moment.

“The main strength of the NSW market [and Sydney] is that it has been undersupplied for a very long time. There is a lot of pent-up demand in the market that is coming through,” says BIS Shrapnel’s Angie Zigomanis.

NSW economy
A possible weakness for NSW is unemployment. The national unemployment rate is expected to rise in the coming months and NSW will likely mirror that trend.

“The state government is forecasting the unemployment rate to head toward 6.25%, and that’s where they think it will peak. That would be the highest unemployment rate since September 2002,” says RP Data’s Cameron Kusher.

Kusher adds that an unemployment rate that high would have a dampening effect on consumer sentiment. If people start getting worried about their jobs, he says, they are going to be less inclined to spend a lot of money on a house. That may be problematic for a market where prices are among the highest in the country.

“You don’t have much of an option but to spend a lot of money on a house in Sydney,” Kusher says.

The unemployment rate is also significant, given the conditions that would be necessary to support the kind of growth that some of the more outlandish commentators are expecting – 20% value increases on the Sydney median house price.

“To get that sort of growth, we would need to have sub-5% unemployment putting pressure on prices and wages,” says Wilson.

“A shortage of labour is what normally puts upward pressure on wages, giving homebuyers the capacity to pay more for their houses. House price growth follows income growth. If there’s constrained income growth, there is really nowhere to go in terms of prices.”

Capital growth prospects
So what does all this mean for house price growth?

For Wilson, the current market conditions in NSW add up to strong price growth over the next two quarters, followed by a gradual tapering off of the growth rate. He reminds investors to keep a little perspective in mind.

“We must remember that the highest annual growth in prices that Sydney has ever recorded over the last 20 years was 22.7%. That was in 2002. The next best was 17.4% in 2001, but back then Sydney had had a lengthy period of overdue prices growth.”

QBE LMI’s Housing Outlook 2013–2016 predicts growth in Sydney’s median house price to continue its momentum into 2014, rising by 6% over the year.

Thereafter, growth will remain solid in the following year as economic conditions in NSW improve and the state’s dwelling deficiency continues to push the market along.

Including 7% growth in 2013, this will push the city-wide price growth figure to 19% over the three years to 2016. This growth might then begin to slow over 2016 as a corresponding rise in dwelling construction begins to erode the state’s housing shortage.

Of the state’s other regions, Housing Outlook 2013–2016 forecasts a mixed outcome.

“Median house price growth has also emerged in Newcastle (+3.9%) in 2012/13, although Wollongong (–1.6%) recorded a decline,” the report says.

“Price growth in Newcastle is expected to accelerate and outpace Sydney later in the cycle as outer-Sydney prices eventually increase and purchasers are attracted to more affordable regions.

“This is also likely to be the case in Wollongong, although price growth could lag given the weaker local economic conditions.”

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