There’s now a new model for forecasting Australian housing prices – and it works!

Wouldn’t it be great to know what’s ahead for our property markets?

Sure lots of “commentators” have given their market forecasts for  2018, but what do they base these on? 

While some do undertake detailed research, others seem to use “gut feel” based on their experience and yet others have vested interests used to confirm the properties they’re peddling.

So let’s be honest…no one really knows what’s ahead for property – there are so many individual markets and so many variables involved.

But recently ANZ Bank have built a new model which in their words: “accurately forecast housing prices over a longer-term.”

Now before I go into details of their methodology..

I’ll give you the bottom line:

According to the new ANZ model, house price growth will slow but still remain stay positive in the first half of the year (around 1% year on year growth) and then property values will pick up  in the second half of 2018, growing around 2% for the year as a whole.

If this is correct, the next few months will give property investors and home buyers a window of opportunity to get into the market as the ANZ forecasts that growth will accelerate to around 4% in 2019.

Source: CoreLogic RP Data, ANZ Research

How are property market forecasts made?

According to the ANZ “existing tools are simple and effective for near term views.”

The common leading indicators (those that provide information about likely future changes in house prices) which are currently being used include:-

1. Auction clearance rates – these are a good indicator of consumer sentiment and, as you can see from the graph below, are an accurate tool for forecasting movements in house prices in the short term.

 Auction clearance rates versus house prices.

Source: CoreLogic RP Data, ANZ Research

2. Credit impulse – which measures the change in new credit issued as a percentage of the gross domestic product (GDP).

Of course it makes sense that the change in the growth rate of new lending (credit) should signal a change in house prices.

 Credit impulse versus house prices.

Source: RBA, ABS, ANZ Research

According to the ANZ:

These tools work because they effectively summarise the key demand and supply factors in the housing market.
The problem is that they only provide short-term signals about the change in house prices — a matter of three to four months in both cases.

To forecast house prices beyond the near term, we need to consider the likely drivers of supply and demand and anticipate their impact on house prices.

So what’s this new forecasting model all about?

If you’re not one who likes detail I suggest you can skip the next few paragraphs and jump ahead to the next section to see how accurate the new model is – the results were pretty impressive when it was back tested.

However, if you like the nitty gritty, the ANZ explain their model as follows: 

We chose an error correction model (ECM), the advantage of which is that it is simple and it captures the main dynamics of housing price movements then makes the link between prices and economic conditions explicit.

There are two steps to estimating the model.

First we determined the fundamental price — that which would prevail over the long term, without influence from the economic cycle.

Population growth emerged as the best predictor there.

To measure supply, we looked at other variables but found them to be practically and statistically insignificant.

Next, we used an equation with three elements to predict shorter-term changes in dwelling prices.

These were:

1. The error correction term — the difference between actual dwelling prices and the fundamental value estimated in the first step — because prices tend to revert to their  fundamental value over time.
2. The lagged growth rate of dwelling prices — to account for the momentum that typifies housing price movements.
3. Changes in dwelling investment, gross total incomes and the average mortgage rate — to capture the effect of economic conditions, ie demand and supply.

Together, these variables are sufficient to capture the main economic drivers of dwelling prices, without over-complicating the model.

How accurate is this model?

The ANZ tested the model’s accuracy by producing two-year forecasts on a rolling basis from 1995 to 2017 and comparing them to actual prices.

The graph below looks pretty impressive to me…

 Actual prices versus forecast.

Source: CoreLogic RP Data, ANZ Research

What does the model predict for the future?

1. IN THE MEDIUM TERM, PRICES WILL KEEP RISING — JUST

• The  ANZ  model predicts that housing price growth will continue to slow in the near term, bottoming out at 0.8% year on year in the second quarter of 2018 and gradually pick up thereafter.
• ANZ believes the RBA will hike interest rates twice in 2018,  and this will be the largest drag on prices in 2018, particularly in the second half of the year.
• ANZ expect our economy to improve with GDP accelerating to around 3%, and the unemployment rate will edge lower, which would prompt the RBA to take the real cash rate out of negative territory.
• However, this forecast assumes an uptick in wage growth, so the Q4 wage price index data

 Interest rates will start to rise in 2018.

Source: RBA, Bloomberg, ANZ Research

2. Construction activity will be a drag on prices in the first half of 2018 according to the model

This reflects the lagged effect that 2017’s elevated levels of construction activity are likely to have on prices.

Roughly 200,000 dwellings are now under construction, which is enough oncoming supply to dampen price growth.

3. ANZ anticipate income growth will have a small positive impact on home prices in 2018.

BEYOND THE MEDIUM TERM

Looking further ahead, the ANZ model predicts that housing price growth will improve in 2019 forecasting 4% growth.

The ANZ are not expecting the RBA to change interest rates in 2019, so the drag on price growth from 2018’s hikes is likely to be short lived.

They also expect a mild slowdown in new construction in 2018, which in turn will be positive for dwelling prices in 2019.

Construction activity set to slow.

Source: ABS, ANZ Research

The bottom line:

Despite all the research done by large organisations like the ANZ and other institutions, most economists get their property forecasts wrong. 

You see…the fundamentals are easy to monitor – things like population growth, supply and demand, employment levels, interest rates, affordability and inflationary pressures.

The problem is that one overriding factor that the experts have difficulty quantifying is investor and consumer sentiment and these are major drivers of our property markets

Humans are funny: we tend to extrapolate the present into the future.

When things are booming we think the good times will never end and when the market mood is glum, we have difficulty seeing the light at the end of the tunnel.

Think about it…

When property markets are booming and stories of investors seemingly making large gains overnight abound, people want to jump on the bandwagon and cash in; often at a time when the market is near its peak.

Conversely when the media reports falling property prices or an impending housing crash, many investors become scared and sit on the side lines, believing the end of property is nigh and things will never improve, when in reality much of the risk has been removed from the market.

Other emotional traps include becoming overconfident, wishful thinking and ignoring information that conflicts with your current views.

In other words, many investors create their own “reality.”

It seems that investor and property consumer sentiment has moved from very positive last year to more concern this year.

However most of the fundamentals remain positive for property in the medium term, so it will be interesting to see how consumers (both property investors and home buyers) react.

WHAT CAN YOU DO TO STAY AHEAD?

As signs point to softer growth conditions for Australian property over the coming months, independent professional advice and careful consideration will be as important as ever in navigating Australia’s varied market conditions. 

If you’re looking for independent advice, no one can help you quite like the independent property investment strategists at Metropole.

Remember the multi award winning team of property investment strategists at Metropole have no properties to sell, so their advice is unbiased.Whether you are a beginner or a seasoned property investor, we would love to help you formulate an investment strategy or do a review of your existing portfolio, and help you take your property investment to the next level.

Please click here to organise a time for a chat. Or call us on 1300 20 30 30.

When you attend our offices in Melbourne, Sydney or Brisbane you will receive a free copy of my latest 2 x DVD program Building Wealth through Property Investment in the new Economy valued at $49.