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Special ECONOMIC UPDATE Edition...

Twice each year, in March and September, members of the Investment House team meet with senior economists from BIS Shrapnel to review recent market happenings and gaze into the economic crystal ball. BIS Shrapnel have long been regarded as one of the leading economic forecasting groups in Australia, particularly in the areas of construction and property investment and have quite an enviable record for calling trends accurately. . 

This March, Investment House Managing Director Colin Ferguson spent a half day with Chief economist Dr Frank Gelber and Senior Economist Mr Richard Robinson. 

Forecasting is not an exact science

Before exploring the forecast, let’s get one thing on the table up front. It’s important to understand that economic forecasting is not an exact science. Economic forecasters are a lot like weather forecasters – the further into the future we look, the more general the forecast becomes. And in the same way that it sometimes rains in one suburb whilst another doesn’t get a drop, there will be different economic outcomes in one area compared to another. We need to listen to their message and apply the trends and approximate timings to our investment decisions rather than pin our hopes on exact highs and lows occurring on exact dates and times.

Additionally, we need to be mindful that they represent just one professional opinion. Much of the “professional opinion” is broadly in line with BIS Shrapnel, but that is not to say there aren’t some significant dissenters.  

A key reason for our working closely with BIS Shrapnel over other forecasting groups is their “medium term outlook”. They look to forecast likely trends over the next two and three years. This medium term outlook is unusual in economic circles. Most commentators getting air-play in the media are employed by the banks and fund managers. Their expertise and focus is more inclined toward the short term money market, so for them forecasting 90 days in advance is “long term”. From our perspective as property investors, a 90 day forecast is almost irrelevant, and the two to three year outlook is much more valuable.

And an apology. In past issues we've been able to include copies of the specific charts made available by BIS Shrapnel. This provided very targeted information to support their forecast, however, due to a recent "changing of the guard" at BIS Shrapnel - this is no longer possible. In place of the BIS Shrapnel charts you'll see ABS sourced charts to offer a statistical framework for the commentary.

So what is it they are saying?

In a nutshell, at the national level, the economy is growing well and will stay that way through 2007 before heading into a downturn late in 2008. Interest rates are forecast to peak at 8.3% before retracing around Christmas 2008.

In Queensland, the resources boom continues to fuel economic growth and we continue to enjoy strong population growth coupled with spectacularly high job creation. Residential rents are increasing on the back of very low vacancy rates, and house prices are experiencing moderate growth.

Dissecting the national figures further, they see

  • The economy has been strengthening since 2001 driven first by the residential housing boom and consumer spending and more recently by business investment comprising expansion of production capacity (mining infrastructure, general warehousing, racking and shelving, telephone systems etc). More recently we have seen the emergence of a two speed economy with the resource rich states of Western Australia, Queensland and Northern Territory enjoying the mining bonanza. Nationally, the economy is forecast to continue to demonstrate this strength through 2007 before softening mid 2008. The strong Australian dollar makes imported goods attractive at present but is not supportive of our export industries (such as tourism and agriculture in Qld). The currently very strong Australian dollar is set to fall back in conjunction with falling commodity prices mid 2008, which will be more favourable to Qld tourism and agricultural exports.

  • Employment levels are very strong with unemployment holding at a low 4.5% (and 4.0% in Qld). Business is feeling the skill shortages and this is putting significant upward pressure on wages which in turn is flowing through to inflation. The majority of workers are in the category of “individual contracts” and the forecast suggests they can anticipate further increases to salaries in the order of 15% over the two financial years ending June 2008. This substantial increase in family income at a time when house prices are forecast to enjoy only modest growth will have the effect of improving housing affordability and confidence, which in turn will help to underpin the next cycle of growth.

  • The employment prospects / skills shortage is exacerbated in both Queensland and Western Australia where the resource booms continue to have a significant impact. Both states are currently experiencing previously uncharted highs in the ratio of job vacancies to unemployed where there are just 2.5 unemployed persons to every job vacancy. There were over 100,000 jobs created in Qld in 2006. This is good news for property investors as job creation underpins continued migration, which in turn generates further demand for housing.

  • Headline Inflation (CPI) fell back from a high of 4% in June to 3.3% in December, just above the Reserve Bank target range. Baseline Inflation remained surprisingly benign finishing the year at 2.7% which remains well within the Reserve Bank’s target range of 2-3%. The forecast to 2008 is for Headline Inflation to fall further to just above 2% (well within the target range) then rebound above 3% around December 2007. But don't get your hopes up yet - during that same period, baseline inflation is forecast to increase steadily to 3.4% causing more concern for the Reserve Bank and forcing them to raise interest rates.

  • Interest Rates are forecast to increase as the Reserve Bank responds to inflationary pressures – after recent rises, variable housing rates are holding at 8.1% but are forecast to rise to 8.3% by mid 2007 then probably stabilising at that level before softening in December 2008. This forecast softening is likely to represent a key trigger for the Brisbane property market.

  • Population migration to Queensland has softened on previous years but remains very positive with net international migration of 28,689 and net interstate migration of 21,584 to the Sept Quarter. The forecast is for it to remain strong (at about this rate). This reinforces the existing high demand for housing.

  • Queensland dwelling approvals are currently around 38,700 pa which is approximately 4,000 less than that required for demand flowing from population gains. To meet demand, it is estimated supply would need to increase to 43,000 pa. This supply deficiency has been growing for several years and has now amounted to an underlying stock shortage of 45,000 dwellings (representing 14 months supply). This stock deficiency represents a huge opportunity for investors.

Okay - that's the "big picture".., let's get closer to the ground and talk about "the view from the front line..,"

In our last economic update (April last year), and for some 15 months prior we’d been describing the retail sales market as being “confused”. There have been mixed signals. On one hand there have been some quite healthy sales prices, but these have been intermingled with other sales at lower than expected prices.

In October / November 2006 that changed and the Brisbane market shifted up a gear. It's happened on the ground - but it hasn't yet been reflected in the statistics. So watch this space!

Median Prices and Sales Volumes represent good indicators of local activity. The following charts show example suburbs ranging from 2km to 25km from the GPO - but they still don't show the recent shift in the market clearly. It is interesting to note the local price growth pattern for each suburb in comparison to the median lines. Although the suburbs were selected randomly and the sample is very limited, it would appear the further out from the GPO a suburb lies, the more volatile the cycle is likely to be. The stagnation phase appears longer and flatter than suburbs closer in, and the boom and bust phase are markedly steeper. It magnifies the importance of selecting quality areas during stagnation phases.

And on the Rental front

On the Rental front, the story has been quite the opposite. Responding to continued demand, vacancy rates have fallen and weekly rents have increased dramatically over the year (generally in the order of 10%) and upward price pressures continue in line with the strong migration element. And BIS Shrapnel's Robert Mellor says they have another 30% to go yet. What that does is adds "pain" to renting, and makes the decision to "buy" more attractive. It will add weight to the next wave once interest rates come back as forecast for Christmas 2008. For Property Investors, Santa should be very generous with the presents!

What About Interest Rates? 

Interest Rates deserve a different approach too. Do your sums, but it's likely now too late to be fixing your loans portfolio. The forecast is for another small rise of approx 0.25% and then we're likely to see rates come back down (for Xmas 2008). Fixing now just may lock you into a "not so attractive" rate in the near future - so do your sums carefully.

Psychographics CONTINUE to Put Brisbane At Odds With Fundamentals?

Up until very recently, the current Brisbane market appeared to be running against the fundamentals. Statistically, there is a strong underlying demand and a substantial housing stock deficiency, yet (in practice) we have seen a relatively soft market. On face value, this runs against the law of supply and demand. Strong demand plus short supply should mean price growth.

Here’s the distinction - the reality is ACTUAL DEMAND is only now building. International and interstate migrants are still arriving in droves, so UNDERLYING DEMAND is high, but they are not buying – so ACTUAL DEMAND is yet to hit.  

One key question is: why aren’t people buying? There seem to be little or no statistics to answer the question. It is my view that the combined “psychographic” (the reason people do things on mass) is holding the market back. If we analyse the buyer market by dissecting it into behavioural groups it enables us to draw some possible conclusions. Consider these groups,

  • First home owners – haven't been able to afford to buy, but are now becoming progressively less happy with seeing their pennies disappearing in high rents, but they're still sensitive to housing affordability. With the skills shortage and tax cuts translating to higher take home pay, they will begin to re-enter the market. We're beginning to see it now. But when interest rates fall back, they will come with gusto - my guess is Xmas 2008;

  • Up-graders (buying second or subsequent homes for owner occupancy) – who largely satisfied their needs during the last boom are now over the “new house honeymoon”. Their kids are now five years older (and perhaps another child has presented in that time) so they really could do with a bigger home. The kids will need one bedroom each - so they are starting to feel an “itch” to upgrade. My guess on timing: just behind the First Home Owners (say 2009);

  • New Arrivals (interstate and international migrants) – a mixed bag with some choosing to rent and others have been buying quite well in quality areas. But the rental market isn't very attractive, and some buyers are now starting to miss out. Some former "renters" are changing their ideas to "buying" and are finding they have to lift the bar in regard to prices if they're to get what they want, and;

  • Investors – are out of the game. Traders have shifted their funds to equities and are enjoying themselves, and the “medium term” investors who bought in the boom are happy with the increasing rental yields - so they're out of the market for the moment. But once the statistics start to flow and the media bandwagon gets going about a new property boom, it will be on for young and old (my guess is about 2010)

This is actually a fairly normal part of the cycle.

The other vital question is: when will will people start buying? And we're seeing it now. This is the calm before the storm, when the smart money recognises a subtle shift in the market and buys to secure early profits. In my opinion, there exists a window of opportunity for the Brisbane market between now and Xmas 2008.

The Property Price Cycle

So, in summary?

In my opinion, the New Arrivals group is likely to lead the way. The tightening rental market is forcing them back into buying mode (and there's evidence this is happening now). Over the next eighteen months or so they will be joined by some of the First Home Owner group as they see housing affordability improving (a function of flattish prices and increasing wages) and they look for alternatives to the uncomfortably tight rental environment.

By this time next year, the Reserve Bank will have reigned the economy in with another interest rate rise. And it’s possible the equities market may well have had its run. The economy will soften, and then interest rates will come back which will usher in the next boom phase. Did I mention Xmas 2008?

With the pressure off interest rates, we’ll likely see the years of underlying demand move into buying mode. All behavioural groups will progressively move into buying mode as the:

  • First Home Owners enthusiastically re-enter the market,

  • Up-graders satisfy their itching for change (having been in this house for six years) and re-enter the market,

  • New Arrivals continue buying as they arrive, and

  • Investors will come flooding back to property (which will over heat the market one more time, and we then we’ll start all over again).

So what does all this mean to the property investor??

Crystal ball gazing is risky at best, but you should certainly be preparing for the next cycle. This is the time to be “loading the bases” in preparation for the next boom phase. Get your finances in order and get funding in place. You don’t have to rush, but you need to be planning. Plan to have the bases loaded by Xmas 2008.

If the tea leaves are right, this next boom will give a bumper crop. Those who position themselves well and take full advantage of the cycle will stand to make a very handsome profit. I’m personally going out of my way to do exactly that!

DISCLAIMER – this economic update is provided as a general overview of the Brisbane Property Market for Investment House clients.  It does not constitute advice and Investment House does not accept any liability for any decisions based on this information.  Be aware there are frequently significant differences between predictions and the actual results subsequently achieved. Property investment involves elements of risk, and no extent of information or advice can completely eliminate the impact of risk. The risk of loss in the enhancement of real estate assets is always present.

 

Disclaimer

 
 

All information in this report is general information only. Nothing in this report is meant to be specific investment advice, nor should you treat it as such. Everyone's individual circumstances will vary widely and you must seek advice from your own independent licensed investment adviser before investing into any form of investment. Investment House, its employees and representatives take no responsibility for the result of any actions taken by the readers of this report.

Investment House and its related businesses makes no representation and gives no warranty as to the accuracy of the information in this document and accepts no liability for any errors, misprints or omission herein (whether negligent or otherwise).