CBA Economics stated last week that property price declines are “inevitable”. It has forecast that prices will fall by circa 10% in Melbourne and Sydney over the next 6 months. It cited many reasons for this forecast including higher unemployment, lower economic activity, lower mortgage volumes, falling rents and fewer overseas buyers.
I wanted to take some time to look at this forecast and provide my commentary. This exercise serves as reminder that all forecasts are inherently uncertain and tend to have limited application for investment decisions.
Relationship with unemployment and property growth
Simple logic would suggest that if less people are employed, fewer people will be able to purchase a property and some may need to sell their properties. As such, if demand for property falls, prices may follow. That’s the basic laws of supply and demand.
However, the chart below (click to enlarge) doesn’t support this hypothesise. We should see the green line (average house price growth for subsequent 3-year period) increase when the blue line (unemployment) falls. That is not always the case. In fact, the data suggests there’s a very weak relationship between property growth and unemployment.
What happened during the last recession?
Let’s look at Australia’s last recession as an example (i.e. the “recession we had to have”). Between 1990 and 1992, unemployment rose from 5.85% to 11.2%. During this period, the subsequent rolling 3-year annual property growth ranged between 1.1% p.a. and 3.4% p.a. Inflation was circa 1.5% p.a. during this period, so in real terms, property prices were flat.
What happened was there was very strong price growth between 1985 and 1988 (i.e. over 20% p.a.) and property prices started falling from early 1989. Unemployment started to rise in early 1990. Therefore, property price falls actually proceeded a rise in unemployment, not the other way around.
Why might there be a weak link between unemployment and price growth?
I can’t offer a definitive answer, of course. But I think a large part of the answer lies in two factors being (1) the fact we all need somewhere to live and (2) the housing market is close to equilibrium in terms of demand and supply i.e. most Australian’s have somewhere to live.
For there to be large falls in prices, there needs to be more sellers than buyers i.e. mass selling. That can happen in the share market (and other asset classes) with limited practical consequences. However, that is more difficult to do with property, because we all need somewhere to live. Of course, investors and holiday homeowners have the discretion to sell, but in the main, these people tend to have a stronger financial position than the average Australian.
And the average unemployment period will likely be short
The important distinction that makes this situation unique is this current recession was caused by a contraction in supply, not a fall in demand. Normally, an economic slowdown is caused by a fall in consumer spending (demand for goods and services) and that can take longer to recover. Today, most consumers are happy to spend (a visit to Bunnings will prove that). It’s just we are not allowed to venture outside our homes to do so (and otherwise viable businesses have been forced to cease trading). Once restrictions have been lifted, demand will likely return at a faster rate compared to a demand-driven recession.
Westpac projects that unemployment will peak at 9% this year but reduce to 5.6% by the end of 2021 (i.e. only slightly above what it was at the beginning of this year). Most of the other banks’ forecasts are consistent with this view.
In summary, the duration of unemployment will likely be relatively short for most people. Furthermore, there are many support mechanisms that homeowners can draw upon to ‘survive’ a period of unemployment (e.g. JobKeeper and mortgage repayment pauses).
Some people will fare worse than others
The impact of COVID will be patchy. There will be some people that will be financially stronger at the end of the lockdown period because their income has not changed and their spending has reduced. Of course, I acknowledge that some people will be worse off too.
My point is that if you haven’t been financially impacted by COVID and don’t expect to be impacted in the future, then practically, your property purchasing plans do not need to be altered. It is possible therefore that there may continue to be a reasonable volume of active, willing and enthusiastic purchasers in some geographic and demographic segments which may be supportive of prices.
What about the other factors cited by CBA?
CBA has made reference to falling rents, economic activity and mortgage volumes as additional factors that may weigh on property prices. In my view rents and economic activity will have little impact on prices in investment grade locations. However, the supply of credit (mortgage approvals) can have an impact on property growth – see the chart in this blog.
I expect that mortgage volumes will fall this quarter, partly because of lower demand but mostly due to operational issues (banks have a large backlog of work due to the disruption of offshore personnel). However, I expect volumes will recover relatively quickly when the lockdown restrictions are lifted.
Sales data might be impacted by motivated vendors
Most people would not decide to sell a property today unless they had to do so (for financial or other reasons). If the choice was yours, you would probably wait for the COVID situation to pass before you contemplated selling your property.
Therefore, it is reasonable to assume that most people that are currently selling property have to do so i.e. it’s not solely their choice. In this case, they may be motivated to drop their price in order to secure a sale. As such, sales data for this quarter and perhaps this year might not be “representative’ of intrinsic value.
I’m not suggesting that the data is flawed or incorrect. It is what it is. I’m just saying that if the only people that are selling are ‘motivated vendors’, then of course we should expect the median price to fall.
Why is this discussion less meaningful for investors?
I admit that I find economics interesting. It was my favourite subject at university. But the reality is, on this occasion, it shouldn’t inform your personal investment decisions.
Whether the median house price will rise or fall this year doesn’t necessarily indicate whether you should hold off purchasing a certain property type in a certain location. Most people understand that property doesn’t behave uniformly. Property can behave differently depending on location and type. Capital city median house prices is such a broad measure and as such has limited application.
Don’t forget, this blog demonstrates that “timing” the market has very little impact on investment returns.
Consider the future impact on borrowable equity
When a valuer completes a property valuation, they will review past sales of comparable properties – normally the past 6 to 12 months of data. At the moment, that data presents well, as the end of 2019 and start of 2020 were relatively strong markets. However, depending on the property’s location, that data may not support a higher valuation post March 2020.
This is something to keep in mind. Getting your bank to revalue your properties today, to lock in access to equity might be wise to do. If you wait to do this later this year, the risk is that comparable sales data won’t be favourable.
Essentially, what I believe will happen is that property sale transaction volumes will fall substantially below normal levels. In the main, the only people selling property over the next few months are the ones that (1) “have to” for financial reasons or (2) are less concerned (motivated) by maximising the sales price. Therefore, if these sellers are dominating the market, of course the median house price will fall.
If you believe that the value of your property(s) is somehow linked to the median house price over the coming months, then yes, the value of ‘property’ will likely fall.
However, if you believe that the intrinsic value of your asset is driven by variables other than the median house price, then it’s quite possible that this statistical measure is meaningless.
Expect ‘noise’ about property prices to get louder
In the 18 years since starting ProSolution, I have only ever read one article that was positive about property i.e. now is a good time to buy. The rest of the time, the theme of property media ebbs and flows between ‘property being overvalued’ and ‘property is about to crash’. I anticipate we’ll probably see more negative stories this year. But remember, these are written to sell clicks/views, not inform investment decisions.