Earlier this week the Australian Bureau of Statistics (ABS) released consumer price index (CPI) data for the June 2016 quarter.  The data showed that inflation rose by 0.4% over the quarter, however over the 12 months to June 2016, inflation has only increased by 1.0%, its lowest annual increase since June 1999.

From a housing market perspective, the housing category of CPI increased by 1.3% over the year to June 2016. This is the slowest annual rate of growth since housing CPI fell by -1.1% over the year to September 1998.

Adjusting capital city home values by headline inflation provides interesting insight into the performance of the housing market.  Of course, people mostly analyse the housing market in nominal terms but looking at inflation-adjusted or real changes provides some valuable insight, particularly from an affordability standpoint.  While inflation has increased by 1.0% over the year to June 2016, combined capital city home values have risen by 8.3%.

Chart 1

Adjusting for inflation lowers the change in home values. As you can see in Perth and Hobart it results in larger value declines.  In all other capital cities, real home values have increased over the past year with Sydney and Melbourne still recording double-digit value increases.

Chart 2

Over the past five years, real home values have increased by a compound annual rate of 3.7% compared to 3.1% over the past decade and 4.6% over the past 15 years.  While the headline figure indicates stronger annual growth over the past 5 years than the past 10 years, this is all being driven by Sydney with all other capital cities recording lower real home value changes over the past 5 years compared to the past 10 years.  In fact, home values have fallen in real terms in all capital cities over the past five years except Sydney, Melbourne, Brisbane and Canberra.

Chart 3

In 2008 between March and December nominal home values fell by -6.1% with real home values falling by -8.3%.  At the end of 2008 the Federal Government was deliberately stimulating the housing market via the First Home Owner’s Grant Boost and interest rates were being aggressively cut by the Reserve Bank.  Subsequently, home values then began to rise.  Over the 7.5 years from December 2008 to June 2016, nominal capital city home values have increased by 54.9% compared to a 32.0% real change in home values.  Real home values have only recorded significant increase over the past 7.5 years in Sydney and Melbourne with slight increases in Darwin and Canberra.  Real home values are lower than they were 7.5 years ago in Brisbane, Adelaide, Perth and Hobart.

Chart 4

Sydney and Melbourne are the only capital city housing markets in which real home values are now above their previous peaks.  Sydney home values are 31.6% higher than their previous peak in March 2004 and Melbourne home values are 12.4% higher than their previous peak in September 2010.  Across the remaining capital cities real home values remain lower than their respective peaks.  In Brisbane, real home values peaked in March 2008 and are currently 9.3% lower.  After a peak in June 2010, Adelaide home values in June 2016 were 7.0% lower.  Perth home values have fallen by 17.0% from their September 2007 peak.  Hobart home values peaked in December 2007 and are currently 15.3% lower.  Darwin home values are 19.6% lower than their September 2010 peak and Canberra home values are 4.6% lower than their June 2010 peak.

While Sydney and Melbourne real home values have surged beyond their previous peaks, in all other capital cities values remain below their peak, which in some instances were now many years ago.  The data indicates that outside of Sydney and Melbourne, housing affordability has improved over recent years due to sluggish value growth.  The data also highlights that improving affordability and historically low interest rates are not proving to be enough to lure buyers and subsequent real value growth into markets outside of Sydney and Melbourne.  Sydney and Melbourne continue to separate themselves from the other capital cities because of strong interstate and overseas migration accompanied by much stronger employment opportunities.  While other capital cities remain much more affordable than Sydney and Melbourne, without decent employment opportunities it seems likely that the two largest cities will continue to see rising home values and deteriorating affordability while affordability continues to improve elsewhere.