How house price predictions are really made, and why they’re often wrong

Australian Property

How much faith should you put in predictions about house price falls?

Fun fact about all those terrifying predictions of home prices falling six figures around the nation: they’re kind of made up.

Hocus pocus, mumbo jumbo, whatever you prefer.

They’re still important, mind you, it’s just they’re not, well, real.

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I won’t go into all of the forecasts, but in their June quarter release, the economics team at Australia’s third largest lender, NAB, was tipping an almost 18 per cent loss to home values nationwide by the end of 2023.

In Sydney and Melbourne the bank was projecting a 22.2 per cent and 21.8 per cent hit.

And only last week PropTrack (the research arm of predicted the nation’s typical dwelling value would fall between 9 and 15 per cent by the end of 2023.

Again, it was worse in Sydney and Melbourne, ranging from 12-18 per cent.

The hand holds a red arrow above the wooden houses down. The houses are decreasing. The concept of falling demand and supply in the real estate market. Economic crisis. The fall in prices.

Ask most economists and they’re predicting a dire future for house prices — but they’re not a sure thing.

They’re sobering figures, especially if you’ve bought recently and that kind of a fall could leave you owing more than your home is worth.

But so long as the average home loan recipient keeps paying their mortgage, the bank won’t care.

A big part of that is because, the forecasts are based on an index populated with theoretical data.

An index is a math-heavy construct that uses recent sales data, as well as separate rental vacancy figures and more nebulous factors such as recent changes to interest rates, to calculate the value of every home in a given region. That includes your place, even if it last sold in the 1990s.

Once this is done, economists then add even more variables and data points that could capture things as far away as the war in Ukraine’s impact on energy prices to lockdowns in China impacting supply chains.

Real Estate Market Crash - Falling Home Prices

There is some truth to the falling home price predictions, with reductions already emerging. The big question is around how far they will really fall.

PropTrack economist Paul Ryan said the firm had only recently started making predictions, but the history of the models in Australia was “pretty poor”. “If you get one variable forecast wrong, then you are wrong about everything else,” Mr Ryan said.

Ray White’s chief economist, Nerida Conisbee, hasn’t made any predictions about specific value falls, due to the difficulty.

“If you get the direction right you are doing pretty well, but to get the scale right is almost impossible,” Ms Conisbee said.

She pointed to the most recent tranche of negative market predictions, made amid the lockdowns of the early days of the pandemic: “there were predictions of a 30 per cent price decline, but they went in completely the other direction”.

Concept Australia attacked by an Coronavirus army troop

Predictions that the Covid-19 pandemic would smash house prices were completely wrong.

Even now, as prices fall in Sydney and Melbourne they’re still rising in Adelaide, she added.

Despite this, she noted that the trend was likely to be accurate – prices in many areas are falling and will continue to fall.

But for all their foibles, the predictions are still important.

For one thing, the banks aren’t just producing them to scare their customers – they’re also using them to put provisions against lending.

While it’s unclear if those provisions materially affect what a bank will lend to you, Mr Ryan noted current figures would likely indicate the banks would look pretty closely at your living expenses and equity position before deciding how much they would lend to you.

Mortgage and Home Buying Concept. Tiny Female Character with Huge Calculator and Percent Symbol at House with Gold Coins

Home equity will be marked down by banks, so you may be impacted if you’re planning to tap into yours.

There could also be impacts if you are planning to tap into the equity in your home, say for an investment purchase or to help your kids buy, with your lender likely to value that equity lower in the coming months.

But, for the vast majority of us, these predictions aren’t cause for concern – they’re just a bunch of made-up numbers.

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Author: Nathan Mawby