3 January 2007

2007 REAL ESTATE MARKET OUTLOOK

Economic overview

Australia’s real gross domestic product grew 2.2% in the year to September 2006, driven by exports and household consumption, although affected negatively by the drought. Unemployment of 4.6% is the lowest level recorded in over 30 years. The Consumer Price Index (CPI) increased by 3.9% in the year to September 2006, while median weekly family income increased by 2.7% over the same period. The Reserve Bank raised interest rates three times during 2006, resulting in an average standard variable interest rate of 7.85% in December 2006.

Residential property prices

During 2006, house prices rose across Australia, ranging from 0.6% in Sydney to 38.7% in Perth. Demand for housing finance weakened sharply in the second half of 2006, in response to interest rate rises and deteriorating home loan affordability. A slowing in demand for property, despite positive population growth in all States and Territories during 2006, will limit price growth in 2007.

Current evidence suggests that Sydney and Adelaide prices will likely remain flat into 2007. The more moderate growth in Melbourne, Brisbane, Canberra and Hobart during 2006 has already begun to slow in all cities except Hobart, and it is likely that price growth in these cities will also be more subdued in 2007. Strong interstate migration to Queensland along with strong commodities prices may assist in maintaining positive price growth, particularly in South-East Queensland.

Perth and Darwin had an outstanding year for median house price growth in 2006, although there is evidence that the boom times of 2006 are slowing in Perth. However, net overseas migration to Western Australia is high, and the unemployment rate is low (3.1%), which will assist in maintaining stronger demand than in other parts of the country. Darwin continues to have strong prospects for price growth into 2007, in response to the commodities boom and high demand for quality contemporary property.

Real estate sales activity

The two year slowdown in residential building activity in the Eastern States will result in reduced availability of housing stock for sale or rent during 2007.

In contrast with the Eastern States, dwelling construction in Western Australia increased during 2005/06 in response to strong demand driven by the housing boom.

This will slow in 2007, in response to skilled labour shortages and higher interest rates. There is some evidence that demand is cooling in the WA market.

Rental market

The demand for rental properties is outstripping supply in every capital city in Australia, with a weighted Australian average vacancy rate of 1.7%, well below the industry vacancy rate benchmark of 3.0%. This is not likely to improve in the shortterm, based on falls in investor financing in the second half of 2006.

Rents increased by an average of 9.8% over the year to September 2006, significantly above the CPI increase of 3.9% and the increase in median weekly family income of 2.7%. They are likely to continue to rise across the country during 2007, particularly in Sydney which has been slower to respond to the tight vacancy rates than other locations.

Renters who are saving for a deposit to purchase a home will have less saving power, thus making home purchase even more difficult, particularly for lower income earners and those living in cities with higher median house prices.

Rental affordability is already a significant issue in several cities, notably Canberra where the median rent for houses is $320 per week, and for other dwellings is $300 per week.

Making the transition from renter to home owner is something most young adult Australians aspire to. However REIA is concerned that many 25 – 35 year olds will have difficulty making the leap from renting to buying because of heavy financial commitments including higher rents, significant credit card borrowings, HECS commitments, increasing child care and fuel costs. Many in this age group, which traditionally earns less than older cohorts, are also part-time or casual employees, thus making it difficult to borrow adequate funds for home purchase.

Home loan affordability

Australian families required 33.8% of family income to pay an average home loan in September 2006, the worst result for 25 years aside from an 18 month period from March 1989 to September 1990. Amongst OECD countries, only the Netherlands and New Zealand have a higher percentage of mortgage debt as a percentage of household disposable income, with the level of debt in the Netherlands being promoted by a policy of negative gearing for owner-occupied homes.

Three interest rate rises during 2006 have had a significant impact on home loan affordability, as increases in median weekly family incomes have not kept pace with the increased amounts required to meet home loan repayments. The situation has been exacerbated by significant increases in house prices in Darwin, Perth, and to a lesser extent, Hobart, during 2006.

First home buyers have been most affected by the deteriorating affordability and the increase in interest rates, with the share of all dwellings financed by first home buyers at 17.4% in September, compared with an historic average of 21.8%.

Commercial property

Office property has experienced a tightening in vacancy rates over the past two years, with yields increasing accordingly. This is expected to continue into 2007.

Although the growth in household consumption has slowed, low unemployment will provide support for a healthy retail property market into 2007.

The industrial property market will remain buoyant in 2007, reflecting the continuing growth in GDP, and recent changes to superannuation.

Property investment

A tight rental market is an attractive proposition for property investors who intend to make quality long-term investments and are not seeking short-term capital growth. The 2007 property market is likely to offer significant opportunities for long-term investors, particularly in locations where prices are moving downwards, eg Sydney.

REIA data shows that the average annual return on property investment over the past two decades has ranged between 12.0% for other dwellings and 14.1% for houses in Sydney; to 17.1% for Perth houses and 17.2% for other dwellings in Perth and Hobart.

Conclusion

A continued softening of the residential sales market in the Eastern States, and rental increases in response to tight vacancy rates, will ultimately lead to improved residential investor yields, creating new interest to re-stimulate the market and values.

The negative impact of the drought on the rural and regional economy can be expected to have a negative multiplier effect which will be particularly evident in rural and regional towns and cities, and may have a flow-on effect to the capitals.

For more information or to arrange media interviews, please call:
Graham Joyce REIA President 0418 923 053
Noel Dyett REIA Deputy President 0418 532 145
Alison Verhoeven REIA Public Affairs Manager 0403 282 501

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