Pete Wargent blogspot

Co-founder & CEO of AllenWargent property buyer's agents, offices in Brisbane (Riverside) & Sydney (Martin Place), and CEO of WargentAdvisory (providing subscription analysis, reports & services to institutional clients).

4 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.

"Unfortunately so much commentary is self-serving or sensationalist. Pete Wargent shines through with his clear, sober & dispassionate analysis of the housing market, which is so valuable. Pete drills into the facts & unlocks the details that others gloss over in their rush to get a headline. On housing Pete is a must read, must follow - he is one of the better property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.

"Pete Wargent is one of Australia's brightest financial minds - a must-follow for articulate, accurate & in-depth analysis." - David Scutt, Business Insider, leading Australian market analyst.

"I've been investing for over 40 years & read nearly every investment book ever written yet I still learned new concepts in his books. Pete Wargent is one of Australia's finest young financial commentators." - Michael Yardney, Australia's leading property expert, Amazon #1 best-selling author.

"The most knowledgeable person on Aussie real estate markets - Pete's work is great, loads of good data and charts, the most comprehensive analyst I follow in Australia. If you follow Australia, follow Pete Wargent" - Jonathan Tepper, Variant Perception, Global Macroeconomic Research, and author of the New York Times bestsellers 'End Game' and 'Code Red'.

"Pete's daily analysis is unputdownable" - Dr. Chris Caton, Chief Economist, BT Financial.

Thursday, 31 July 2014

Credit growth up to near 6 year high

Credit growth stronger again

The Reserve Bank released its Financial Aggregates today which showed credit growth of 5.1 percent for the past year, the highest rate of credit growth half a decade which is lovely to see.

When I spoke to two members of Commonwealth Bank's small business lending team last month they were adamant that business lending was on the up and up, and it appears that they may be right.

Business lending jumped by 1 percent in June to be 3.5 percent higher over the past year.


As you can see above housing credit growth is now tracking at a very robust 6.4 percent per annum with strong increases over the last quarter in both owner occupier and investor credit, spurred on by low interest rates (click below chart):


In terms of percentage credit growth, there was a good deal of excitement back in 2012 about the lowest growth rates on record which could stymie any housing market recovery.

What this commentary overlooked, apart from the fact that as we're coming from a higher base lower credit growth than times past is inevitable, was the role of cash buyers, overseas buyers and most importantly of all the lag effect of interest rate cuts.

When the effects of rate cuts gradually started to flow through, house prices started rising and now too are transaction levels, building approvals, dwelling commencements, construction activity and building work done.

Housing credit growth is now rising strongly for owner occupiers and even more strongly for investors (click chart):


We always expected this to be an investor-led recovery and thus it has proved as the red line on the above chart shows. 

In fact, if we re-run the chart smoothed out on a rolling annual basis, it becomes increasingly obvious what has driven the housing market rebound - investors.


Indeed, as more Aussies choose to invest in property, home ownership rates will continue to slide towards 60 percent over the coming decade and the percentage share of credit for investors will rise.

This has been playing out over the last quarter century and the percentage share of credit for investment housing is steadily continuing to creep higher.


Low interest rates are steadily taking effect, but in a somewhat unbalanced fashion.

Approvals close to 20 year highs

Approvals down but solid

Building approvals, always a volatile data series by the month, were lower in June, at a seasonally adjusted 15,659, which was 5 percent lower than May.

While this will no doubt be reported as approvals having "collapsed" or "tanked" or "dived", the only thing really worth watching on such a volatile series is the trend.

On an annualised basis, rolling 12 monthly approvals are a mite away from their highest ever level at 194,000.

This is an increase of 16 percent on June 2013, clearly demonstrating the impact of low interest rates and rising dwelling prices (click chart):


On the face of it this is good news for the economy, leading to stimulated construction activity.

Note, though, that when we look at the product mix, this upturn has overwhelmingly been driven by a huge upturn in apartment approvals, which are up by 23 percent over the past year to easily the highest level in Australia's history.

House approvals by contrast are up by a more sedate 13 percent.

Accordingly, the value of residential construction activity may not be as high as implied by the first chart.


On the face if it a solid uptrend - however, approvals have fallen on a seasonally adjusted basis in four of the last five months.

So while there is a large volume of building work in the pipeline, approvals may now be hitting a plateau or peaking. 

State by state

In terms of what is happening at the state level, it is interesting to note that despite relatively high vacancy rates and an elevated level of building over the past decade, approvals are rising again in Victoria.

This will potentially result in a cooling of the housing market at some point, whenever that may be triggered .

Generally, the upturn in house approvals has been solid but not spectacular (click chart).


In terms of apartments, after a woeful decade of undersupply, New South Wales is at last pushing through high numbers of much-needed approvals. 

As this translates to dwelling commencements we should see new supply coming on to the market in the next few years. 

Investors should be wary of buying expensive new stock in Sydney in our opinion - there is far more value to be found in the established sector (click chart).


City by city

Over the past year, Sydney and Perth have now recorded their highest ever level of approvals.

The level of increase in approvals year-on-year has been dramatic in Brisbane (+47 percent), Sydney (+31 percent) and Adelaide (+30 percent).

Lower increases were also seen in Hobart (+13 percent) and Canberra (+23 percent).

It's interesting to note that Melbourne's approvals rose by another 14 percent over the past year, suggesting that oversupply may become a serious issue in some areas on a localised basis.

Summary

Overall, building approvals are punching at very solid levels on an annual basis, but may have hit a plateau.

Elsewhere we see these figures are presented as building approvals versus established population, which therefore show a decline as the population grows.

This is a stock versus flow confusion, though.

How much new stock is actually needed a complicated question - Australia's population grew by around 400,000 persons last year, a figure which will be somewhat less this year, and average household sizes are lower than they once were at around 2.5 per household.

If all approvals are constructed (which they won't be) then Australia looks set to build enough new dwellings for the growing population, if perhaps not enough to bring down dwelling shortages in some areas.

This too is a gross oversimplification, though, which takes little account of regional variances and household formation.

In truth, to understand the impacts on the property markets you need to drill down further to regional and suburbs levels.

Over the long term, we'll see property prices outpace incomes and continue to grow strongly in certain landlocked capital city areas which are close to being fully built out, but outer suburbs will see prices decline in real terms as younger generations put more emphasis on living close to the city, often in medium-density dwellings.

Strong approvals figures are all jolly good news for the economy, but in truth, building more houses and flats can't in aggregate replace the forthcoming fall in mining construction, which means that there is no getting around the fact that low interest rates will be needed for a long time to come yet.


As a result futures markets aren't pricing in a rate hike in 2014...or even through to the end of 2015.

Strongest month in 2014 - stocks up to 6 year highs

The new financial year starts with a bang, with the ASX 200 moving up by another 4.4 per cent in July.

This takes the stock market index up to 6 year highs. 

In particular mining companies fared very well in July adding 7.7 percent following strong production results.

BHP Billiton (BHP) was up 7.7 percent in July and Rio Tinto (RIO) nearly 12 percent as the iron ore price recovered by just over 2 percent in the month.


August reporting season so come...


2 million more vehicles on Aussie roads in 5 years

Motor Vehicle Census

The next fortnight brings with it an avalanche of economic data. Much quieter this week, so let's take a quick look at the Motor Vehicle Census to see what we can learn from it.

Firstly and most obviously there has been a huge increase in the number of vehicles on Australia's roads, up from 15.67m in 2009 to a staggering 17.63m in 2014.

The population of Australia is growing at 1.7 percent per annum but the number of vehicles is increasing at a much faster pace of more than 2.5 percent per annum, and the growth rate has accelerated.

The number of vehicles is up by a staggering 12.5 percent over only five years equating to nearly 2 million additional vehicles. 


In terms of vehicle types, there are many more motorcycles over the past half decade as our major capital cities become denser, but in fact there are just many more of, well, everything.


The lowest percentage increases in vehicles were in South Australia and Tasmania largely due to weak population growth in those states, but elsewhere the percentage growth rates were exceptionally strong ranging from 2.1 percent to 3.5 percent.


The percentage increases instead presented graphically:


Australians are becoming wealthier and with low interest rates have higher disposable incomes and this is translating to what can only be described as a splurge on vehicles. 

When we look at the number of motor vehicles registrations by population we can see that there has been a dramatic increase across every state, reinforcing the point.


The average age of vehicles has remained flat for the past five years at 10.0 years as new vehicle sales have remained robust.


When we consider the absolute numbers of vehicles on the register the figures make for eye-popping reading.

In particular, New South Wales has seen the number of vehicles increase from 4.56m to more than 5.1 million in only five years.

Meanwhile Victoria is not far behind running up from 4.0 million to nearly 4.5 million, and Queensland (3.3 million to 3.7 million) and Western Australia (1.8 million to 2.1 million) are also seeing similar trends.


The figures were comparatively small in other states.

Implications for investors?

This is all good for levels of economic activity in the four major capital cities, but what does it mean for investors?

Firstly and most obviously, don't spend more money on new cars, because in ten years you will have an average car which is worth a heck of a lot less than you paid for it!

In terms of the share markets, the last century has taught us that it does not make sense to invest blindly in car manufacturing companies simply because there are millions more cars on our roads.

Clearly, that would not have been a profitable move in many cases. In a similar vein, while one of the greatest trends unfolding over the past century has been a huge increase in global travel, investing in aviation companies has largely been an unprofitable exercise, some of the reasons for which I discussed here previously.

Ultimately, investors tend to see outstanding returns when they invest in companies which have a strong economic moat, generate strong and sustainable profit margins and that cannot easily be undercut by competitors based in locations with cheaper labour and materials costs.

Australia's car industry, as has been the case in other developed countries, has struggled badly to remain profitable or viable, and will now be allowed to die.

Just as investors in companies which service the resource giants have frequently seen greater returns that those owning shares in the mining companies themselves, investors might instead look towards investing in infrastructure and engineering companies. 

Property market impacts

As for property market impacts, we've always believed that the best property investments are those located in prime-location, landlocked suburbs in thriving capital cities with booming population growth, such as Sydney and London. 

Over the course of a property cycle, the demand outstripping available supply helps certain properties in these locations to outperform.

One of the things we have always looked for is easy access for train links to the Central Business District and employment hubs.

It's been an important lesson learned from mature capital cities such as London where car ownership is often seen to be a bind rather than a benefit, and homes located close to Tube stations and key transport hubs can at times fetch huge premiums while remaining more robust in economic downturns. 

The new Crossrail in London which is to be constructed over the next four years is forecast to increase property prices by 40 percent in certain suburbs which stand to benefit from the improved transport links.

The above data merely serves to reinforce that view in relation to Australia.

With more than half a million vehicles on New South Wales roads in only five years it is a cast iron certainty that Sydney traffic congestion will continue to worsen dramatically over the coming decades, and I for one know that I want to own as many inner suburb properties close to key train links as possible.  

Wednesday, 30 July 2014

New home sales rise again in June quarter

Detached house sales up but South Australia "vulnerable"

New home sales increased by 1.2% in the month of June and 2 percent in the June quarter.

Detached house sales rose in four out of five states and rose by 2.6 percent in the June quarter, and look set to continue their solid uptrend into a third year.


Source: HIA

However, the Housing Industry Association did note the following regarding South Australia:

"Detached house sales fell by 8.4 percent in the June quarter, perhaps an insight into the possibility that SA may be the most vulnerable new home building market in the second half of 2014."

With the volatile number of new home sales only up moderately in the month of June this led to commentators calling the peak for the sixth time in this cycle.

Correct this time? Perhaps...but maybe not.

It could be that we'll now see new home sales rotate away from detached house sales and into multi-units and apartments.

Sales of new multi-units jumped by 16 percent in June and commencements are ramping up, although it's worth noting that a fair proportion of new units are sold offshore to investors.

Finance for new dwellings 

It might be useful to put the number of new housing finance commitments into some historical context.

Below I've run a 3 month moving average of the number of commitments for new dwellings as recorded by the ABS Housing Finance series.

This series will not pick up properties bought for cash, financed offshore or by non-Australian domiciled bank branches.

The 3 month moving average number of finance commitments suggests that the demand for new housing is solid and has been in a very encouraging uptrend, but one that may have stumbled a little.

The housing finance series only runs to May, so more will be revealed over the coming month or two (click chart).


While the Australian population has grown strongly over the decades, the level of demand for new dwellings appears to be robust, but ideally would have plenty further to run in this cycle.

Confidence explodes higher

US consumer confidence roared up by 6.7% to 90.9 in July from 86.4 in June.

This takes US consumer confidence to its highest level in nearly 7 years.

The index has not run so high since October 2007 as the US labour market continues to improve and the stock market remains robust.


Meanwhile, in Australia, the ANZ-Roy Morgan consumer confidence index rose again by another 2.4% to 116.2.

The "sticker shock" from the budget has now well and truly been erased and consumer confidence sits well above its average level from the last 25 years. 

It also brings consumer confidence into line with business confidence "which is good news for business, the economy and investment going forward".

It certainly is!

Mortgage stress

Inflation-adjusted dwelling values remain below peak

It was reported this week by Cameron Kusher of RP Data on Property Observer here that dwelling values when adjusted for inflation are well below their previous peaks, implying that this housing market cycle may have a way to run yet.

Chart 2

Source: RP Data

Clearly the so-termed "property boom" has largely been a Sydney affair.

Mortgage serviceability improved by a third

It's clear that the low cost of borrowing has made life relatively easy for homeowners with a huge drop in the percentage of household disposable income required to service interest repayments from above 13 percent to below 9 percent.

Household Finances graph

Contrary to anecdotal reports of mortgage stress, due to a unique system of repayment scheduling in Australia (where loan repayment amounts do not necessarily shift in response to lower variable rates) we would expect to see the average mortgage in exceptionally good shape for those remaining in full-employment.

And so it is.

In some excellent news, NAB confirmed this week that the the overwhelming majority of its mortgage customers are miles ahead on their repayments, with those ahead on average being more than a year ahead of schedule.

Another enlightening article here from the excellent Business Spectator:

"Record low interest rates continue to have a strong impact on the housing market, with National Australia Bank reporting 85 per cent of its mortgage customers have forged ahead of minimum repayments.
In an emailed statement, the lender revealed those home loan accounts are ahead on repayments by an average of 13 months, an improvement on 12 months in 2012.
Victoria was the best performing state with 32 per cent of customers in the state ahead on mortgage repayments, while New South Wales was close behind on 31 per cent.
Credit card customers are also paying down their debt faster, with NAB reporting a 6 per cent increase in the number of credit card accounts paid in full.
The development follows news last week of the ‘big four’ banks slicing their home loan rates to record depths below 5 per cent.
Consumers are ahead on repayment of other borrowings too, showing just how effective easier monetary policy can be. 
Read the rest of this interesting article here.

This ties in with independent research from the Reserve Bank last year which found that mortgage buffers were on average the equivalent of a staggering 21 months ahead of scheduled repayments.

"Mortgage buffers – that is, balances in mortgage offset and redraw facilities – remain near their highs since the series began in 2008, at 14 per cent to outstanding mortgage balances, equivalent to around 21 months of total scheduled repayments at current interest rates. 

Together, these data suggest that many households have the resources to continue to meet their debt obligations even during a transitory period of unemployment or reduced income."

Graph 3.12: Mortgage Repayment Buffers

The average household has a huge mortgage buffer thanks to low mortgage rates.

And since last year with the cash rate falling to 2.75% on 7 May 2013 and then only 2.50% on 6 August 2013 and borrowing rates declining over the past year, household budgets for property owners have likely continued to get stronger and stronger.

Tuesday, 29 July 2014

Monthly housing market update - July

Housing market snapshot

A lot of property market commentary revolves around clever wordplay or semantic debate, but let's cut to the chase in our monthly housing market update for July and take a look at what is likely to actually happen to the housing market.

Space here doesn’t permit a detailed drill-down across each region and every suburb in Australia, but we’ll aim to at least deliver a flavour of the macro picture and housing market fundamentals in a five-part blog post, commencing with…

Part 1 – Interest rates

We’ve already considered Australia’s macroeconomic picture in detail in many other posts.

Summarily, the growth of the economy in Q1 was driven overwhelmingly by net exports, and most data reported since that time implies a soft GDP print in Q2 with the near-term outlook for economic growth appearing to be fading as commodity prices decline.

Unemployment has ticked up to 6 percent, yet future markets seem to believe that headline inflation hitting the top of the 2-3 percent target band will put an end to the interest rate easing cycle.

That looks at best doubtful, particularly when one looks to split out the impact of tradables inflation (which has been rising quite sharply) from non-tradables inflation which is surely in a downtrend.


Non-tradables and Tradables Inflation graph

The headline and core CPI figures appear to have picked up largely as a result of the pass through from the weakening Aussie dollar, but this effect should now be washing out the other side with a strong reading in the September 2013 quarter due to drop off from the annual reading at the next print. 

With wages growth the at the equal lowest annual level on record across 17 years of data in the ABS series - chugging along at an annualised pace of only +2.6 percent for the last two quarters - the forward-looking risks for rising inflation do not appear to be a huge...at this stage.


In short, there appears to be an each-way chance that the next move in interest rates could still be down.

At the very least it can be said with some certainty that there is no imminent threat of an interest rate hike, and this alone looks set to keep demand for the housing markets buoyant enough.

Moreover, the major banks are scything mortgage rates independently of the Reserve Bank, with 5 year fixed rates declining to record lows of under 5 percent, an exceptionally cheap cost of capital.

Part 2 – Demand

Demand for property in Australia is driven partly by very strong population growth of 1.7 percent per annum or around additional 400,000 persons, although notably the growth is taking place disproportionately in four capital cities and certain other parts of Queensland.


One of the key trends for housing market observers to follow is jobs growth, and here the unadjusted trend figures show that while the economy is adding jobs, the trend was soft in 2013, and has not yet returned to the robust growth rate that would be desirable.


Notably jobs growth has been non-existent on a net basis for some years in a number of states, including South Australia and Tasmania. It is possible that the Australian Capital Territory may face also labour market headwinds going forward due to restructuring in Canberra.

As a result of the employment growth in the southern states, the unemployment rate is too high for comfort in Tasmania where it has been above 7 percent for some time, and the same is true in South Australia where the seasonally adjusted unemployment rate has leaped to 7.4 percent.


Investor demand at record high

A key factor which we identified long ago for this housing market cycle will be the enhanced role of investors and massively increased demand for investment property driven by record low borrowing rates and some investors having been spooked by the most recent equities markets crash. 

Real estate investor loans are continuing to rise very strongly in Victoria and Queensland, while the level of investor activity in Sydney is beginning to mimic what we saw in London many years ago.


As noted above, it was reported this week that the major banks are engaging in a turf war slashing 5 year fixed mortgage rates substantially, down to unprecedented lows of below 5 percent, arguably to keep the housing market rising.

All other things being equal, and in the absence of macro-prudential measures, the combination of low deposit requirements, rising prices and an ongoing quest for yield will likely drag further buyers into the property markets.

Part 3 - Supply

There is better news to come here for property owners and investors in the southern states with regards to dwelling supply.

At the national level, low financing costs and an outlook of rising prices have brought developers back into the fold as expected, and dwelling approvals have been cruising towards record highs.


In particular, national unit and apartment approvals have already crunched through all-time record heights as margins on multi-unit developments have gradually become more favourable since the early part of 2012.


It was quite rightly pointed out by Cameron Kusher of RP Data this week that not all dwelling approvals result in commencements, and this is particularly so for multi-unit projects where the project-specific risk for the developer may be elevated. 

Nevertheless, as recorded in the chart below commencements are also rising strongly and we’ll see record numbers of apartments built this year.


Will this lead to oversupply risk? In some areas, indeed it will, as explored in a little further detail below.

Part 4 – Supply/demand imbalances?

The dwelling commencements data by state reveals great contrasts including how Victoria has been over-building quite dramatically in some locations, while supply in New South Wales has been woefully inadequate since the last property boom ended in early 2004, putting huge upwards pressure on the Sydney housing market as we anticipated years ago.


When considering where building activity has taken place at the state level, it becomes increasingly clear that while some states have flailed, Victoria has been building large volumes of detached housing in some locations over the past decade, and particularly so over the last five years following on from the tremendous run-up in dwelling prices.


And Melbourne in particular has also been building ever more apartments, churning out new stock at an accelerated rate for some years.


This surely must manifest itself in higher vacancy rates, and at some point will likely translate into a slowing property market, although naturally speculative behaviour and rock bottom borrowing rates can easily see prices overshoot at this stage in the cycle.

Just as in the stock market, prices are only linked to fundamentals by the proverbial mile-long rubber band, but ultimately at some point they must snap back into line.

I own property in Victoria myself but would have to concede that the state-level supply figures imply that after a substantial increase in values since 2006, price growth will eventually fall due for a reversal.

The chart above shows that Sydney is also now ramping up its apartment building dramatically which will lead to oversupply medium- and high-density dwellings in some inner south locations as well as potentially in the Central Business District itself.

Vacancy rates

Vacancy rates are now elevated in Melbourne, and stock on market has ben tracking at well over 40,000 which is way higher than in the only state of an equivalent size, should also eventually act to pull up dwelling price growth.

On the other hand our chats above show that there has been very little ramp-up in dwelling construction in Hobart or Adelaide since there has been so little price growth over the past four or five years to inspire developers.

I the true spirit of a housing market cycle, this lack of building is translating into tightening vacancy rates in Hobart and Adelaide, and over the near term an increase in transaction activity suggests that prices should now rise in Adelaide.


Part 5 – Dwelling price forecasts

I explained the rationale behind our 2014 dwelling price forecasts by city here, but will we be accurate?

It should go without saying that city-wide median prices are necessarily of relatively limited value to investors acting rather as one useful indicator, but we present this information here as part of our macro picture overview.

There has been plenty of debate about the merits or otherwise of RP Data’s Daily Home Value Index, but it’s nevertheless been a huge talking point and price movements are reported religiously each week and month in the media.

With only three days left in July, below is what we’ll see approximately for the past month, quarter and year by capital city.


Monthly figures are fairly volatile as expected with Sydney notching 2% growth in July and Melbourne recording some wild manic-depressive swings of late, but over the past quarter dwelling price growth appears to have moderated somewhat on a national level.

Sydney and Melbourne flash up as having recorded growth of around 2% over the quarter, but this iss partly offset by a 2.3% decline in Adelaide.

Some media talking heads and outlets have been gung-ho in torturing the Adelaide figures for a confession this year, highlighting monthly and even weekly gains as ‘evidence’ that the South Australian capital has been the strongest market.

Obviously anyone who can read a simple chart can clearly see that this has not been the case, but as I’ll explore below, thanks to low interest rates and a tightening market the time for improved dwelling price growth in Adelaide is finally upon us.

Sydney

Sydney’s economy looks very strong, with low unemployment and infrastructure and dwelling construction fueling economic robust activity and economic growth set to track at around a pleasing 3 percent over the coming years.

Our forecast of +6 percent to +9 percent property price capital growth for 2014 appears to be well on track, with preliminary auction clearance rates still punching at around 76 to 77 percent last weekend and demand from investors having continued to rise almost exponentially. 


Melbourne

Melbourne is probably the most interesting case in point for the capital cities. I read Louis Christopher of SQM Research in API Magazine stating lately that:

“There’s no boom in Melbourne. This is just a joke. It’s not happening, full stop. A pocket we can talk about is inner-ring freestanding homes, yes we’ve seen strong capital gains there. The rest of Melbourne has done nothing”.

Yet below is what RP Data’s daily index has recorded for the year-to-date as compared to our +2 percent to +5 percent price growth forecast for 2014.


Christopher produced his own research via SQM’s Asking Price Index to show that while there has been a “modest recovery”, the market is now slowing.

In stock market cycles it is frequently observed that fewer and fewer stocks driving the market to new highs is a sign of an imminent market reversal. Whether or not this is what we are now seeing in Melbourne remains to be seen.

Auction clearance rates have declined from their peak and have been well down on those seen in Sydney, but nevertheless have remained reasonably robust, but there's a swathe of stock on the market and vacancy rates are relatively high on a city-wide basis.

Brisbane

Summarily, our view for Brisbane is that the prospects look bright for the few years ahead in the housing market after a lean run spanning several years.

Market activity looks to be picking up and median price gains in 2014 look set to test the top end of our forecast range by the time the year-end rolls around.


Adelaide

Over the longer term, the economic fundamentals show that Adelaide has some substantial challenges and hurdles ahead.

Net-net South Australia has added a total of zero jobs to the labour force since 2010, unemployment in South Australia is the highest in the country at 7.4 percent and population growth (whether by cause or effect) is relatively weak both in absolute and percentage terms.

However, housing markets by their very nature move in cycles, and with house prices failing to match inflation for some years now construction activity has been muted, and the market is tightening.

And importantly, Adelaide has one ace up its sleeve as compared to the other major capital city markets in Australia: affordability.

The number of sales transactions is rising, and therefore while RP Data’s index actually shows median prices declining it now appears likely to us that prices should eventually challenge and possibly eclipse the top end of our forecast 0-3 percent price growth forecast range.


However, that said, it does seem that price growth in this cycle could be capped given the weakened state of the local economy and other fundamentals noted above.

The ABS Lending Finance data series shows that aggregate demand from investors in South Australia remains below where it was in Q4 2007.

Meanwhile, the weak employment data therefore suggests that rising prices are overwhelmingly to be driven by low interest rates rather than jobs and population growth, which logically suggests that there ought to be a limit to how far prices might be stretched in this cycle.

Perth

I considered the outlook for Western Australia in some detail hereOur forecast was for flat dwelling prices in real terms in 2014, and this looks likely to play out as the remainder of the year unfolds.


The economic outlook for Canberra and Hobart remains somewhat subdued and we believe that our forecasts could be on track, although we'll watch out for an upside surprise from Hobart.

Sunday, 27 July 2014

UK GDP recovers in full

It's been a heck of a long time coming but the UK economy is finally now larger than it was before the financial crisis, with GDP at last having recovered in full.

The financial crisis recession has been one of the deepest and longest, with the economy taking fully 25 quarters to recover to its previous level, as compared to 5 quarters and 13 quarters for other recent recessions in the 1990s and 1980s respectively.

From peak to trough the UK economy shrank by a shocking 7.2 percent, and it has taken more than six full years for the previous level of activity to be recovered (click chart).


The UK economy recorded growth of 0.8% for the April-June 2014 quarter and 3.1% over the past year, the fastest annual rate of growth recorded in Britain since 2007.

Britain is also set to have the fastest growing developed economy through 2015 according to IMF forecasts.

The growth was largely driven by services output (+1.0% q/q). While manufacturing and construction have been picking up, these sectors had fallen so catastrophically since the onset of the crisis, that it will be a long, long road back.

Housing construction in particular has been tragically inadequate, resulting in a massive dwelling shortage in London and the south-east of England.

So, it's been a long time coming but the British economic recovery is now in the bag.


Employment is at a record high, house prices are at long last at or approaching record highs and the FTSE has ripped up to above 6,800, around 8 percent higher than a year ago.

It's been a long, slow haul granted - wages have slipped in real terms, and GDP per capita is not expected to recover in full until 2017.

But it's a fine case in point to demonstrate that even the deepest and most brutal recessions will end eventually, and long-term investors in quality appreciating assets will succeed over the long haul.

Saturday, 26 July 2014

Large cities - the engines of Australia's economy

Capital city hubs the engines of our economy

There has been a long running debate in Australia about the seachange phenomenon, but to my knowledge there has been not one iota of compelling evidence that Australians are moving away from the capital cities en masse.

In fact, all of the available evidence has proved precisely the opposite to be true: we have an overwhelming and increasing focus on the inner suburbs of our major capital cities.

The Reserve Bank of Australia recently carried out its own demographic research into the subject and found that jobs growth, population growth and house price growth are all becoming ever more inner capital city centric.

I didn't form my views by accident, by the way. Rather I've watch similar trends play out over the last couple of decades in a mature capital city (London) where the focus on prime central locations continues to grow and the disparity between dwelling prices in inner and outer/regional locations grows by the year.



With another 1 million people expected to descend upon London over the next decade, properties located to key transport hubs on the new Crossrail transport links are anticipated by analysts to boom by another 40% over the next four years.

Still, it's always good to consider a range of independent sources, and in that context I'll take a look today at the Grattan Institute's recent report "Mapping Australia's Economy" to see what we can learn from it.

Finding 1 - Economic activity is focused on a few capital cities

First and foremost, Grattan found that a stunning 80% of Australia's goods and services are generated on just 0.2% of our land mass leading to the inescapable conclusion that "cities are the engines of our prosperity".

This is partly because of the concentration of jobs in our Central Business Districts, but also because jobs based withing the inner cities are more productive than those located elsewhere. 

The largest cities and not regional centres are the key to Australia's future because economic output is becoming more knowledge and services based than it was in decades gone by when agriculture and mining dominated the economic landscape, a conclusion also reached by the most credible of economists, Ross Gittins. 

Even in the mining states such as Western Australia, a third of employees in that industry live in the state's capital city of Perth, partly due to fly-in fly-out, and partly because the accountants, engineers, executive and administrators are based in the city locations.

The red areas on the map produce 80% of Australia's economic activity on just 0.2% of the land mass.


Grattan found that capital cities are vital to economic activity, driving most of the economy is every state .

Even for regional centres, Grattan found that it is their proximity to the CBD which largely drives their fortunes and respective rates of growth. According to Grattan's research, regional centres located less than 150km from the CBD are growing at a considerably faster pace than those located further away.


Finding 2- Economic activity is most intense in Central Business Districts (CBDs)

Even within metropolitan areas, economic activity is heavily focused on central areas, and in each capital city intense activity is focused on only a small number of locations.





In Sydney, for example, half of all economic activity is generated from less than one percent of its land mass, with a similar pattern evident in other large cities.


Finding 3 - Inner city hubs have greater economic productivity

Economic productivity is much higher in the CBDs, partly because these areas are the major employment centres. But according to Grattan it's more than that, because concentrations of economic activity offer other big economic benefits:

"Businesses are more productive when they interact with larger numbers of customers, suppliers, competitors and partners, and when they can do so more frequently and closely. Employers are more productive when they have a larger pool of employees to draw on. 

Employees with a larger choice of potential employers are more likely to develop and make the best use of their skills. They also typically have better chances to be re-employed quickly if they lose their job."

In a virtuous circle, businesses also benefit from having a wider range of employees to choose from to fill vacancies, while specialist roles are also easier for them to fill. Being near to and interacting easily with other businesses helps corporations to flourish.




Finding 4 - Access to jobs is poor in outer suburban locations

Unfortunately, Grattan found that access to jobs in outer suburban locations is poor and "too many workers live too far from jobs. Few people are willing to commute further for jobs than they have to".

In all major capital cities, concluded Grattan, there is a major advantage in proximity to the city's centre. Research showed that in outer locations a very small percentage of jobs can be reached with 45 mins by car travel.


When Grattan considered public transport, their conclusions were diabolical for outer suburbs. In Sydney, for example, huge swathes of the city are almost totally cut off from access to jobs even if commuters are prepared to travel for a full hour by public transport.


Conclusions

Grattan's conclusions were direct and to the point: further urban sprawl would be damaging for economic prosperity, job opportunity and productivity.

"The vast majority of economic activity takes place in Australia’s large cities. And within these cities, economic activity is heavily concentrated. Australia's cities are the backbone of our economy, with CBDs and inner city areas critically important to the nation’s prosperity. 

Their predominance reflects the economy’s evolution from one based on primary industry, then manufacturing, then increasingly knowledge-intensive services."

Grattan advises that governments need to rezone or make land available for more people to live close to the cities while also improving transport links for those located in middle ring suburbs.

Former Reserve Bank of Australia senior analyst Callam Pickering, who's views and analysis are always worth a read, similarly concluded:

"Australia will continue to shift towards a more services-based economy, which suggests that activity will become increasingly concentrated within our major cities. As that happens, I expect that higher-density living will grow more popular as Australians put a premium on living where the action is."

Indeed so. The above conclusions help to explain why house prices have continued to and will continue to rise faster in inner ring city locations than outer ring suburbs in every capital city. This has demonstrably occurred both over the long term and over the past 7 years too as the ratio of inner ring to outer ring prices continues to widen in its disparity.

Graph 11: House Price Gradient