Have we reached a new normal with property prices?

I was attracted to an article today posted by Realestate.com.au entitled “Expect slow house price rises, says RBA” – now given the fact that Australia seemed to have skipped the last property price crash allied to the GFC I thought this was a very interesting headline and article, certainly worth reading and sharing.

The article referenced a speech by Luci Ellis, the head of The Reserve Bank of Australia’s financial stability department delivered this week in Sydney.

Now I am not an economist. I have an interest in the subject and with an eye for statistics and trends I was fascinated to delve a little deeper into this hypothesis presented by Ms Ellis that we are at, or at least close to, a new normal that may well see slower increases in house prices and more occasions when prices are  falling.

The full text of her speech and contextual charts are available to read and I would encourage a review as they are very enlightening. I hope someone may be motivated at Statistics NZ or the Reserve Bank here in NZ to produce similar charts to see how paralleled our markets and economies are in this regard.

To summarise the hypothesis. The view is that the move to lower inflation through the 80’s and 90’s lead to lower interest rates. As this occurred, lenders were more comfortable to increase the scale of lending without driving up loan-to-income ratios. In the view of the presenter, this resulted in almost a doubling of the amount households could borrow. This rise in borrowing capacity almost had to result in higher property prices which eventuated in the past decade or so.

Reserve Bank of Australia, Financial Stability Dept: April 23 2013

After this adjustment worked through the system the household debt-to-income has in Australia remained largely flat. The capacity to repay debt grew in the same period in someways replacing ‘old fashioned’ savings which in total edged down to zero although has crept back up as house prices have stabilized.

Reserve Bank of Australia, Financial Stability Dept: April 23 2013

The view is that these adjustments, having now worked through the system, have created a less volatile environment where house prices are less likely to experience significant rises and may self correct with price falls.

What is very interesting in studying the charts within the presentation is the similarity between Australia and NZ on issues such as scale of new construction, urbanization, immigration and land availability. These similarities whilst no guarantee that this hypothesis will be experienced in NZ, certainly give pause for thought around the much discussed and often debated view as to the future of house prices here in NZ.

Where are NZ house prices? – hitting new highs?

I thought it was about time to examine the latest house price data from REINZ. My favoured set of data is the Stratified house price index which as I have stated before is a more accurate reflection of true house prices across the country than the pure median.

The latest figure for March showed that house prices in NZ hit a new high of $409,080. This is the first time this measure has broken through the $400,00 level and represents an 8.6% rise over the past 12 months.

Interestingly the rise in the past year represents only just more than the rise since the peak of the market, now over 5 years ago in November 2007. Price today are just 7.4% ahead than that peak. As the chart shows the market fell by 11.4% over the first 14 months to a low of $337,400 before initially rebounding in 2009 and then slipping sideways through 2010 and starting to recover in early 2011 before starting the ascendancy to climb through the prior peak which was passed in May 2012.

The rate of increase in appreciation of property prices as shows in the chart above has been growing significantly over this last 18 months edging ever closer to 10% on an annualized basis. No signs yet, of the heady days of 2002/2003!

However when assessing the appreciation of any asset over time it is an oversight not to factor in the impact of inflation. A basket of goods valued at $100 in 2007 at the very peak of property prices would now cost $114.54. Sure the recent years have seen low relative inflation, but the compound impact of inflation cannot be ignored.

Property prices adjusted for inflation shows a very different story for the past 6 years as the chart above details. In today’s $ terms the peak of the market price in September 2007 actually equates in todays $ terms to $436,508. That compares to today’s price of $409,080 – so in fact we have not as yet broken the peak of the property market pricing. We have not hit a new high. Property prices are still 6.3% below the peak.

Real estate is massively inefficient

Picture courtesy of TVNZ Agent Anna

The analysis I recently undertook to ascertain the average earnings of real estate agents certainly provoked some interesting response when published in the NZ Herald.

Clearly the quoted contributors to the article did not have to hand an accurate sense of what an average agent earned in Auckland or any other part of the country. There only comment was that “Auckland agents would be on higher (earnings)” or “if agents were not making enough .. they would move”.

You would have thought that an industry employing over 9,000 active salespeople together with over 1,500 support people in over 1,000 offices across the country accounting for a gross sales value of services in excess of $1 billion would know how much people earn on average.

The fact is the real estate industry does not analyse this kind of data. It does not care about this data or worry as to the efficiency of the industry at large or the many thousands of agents within the industry.

An industry that pays an average of just over $43,000 a year to its front line representatives for what is a serious and complex process involving hundreds of thousands, if not millions of dollars I judge should be concerned.

The fact is the real estate industry is massively inefficient. There are just too many agents tripping over each other, fighting one another, stabbing each other in the back to get a listing and from there to conclude a sale and ultimately earn a commission.

That commission is very alluring – the median house price in NZ last month was $382,000, the average commission charged by real estate companies to sell a house of this value is around $16,000 + Gst. The listings agent will receive on average between 50% and 60% of the commission charged to the vendor – that’s around $9,000. So if you could list and sell just one property a month then you could earn $100,000+ per annum!

Just one property a month. That would seem to a lot of people a simple task, 22 working days to find a property and sell it. The fact is that on average each agent in NZ sold only 8 properties in the whole of 2012. So in theory they could take 4 months off and sell a single property a month for 8 months and earn $72,000.

How can this be – the numbers don’t seem right!

The numbers are right, but only make sense when you look into the workload of an average real estate agent. I have spoken to quite a few agents to ascertain the time component of their work and what I have found did not surprise me, but may come as a surprise to many.

Just shy of two thirds of the working time of real estate agents (64%) is spent prospecting for new work. The productive time spent on behalf of their clients in facilitating the sale of a house represents less than 25% of their working week. Yet their income from vendors supports their full working week.

This is where the inefficiency shows itself – 9,300 agents spending nearly two thirds of their working week prospecting for future work. A massive 230,000 hours of working time each week spent by the industry to list just 2,300 properties. That means that the industry collectively spends 100 hours a week prospecting for every listing.

The bizarre thing is that a single listing that collectively the industry spent 100 hours chasing was going to happen anyway. That vendor wanted to put their house on the market. The industry just fought tooth-and-nail to get that listing, or at least one agent beat the others to it.

There has to be a better solution. Technology should be able to play a better part in the process. Vendors want to sell, they want the best agent that knows the market for their type of property in their area – there must be a better way of evaluating agents and allowing them to pitch their proposal. Agents must want to be more efficient.

However a more efficient real estate industry would be a massively smaller industry.

If a more efficient process could be implemented to allow a vendor to choose an agent, it is likely that the amount of time each agent spent on average securing a new client per week could drop from the current 25 hours to around 8 hours. This would then free up time to provide more service to more clients, each agent then handling far more clients. A result of this would likely be a reduction of the number of real estate agents from the current 9,300 to around 1,500.

But then the issue arises as to the commission payable; because if the same commissions were charged and the industry only needed 1,500 agents then they would earn on average over $250,000 a year! This is where the hypothesis falls down because the real estate industry does not want to change. The industry, for that read the real estate companies; want the inefficiency, they want to have agents fighting each other for listings and earning an average earnings of $43,000 a year. The industry protects the model and the consumer pays - heavily!

Update

This article and full analysis was featured on TV3 News on Saturday 6th April - the reporter spoke to some buyers who recognised the value of having an assistance in selecting an agent and thereby helping agents become more efficient.