WHY PROPERTY PRICE MOVEMENTS ARE NOT AS THEY SEEM
Introduction
We have commented before about the press promoting what is sensational, rather than giving a
balanced picture.
It did this during the Global Financial Crisis, producing articles claiming that Australian residential
property prices were likely to crash. It is still giving press coverage to the academic that falsely
predicted that Australia would see dwelling price falls of 40%, and a decade long depression where
unemployment would reach 15-20%. This undoubtedly sells newspapers, but in our view is
irresponsible and encourages people to make foolish decisions.
Now the press is providing sensationalist comment in the other direction, focussing on the recent
report by the Australian Bureau of Statistics (ABS) that property prices have increased 20% over the
last year, and by more than 20% in Sydney, Melbourne and Canberra.
We believe that the actual increase is far more modest.
The following table shows the growth in house prices over the past four quarters estimated by four
separate sources.
Many measures use some concept of the concept of the “median” price, calculated by ranking all
sales from highest to lowest, and taking the price of the dwelling in the middle of sample.
A problem with the median price is that even if the price of each individual dwelling shows no
change at all, the median price can still change. The median dwelling – the one which falls in the
middle of the range - will:
Be a cheaper dwelling if activity is biased toward cheaper dwellings, as occurred a year ago
when there was a lot of activity in cheaper dwellings from first home owners
Be a more expensive dwelling when there is more activity in expensive dwellings, as there is
now
In this example, the change in the price of the median dwelling has nothing at all to do with a change
in dwelling prices – it is purely a result of high activity in one part of the range altering the type of
dwelling that falls in the middle of the range where activity is occuring.
Applying this to the current situation, we see that the latest median figures compare a market where
the proportion of cheap homes sold was low (now), with a period when it was high (a year ago) – it is
no surprise that the two medians are well apart, because the groups of sales being compared are
quite different.
This change in activity of first home buyers is evidenced in the RBA chart below.
The other interesting feature of the chart is that investors are moving back into the market.
Lessons
1. Do not to take at face value what you read in the press – often you only read that part of the
story most likely to grab attention
2. Do not even take at face value what the experts tell you e.g. did house prices rise over the
year by 10% (Residex) or 20% (ABS)?
3. Do not take forecasts at face value – if the experts cannot even tell you what happened in
the past, can they really accurately forecast the future
4. Take the time to understand how the various price estimates are calculated, so that you can
interpret them more sensibly (this is explained below)
5. Recognise that property investment is a medium/long term proposition – over the longer
term, the various measures fall into general alignment
6. Make any investment decision based on long term fundamental forces, not what (potentially
biased) month to month, or quarter to quarter figures are showing
How property prices are calculated
The main measures used to calculate dwelling prices are outlined below. This is a high level
overview only, as the various approaches can be quite sophisticated (eg the ABS explains its
approach in a document of 40 pages), and some are proprietary, so the outlines below are designed
to provide a useful general picture in a simple way, not to explain the detailed statistical analysis.
The Real Estate Institute (REI)
The REI uses a simple median i.e. the sales are ranked from highest to lowest and the one in the
middle is picked. This has the flaws mentioned above.
Australian Bureau of Statistics
The ABS has in recent years upgraded their approach to a “stratified median”. They divide (or
stratify) each capital city into clusters, based on similarities in the type of dwelling – there are 5
regions in Hobart and 22 in Sydney. They take the median of each cluster. They then weight each
median by the estimated importance of its cluster based on 2006 census data.
This approach will help to eliminate flaws caused by a change in activity between the various
clusters, but not within the cluster itself – eg. a shift of activity within each cluster from low to high
quality dwellings will bias the figures.
The ABS sample data do not include units or semi-detached dwellings (about 25% of dwellings in
capitals) or dwellings in regional areas (about 40% of dwellings).
Australian Property Monitors (APM)
We understand that APM also uses a “stratified median” approach, similar to the ABS. However, we
understand that less strata are used and that the strata are not weighted.
APM calculate capital city prices only, separately for both for houses and units.
Residex
Residex use a “repeat sales” methodology. This looks at the change in price from properties that
have been sold before.
This approach does not suffer from the shortcomings of the median or stratified median approach.
But has different shortcomings: it excludes dwellings where data on earlier sales is not available
including new dwellings, and it excludes the value of renovations.
Residex has house and unit data for each postcode region of Australia.
RP Data-Rismark
RP Data-Rismark is the most recent producer of dwelling price indexes. The most sophisticated of
their indexes is an “hedonic” index, which attempts to make adjustments for the unique attributes
of each property, including location, landsize, type (eg house or unit), number of bedrooms &
bathrooms, etc.
Not all statisticians support the use of an hedonic index. For example, the ABS states that “sufficient
data is not available for timely production of the index using hedonic methods ... It would be
necessary to collect considerable amounts of supplementary data. Due to the cost of collecting and
processing this data, the ABS considers that the hedonic approach is not viable at this time.”
It is indeed expensive. RP Data spends over $9 million annually collecting new property information
and has amassed a database comprising over 140 million property data records covering 99% of
dwellings. Their hedonic index has received supporting comment from representatives of CommSec,
Macquarie Bank, the Securities Industry Research Centre of Asia Pacific, and Moodys.
RP Data-Rismark include all regions, house and unit data separately, and “seasonally adjust” the
figures to take account of the fact that certain quarters typically show stronger growth than others.
Assessment
In our view, in a period in which there have been unusual levels of activity by first home owners, the
median approaches are likely to have a bias, and the approaches of RP Data Rismark (hedonic index)
or Residex (repeat sales) are likely to be more accurate.
This suggests that growth in dwelling prices is not nearly as high as the recent headlines have
suggested.
That is not bad news for investors. It means that there is scope for continued steady growth in
dwelling prices. History tells us that the current environment has characteristics that lead to
sustained growth in dwelling prices: recovery from a share market crash; recovery from an economic
downturn; strong economic growth; strong population growth; and, importantly, a huge
undersupply of residential dwellings.
Rising interest rates obviously weigh against rising dwelling prices. However, historically there is no
statistical correlation between interest rates and dwelling prices (often they rise together) – this is
because interest rates are usually raised to try and lean against the forces that are pushing property
prices higher and are only partly successful.
Clearly, the last year has been a good time to buy well researched investment property. However, in
our view, the overall cycle still has a considerable way to run and the next few months will continue
to provide excellent buying opportunities for well researched property that is supported by strong
economic fundamentals.
We have sourced good quality investment property in selected areas of NSW, Victoria, Queensland
and SA.
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