Adjusting property value growth for inflation
Sunday, August 21, 2011/
With property values falling across most parts of the country and inflation climbing we look at the impact of inflation on property values and how the capital city property markets are performing in inflation adjusted terms.
Inflation, as measured by the Consumer Price Index (CPI) has been heading higher over recent months. During the three months to June 2011, headline inflation was recorded at 0.9% in comparison, property values across the combined capital cities fell by -1.5%. The net result of the 0.9% inflation and the -1.5% fall in property values is that in ‘real terms’ property values fell by 2.4% over the quarter across the combined capital cities.
The fall in real terms will most likely be welcomed by those looking to purchase property. As property values ease and the cost of other goods and services increase, property becomes relatively more affordable. Now a couple of quarters of falling values is unlikely to result in a substantial improvement in affordability however, if property values continue to grow at a rate below the growth in inflation (as we anticipate) affordability will continue to improve.
Despite the recent falls in property values, for much of the last fifteen years growth in capital city home values has well and truly outpaced the rate of inflation. This has resulted in properties becoming relatively more expensive. Now there are some reasons for the surge in property values: lower mortgage rates, greater availability of credit and a rise in dual income households to name a few.
The Australian Bureau of Statistics (ABS) also publishes inflation figures at the capital city level, utilising these figures we can adjust individual capital city property value growth based on inflation within that city on a quarterly basis.
At an individual capital city level, property values have grown by as much as 166.2% over the past fifteen years in Melbourne and by as little as 87.5% in Sydney. Note that Darwin housing data is not available back fifteen years.
What is probably the most interesting take-away from the data is looking at how much capital city home values have fallen from their peak in non-adjusted terms as opposed to adjusted terms.
In non-inflation adjusted terms, capital city property values as at June 2011 were -2.3% below their quarterly peak which was recorded in September 2010. When the results are adjusted for the effects of inflation values peaked during the March 2010 quarter and to the end of the June 2011 quarter values have fallen by more than double the non-adjusted figure at -5.8%.
Sydney is the most interesting city to analyse. In non-adjusted terms, property values peaked in March 2011 and were recorded at -0.8% below the peak as at the end of June 2011. However, when the data is inflation adjusted on a quarterly basis the Sydney market actually peaked during the September 2003 quarter and values remain -7.9% below their September 2003 peak despite recent strong growth. The reason for this is due to the fact that Sydney property values peaked during February 2004 and thereafter fell for more than five years, not eclipsing this previous peak until April 2009. At the same time, inflation was obviously prevalent in the market resulting in real value falls of as much as -17.0% at the weakest point in the market (December 2008 quarter).
Brisbane has been the weakest performing capital city market over recent times with property values down -7.3% from their March 2010 peak. When the results are adjusted for inflation, the fall in values from the March 2008 peak is much more pronounced at -12.3%. Similarly in Perth, the fall from the market peak is more than double (-5.4% versus -11.3%) when the results are adjusted for inflation.
Overall, we tend to focus heavily on the nominal change in values but it is also important to look at the affects of inflation on value changes. Given the expectation of limited value growth as a result of consumer conservatism and limited availability of finance, in inflation adjusted terms (and real terms) homes are likely to continue to become relatively more affordable. This is great news for potential home owners at it will make home ownership a more realistic prospect over time.
On the flipside these conditions are likely to impact on negatively geared investors. Given this, RP Data anticipates that investor activity is likely to remain relatively subdued and those investors which are active in the market are likely to have a much greater focus on yield maximisation rather than negatively geared properties. At least for the short term, investors chasing substantial capital gains are likely to be disappointed given the anticipated market conditions.
Tim Lawless is research director at RP Data.