Where is the housing market heading in 2011?

What a difference a year makes for the Australian housing market.

Twelve months ago, Australia’s housing sector was steaming along, with most metropolitan cities enjoying year-on-year price growth well above 10%, and some commentators starting to fret that the market was starting to look decidedly overheated.

As agents around Australia gear up for the start of the 2011 auction selling year, it’s a very different story. House prices essentially stagnated in the second half of 2010 and a glut of listings in the last few months of the year has many home owners worried about the potential for further price falls.

But of course, that’s only part of the story.

Underlying the somewhat confused short-term outlook, the debate about the “fundamentals” of the housing market shows no sign of ending.

On the one hand, the housing industry and the organisations including the Reserve Bank continue to express concerns about the long-term effect of what they say is a growing shortage of houses in Australia.

On the other hand, the big bubble issue just won’t go away. The release of a controversial report by US-based researcher Demographia suggested Australia has some of the least-affordable housing markets in the world, again raising the question: Despite the weak outlook and despite the price falls, does Australia still have a housing bubble problem that hasn’t been resolved?

Let’s unpack these issues with a special SmartCompany Q&A.

So the golden run house prices have enjoyed looks to be all but over.

It’s looking a little like that. According to the latest RP Data-Rismark Hedonic Home Value Index, capital city home values decreased 0.2% in November, and were basically flat in the three months leading up to the end of November.

The situation looks a bit better when you take a longer-term view. Over the last 12 months, capital city home values are up by 5.2%.

Well that’s not too bad at all, is it?

It’s solid but not spectacular growth. And it’s also a long way from the double-digit growth we saw at the start of 2010.

Indeed, 2010’s house price movements really pale into comparison with what we’ve seen in the last decade in Australian capital cities (based on ABS house price data):

• 2009 – up 13.6%
• 2008 – down 3.3%
• 2007 – up 12.7%
• 2006 – up 8.3%
• 2005 – up 2.3%
• 2004 – up 2.7%
• 2003 – up 18.3%
• 2002 – up 16.4%
• 2001 – up 15.1%
• 2000 – up 6.6%

There are five years out of the last 10 with growth over 10%, and average growth rate over the period of 9.3% a year. In this context, the 2010 performance – and particularly the slowdown towards the end of the year – does suggest that the market has lost momentum.

What’s driven the slowdown?

In recent months, it’s clear that interest rates have had a big impact. While official interest rates are still well below pre-GFC levels – it should be remembered the cash rate was sitting at 7.25% in the middle of 2008 – the fact that the banks have increased mortgage rates over and above the recent official rate rises means were are now back in the territory where property owners and buyers traditionally think carefully about buying and borrowing.

The unwinding of incentives for first home buyers has also had a major impact on house prices in 2010. At the height of the GFC in 2008, the Government announced it would increase subsidies for first home buyers to up to $21,000 for new homes and $14,000 for established homes – on top of existing state-government subsidies. Many commentators complained the grants artificially boosted house prices, as many vendors simply added $14,000 to the price of their home.

Anything else?

Housing affordability is also a factor. The Housing Industry Association’s housing affordability ratio fell 18.3 points over the first nine months of 2010 (the latest available figures) driven largely by interest rate rises in the first half of the year.

But it’s not just rates that contribute to concerns about housing affordability. Being able to afford to take on a loan is one thing, but being prepared to take on a larger amount of debt is another. The latest housing finance data, released on January 12, highlighted the hesitancy that exists around taking on a mortgage – the number of new loans sold in November 2010 was 11.5% lower than a year earlier, and the number of cancelled loans (that is, loans where the lender has committed but the buyer had not followed through) was the highest in a year.

Is there any evidence that buyers have just decided prices are over the top?

One tool that RP Data uses to get a feel for the performance of the market is to measure the length of time properties are spending on the market and the discount that vendors accept from their original asking price. The most recent figures show that the average time it takes to sell a house has increased from 45 days to 47 days, but the discount rate has jumped from 4.9% to 5.9%.

When you combine that with recent research from property analyst Louis Christopher at SQM Research that shows the number of property listing increased 44% over 2010, you can see that battle between buyers and sellers has clearly swung the way of the buyers.

So what sort of price movements can we expect in 2011?

Economist Craig James is one of the more upbeat forecasters, tipping growth of 3-6% across the year.

Rismark’s Christopher Joye says that if the RBA was to leave interest rates on hold for the year, house prices would probably grow by 4-6%, but this is unlikely. He expects three official rate rises during 2011, which means there will be “little-to-no nominal dwelling price growth over 2011, with a chance of small nominal declines”.

However, a survey of real estate agents, property developers, asset managers, investors and home owners taken in December suggested those in the industry are quite pessimistic, tipping prices will fall by 0.5% over 2011.