Given the problems and the position of global economies, Australia has done well by comparison and in global stakes it remains one of the few bright spots.

Adverse comments and the position currently surrounding European economic problems have certainly had an impact on Australia’s economy; however it is important to recognise the position Australia holds, and that if things do go horribly wrong, Australia has the capacity to simulate its economy by increasing borrowings and decreasing interest rates.

Our housing markets ended 2011 in a better position to where they started and I am confident that the year ahead will be better for residential property owners compared to last year. Most owners should see their assets hold value or increase and this year could in fact be a good time for investor activity provided the world economy doesn’t move into severe recession as a consequence of the problems in Europe.

Current data suggests that we are exiting a period of negative adjustment however, in my view, we should not expect any rapid uplift in housing values because current economic conditions are not capable of supporting strong consumer activity. Retail activity during the Christmas period certainly suggests that consumers are cautious.

While most of us will not be happy to see the adjustments that have taken place in the last year, we should recognise that our markets were overvalued and affordability was a real issue. Realistically, affordability is still an issue but provided growth rates over the next few years are in line with long term growth trends of close to one percent real growth (one percent above inflation), and interest rates decrease a little further, last year’s adjustments have been good and ensured that we avoid the speculated housing “bubble bust”. The bottom line is that we have achieved a good result and it looks like an overall improving position may be the trend in the coming year.

The unemployment rate is going to play a significant role in Reserve Bank decision on the cash rate this year. Employment growth has slowed to less than 1 per cent and in annual terms the rate has ranged from 5 per cent to 5.3 per cent since mid-2011. The Reserve Bank closed out 2011 with two consecutive rate cuts of 25 basis points and the RBA will be closely monitoring unemployment figures. Any increase in unemployment will trigger further interest rate reductions and with the slowing in retail activity we should expect an increase in layoffs in this sector in the first quarter of 2012.

A further potential driver of RBA interest rate reductions this year is the trading bank funding costs. The eurozone crisis has seen an increase in the spread between the Reserve Bank’s cash rate and its cost of funds. Should this continue, it will cause banks to hold back on passing on the full benefit of RBA cash rate reductions. This in turn will cause the Reserve Bank to make larger reductions than it might not have otherwise made.

I believe that the top of the current interest rate cycle has passed and from here we will see rates decrease. Interest rate decreases have an added benefit in that they will reduce the value of the Australian dollar and help to stimulate exports. Should the time come when Australia does find it necessary to stimulate the economy, as I mentioned before, there is plenty of monetary adjustment available to do so.

Overall, the outcome for the year ahead will depend on interest rates, the eurozone crisis, inflation, the employment level and the carbon tax.

The recent move by the ANZ bank, which will probably be followed by others in due course, to set its home loan rate independently to any interest rate adjustments by the Reserve Bank has reduced the power of the only economic lever that the RBA had. The banks tell us, and it seems very reasonable to believe, that borrowing rates are not significantly aligned with the Reserve Bank cash rate as banks are significant off-shore borrowers.

Consumer confidence and recent retail activity points to a cash rate reduction by the Reserve Bank in February as the most probable outcome. The issue will then be, will lenders pass on the cut and how much will they opt to pass on. The interest rate separation will probably lead to larger RBA cuts in the cash rate than what would have otherwise been necessary.

For Europe, we are approaching the point where decisions and actions are needed and it is likely that the markets will force an outcome. We expect the 17 nation eurozone to change and that it will spend a significant part of this year in recession; in particular the first part of 2012. Further, Standard and Poor’s has just cut the credit rating of nine countries using the euro, including France. This action has the potential to make things worse as the cost of funds is likely to rise as a consequence.

Domestic inflation will be critical to the actions of the Reserve Bank. Recent inflation outcomes have been favourable and in November, the RBA lowered its inflation forecast for 2012 to 2.5 per cent which is within its target band. Inflation doesn’t appear to be an issue in 2012 and should not be the cause of any rate rises.

The new carbon tax comes into effect from July 2012 at $23 per ton of carbon pollution. Tax payers with incomes of less that $80,000 get a reasonable tax cut but we are not prepared to guess the actual impact on the economy and the resulting behaviour of consumers.

In light of all of the above, it is easy to form a negative view about the likely outcome in 2012. I urge you to acknowledge how lucky Australia is and recognise that if the year does unfold in a negative nature, it also provides opportunity. Australians are much better placed than many other people in the world and the adjustment period we have recently seen, with a clear upswing in our markets in the last few months, means that there is a reasonable chance that our markets will advance positively, albeit by a relatively small amount, in the current year. Additionally, in this situation there will be bargains for the astute house hunter along with quality growth in many suburbs.

About John Edwards…

John Edwards is CEO of FindMeaHome.com.au and Residex, and is recognised as Australia’s leading property researcher.

Indications are for further corrections being more likely than not. In fact without any government stimulus (which we don’t expect) that the correction process across Australia has around six to nine months to go.

SYDNEY

Market performances are not uniform. There are some areas that are just starting the correction process while others have move beyond this process and are presenting growth. Sydney falls into this later category with this market having the most significant stock shortage at 20,000+ dwellings on our estimations.

BRISBANE

The worst performing capital city market is Brisbane. Its annual growth rate has deteriorated further since our last report and has now recorded its worst annual growth rate on record at -6.0 per cent.

Given the corrections taking place in this market, the stock position in Brisbane is not as one would expect. Aside from Sydney, Brisbane is the only other capital city where a potential shortage of stock remains. The only rational reason one can point to for the correction is the negative sentiment being generated out of the Gold Coast market and the natural disasters earlier in the year. We continue to believe that this market will move to growth in the short term as the impact of the stock shortage is felt and the state’s economic performance improves following the natural disasters.

GOLD COAST

The Gold Coast also continues to adjust and it too has posted its worst recorded adjustment. The correction for the year was -9.9 per cent while in Southport the correction has become significant at -11.8 per cent. Corrections of this magnitude are very abnormal and rarely seen. For example, a correction of this magnitude was last seen in Sydney in 1930.

MELBOURNE

Melbourne, until recently, has been a “star” of the Australian housing market with its performance being exceptional. However, it is currently presenting as if there is a serious risk of falls. The city is in the early stages of the correction phase and is a market where there needs to be caution. Many people will fail to realise that this market is correcting and will be focused on the recent quality returns. The correction process is likely to take the best part of two years as there is a significant stock overhang (we calculate the surplus to be in the order of around 20,000+ dwellings).

Weekly rental costs in Melbourne are now similar to what they were in July 2008. The lead indicator that the correction phase is almost over will be an increase in rental costs. Rental yields are now the lowest in Australia (3.38 per cent for houses and 4.18 per cent for units). Yields need to be close to 4.5 per cent for houses and 5.2 per cent for units). This suggests that there is the potential for this market to correct by something in the order of 12 per cent over the next two years with a rental increase of around 17 per cent, or $64 per week. We saw a similar need for correction in Perth and the correction has taken place in recent times.

PERTH

The corrections that have taken place in the Perth market are significant. The peak median value of a house was $521,000 in March 2008 whereas today it lays around $471,000 – a total reduction in value of 9.6 per cent, or $50,000. Rental yields and weekly rental costs are increasing, indicating that the surplus stock position is reducing – we currently calculate the surplus at about 4,000 dwellings.

There are further corrections to take place however they are unlikely to exceed five per cent. Before property values increase, we should also expect weekly rentals to increase in the order of $425 per week, placing rental yields in Perth at something in the order of 4.9 per cent.

Until next month
Best regards,
John E Edwards,
Founder and CEO, Residex

About John Edwards…

John Edwards is CEO of FindMeaHome.com.au and Residex, and is recognised as Australia’s leading property researcher.

I can tell you that in the whole time I have been studying the market I have not seen the makings of such a perfect storm. The June quarter numbers in some states are the worst recorded for more than 30 years (you would probably have to go back to the 1960s to find worse).

The market right now is very patchy. There are bright stars on the horizon but they could be dimmed very easily as their glow is weak and flickering, like any new flame is in its infancy. Our star is Sydney, which is the market that generally points to the future performance of other markets across Australia, and the worst performing capital city, Brisbane, is in trend terms indicating that the worst of its corrections are probably over.

Before we look at the trends in various markets let me point out another observation – our housing markets are usually a lead indicator/pointer to what is happening on the domestic economic front. This should clearly be the case as consumer mood will be largely driven by the view of their financial health. We can often point to potential increases of unemployment in areas of a city by simply looking at how that housing market is performing. People stall their buying activity when they think their jobs are at risk or their wealth is falling. We also have changes of government when the housing market is adjusting. It is clear what would happen if we had a Federal Election tomorrow.

Leading into the global financial crisis, I called the potential for a 1 in a 100 year event when all markets in Australia were correcting. The event was averted as the Reserve Bank held back on making an interest rate increase, then later made some dramatic interest rate reductions. Today, all markets are not correcting but some have done very poorly. Poor management of our economy at this point in time could easily bring about that 1 in a 100 year event that was previously avoided.

The worst performing market in Australia was a region in the Gold Coast area – Southport.  For the year, Southport houses adjusted by 8.05 per cent and has now fallen in value by $51,000.

Brisbane has also fallen in value and, as previously mentioned, the fall of 5.66 per cent is the highest we have recorded in any 12 month period.

The unit market trend indicates that further increased adjustments are likely while the housing market appears to have bottomed out. This is likely, given the probable improving situation and an economy that will be strengthening following the natural disasters.

Moving down the eastern coast to Melbourne, the picture is better than Queensland but the market is early in its correction phase with houses dropping 1.1 per cent in value in the last month and down $6,800 over the last 12 months.  The unit market is correcting more strongly, however when we look at the supply of stock of properties in Victoria it is clear that this market could have a considerable amount of adjustment in it. Our numbers indicate that Victoria could have a significant stock surplus of something in the order of 24,000 dwellings, mainly in the medium density market. The net outcome, without careful economic management, could see reductions in value in this market that are considerable higher than those recently seen in Brisbane (where there is more than likely no shortage of stock). Overall I view the Melbourne market as our most at risk market at this time.

The current stock surpluses that are evident in all states other than in New South Wales and Queensland are a consequence of reductions in immigration in recent times. For example, in Victoria the reduction in population growth due to reduced immigration is about 6,000 people per quarter when compared to the five year median.

The above demonstrates the fragile nature of our housing markets.

I’m not against a carbon tax or how it encourages us to be “greener” and work toward reducing the excessive amount of carbon dioxide we are producing. However, I do believe there is a sensible process and time to introduce this tax and that time does not seem to be now when we are most vulnerable.

We know consumer sentiment is low; if there is any doubt then we simply need to look at the retail sales numbers and the public downgrading of David Jones’ profit forecast. We don’t need issues that will reduce consumer confidence even further at this point in our economic cycle. Frankly, I would have thought that the RBA has a tough enough task in managing a two-speed economy as Australia goes through a period of structural change, moving to be more of a resource based economy with a portion of our population relocating and finding employment within that industry.

Reduced consumer confidence will put more downward pressure on our housing markets at the same point in time when it is naturally in decline and is most at risk. Significant reductions in these markets could quickly change our economic fortunes. The impact of significant reductions in housing values on an economy has been well and truly demonstrated in the world events of the last five years.

Late last year I suggested the next interest rate movement would be down and reiterated this just before Easter as it became clear that consumer confidence was turning down and our housing markets started to produced some negative numbers. I remain of this view and think that a rate cut will be sooner rather than later – I expect this to take place in September, however if the carbon dioxide tax does not come to pass then I predict the rate cut will be later.

The months ahead are going to be very interesting. The markets for opportunity are in New South Wales (lowest risk), Queensland and Perth. The latter two should be used to find bargains as these markets do have a little more correction in them.

Until next month
Best regards,
John E Edwards,
Founder and CEO, Residex

About John Edwards…

John Edwards is CEO of FindMeaHome.com.au and Residex, and is recognised as Australia’s leading property researcher.