IMG_2386What causes a property market to crash? Is it a falling economy? An unemployment outburst? A building oversupply? Should we concentrate on consumer confidence data? Or is it as simple as common-sense about supply and demand?

There has been a long-standing fear that Australian property could tumble, with some of the world’s most renowned investors (Jeremy Grantham and Robert Shiller included) claiming the valuation metrics for Australian property appear distressed or weak. However, these investors have been proven wrong again and again.

It raises an interesting point about the real drivers of residential property. The Investing Times tracks nine key supply and demand data indicators to answer this question, and while we acknowledge is not a crystal ball, it does seem a useful proxy in a world of excessive fear-mongering and ignorance.

Here are nine metrics you might want to add to your watch-list if you are interested in the wellbeing of the property-market. For strong future returns, you want to see:

  1. Rental yields strong relative to interest rates (differential less than 1.5%). Positive (Current stance) 
  2. Overall employment growth above long-term average. Negative
  3. New building growth sustainable relative to the population (between 1-2x population/building ratio). Negative
  4. Total housing market sustainable relative to size of the economy (housing stock to GDP ratio less than 300%). Negative
  5. 5-year price growth at sustainable levels (equal to or less than nominal GDP). Negative
  6. Recession risk low (yield curve positive). Positive
  7. Overseas arrivals increasing (six-monthly trend change). Neutral
  8. Lending growth expanding (home loans and other credit) above long-term average. Positive
  9. Rental income growth exceeding inflation (YoY change). Negative

Property marketSaid another way, for a crash to occur, we should be able to identify it because the catalyst is likely to be rising unemployment, falling migration rates, a recession, an interest rate spike, or a realisation that prices are simply too expensive relative to the size of the economy. And as can be seen in the chart, the strength of the data has a strong correlation to the future 5-year outcome.

Of course, this could be narrowed on a state-by-state level, or suburb-by-suburb level, and would make the research even more relevant (eg. Sydney and Perth have very different dynamics currently). However, using the weighted average of the 8 capital cities is still useful for the overall health of the property market.

Is a property crash likely in the next 5 years? With the current scenario showing only 3 of the 9 indicators positive, the data tells us there is an increasing reason to fear for the wellbeing of the property market in the short-to-medium term; although any calls for a crash would appear premature – at least for now.

One reason for continued demand is record low interest rates – especially relative to rental yields – and this is unlikely to change in the near term. Another reason is offshore demand, although the official numbers have shown overseas arrivals have stagnated since the currency fell below $1.00 in mid-2013, this currency drop has made Australian property 25% cheaper for an offshore buyer.

Therefore, while the general supply and demand outlook of property fundamentals has deteriorated over the past year, there are still healthy demand drivers. Overall, the data seems to illustrate there is a basis for growing caution, with the overall score  significantly lower than we have seen on average over the past 20 years, which may point to lower average returns and/or marginally increasing risk (although this should be no surprise).

What do you think of the supply and demand backdrop? What other factors would you consider? It is a healthy debate worth having.

Please note, this will be a regular feature in the Investing Times reports, so if you are interested in seeing more data like this (we run a similar model on the share-market with similarly strong correlations) then please request a free trial report below. We also have a range of other thought-provoking articles available at www.investingtimes.com.au or encourage you to subscribe at www.investingtimes.com.au/subscribe

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