Australia’s residential and commercial property markets have undergone strong capital value appreciation post the financial crisis. Now, the residential sector has appeared to have peaked and moderate residential price declines in Sydney have gained a lot of media attention in Australia. Increasingly clients are asking us: How correlated are the Australian commercial and residential property markets?
Have commercial and residential price growth been linked in the past?
The answer is largely no. While in some periods price growth has moved together, in other periods it has been completely uncorrelated. Figure 1 shows that since 2004, correlation between price movements in core commercial property sectors and residential property is below 0.30, whereas we have observed a high degree of correlation between commercial property sectors.
Figure 1: National capital value growth correlation (since June 2004)
Source: JLL Research, ABS
Figure 2: Annual capital value growth in national property sectors
Source: JLL Research, ABS
What explains this disconnect in growth?
The results shown in Figures 1 and 2 can be explained by the differing drivers of each sector. These include varying sources and availability of capital, macroeconomic influences, and sector specific changes in tax and regulation. For example, credit availability is an important factor for each sector and this is currently restricted for residential property. This has been driven by nationally set macro prudential policies that have resulted in Australia’s major banks tightening their lending to residential investors and consequently affecting residential price growth, particularly in Sydney and Melbourne. In contrast, funds equity continues to flow into commercial property. Bank lending criteria has become more onerous for risk assets and development, but we see strong bank appetite for stabilised assets.
Some factors can affect all sectors resulting in periods of cohesive movements. An example of this is the general market downturn of the financial crisis which affected all Australian property. Analysis covering just the past five years (since 2013) shows that correlation between commercial and residential price movements does not exceed 0.14, which is largely due to the exclusion of GFC price declines felt across all sectors.
How correlated are house prices across Australia?
The answer is mixed. Some markets have moved in unison, but Sydney has been largely uncorrelated with the rest of Australia. Sydney’s average[1] correlation to other capital city markets since 2004 is 0.27. Sydney prices sit well above the other markets with a median house price 30% higher[2] than Melbourne – the second most expensive Australian city. Sydney is a global city and is a gateway city for migration and foreign investment. Generally high demand and relative undersupply of residential property has pushed prices higher.
Additionally, Figure 3 shows that the mining cities (Perth, Brisbane and Darwin) are lowly correlated to the bulk of Australian cities. The resource sector has a major influence on these markets and prices are more sensitive to mining sector capital expenditure cycles.
Figure 3: Capital value growth correlation – residential markets (since June 2004)
Source: ABS, JLL Research
What does this mean for investors in Australian property?
Historically, commercial and residential price movements have not been correlated. Therefore, the recent slowdown in the residential market does not necessarily mean commercial values will decline. Fundamentals in commercial property markets remain healthy and if capital continues to be available then values will be supported. Similarly, there is not just one housing cycle in Australia. Price softening in Sydney and Melbourne, will be at least partially offset by improving conditions in the resource markets after a period of weakness.
Definitions:
Retail: JLL national sub regional capital value data
Office: JLL CBD markets capital value data
Industrial: JLL national industrial capital value data
Residential: ABS all residential price index
[1] Arithmetic average
[2] CoreLogic May 2018 data
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