Throughout most of 2011, dwelling sales were crawling along at their lowest levels in over a decade. As of October 2011, dwelling sales were 28 per cent below the ten-year average and nearly half of 2003 highs. The more cyclical vacant land market was in worse shape with sales running at 33 per cent below historical averages. The rental market was just starting to tighten on the back of a big lift in overseas migration in the September quarter, but first home buyer and investor activity was still largely flat.

One of the biggest drivers of the upswing was a reduction in interest rates. The standard mortgage rate had remained unchanged for nearly a year at 7.8 per cent but would subsequently decline by more than 24 per cent over the next two years. It started with one rate cut on Melbourne Cup Day in November 2011 and another in December. The RBA’s decision to cut rates was driven by concerns about the sovereign debt issue in Europe rather than domestic economic conditions which were not showing any clear signs of a slowdown.

As we entered 2012, Perth’s population grew strongly on the back of increased migration and very tight labour conditions. The rental market consequently moved very quickly in favour of landlords as the vacancy rate fell from 2.8 to 1.8 per cent and the median house rent increased 6.25 per cent over the six months to March. Dwelling sales volumes lifted throughout the start of the year and they were helped along by further rate cuts in May and June. By mid-2012, dwelling sales were at their highest level since 2009 and only five per cent below the ten-year average.

The lift in sales volumes was driven primarily by first home buyers and investors (at the low-priced end). As of mid-2012, first home buyer levels were up 40 per cent and investor dwelling finance up by 24 per cent on levels 12 months earlier. Upgrader dwelling finance, meanwhile, was up just 8 per cent.

Although another two rate cuts in the second half of 2012 brought the cash rate to the GFC low of three per cent, property market momentum was already heading in one direction and the Perth market was shifting in favour of vendors. By early 2013, no longer was the worry about prices falling but rather the fear of missing out – buyers were eager to purchase before expected price increases and vendors were holding out until prices rise (listings declined 30 per cent in 2012).

The vacant land market was the main beneficiary of tight supply at the lower end of the market. Vacant land sales during the March quarter 2013 were up more than 51 per cent on levels 12 months earlier. And the sharp increase in land sales raised supply concerns as vacant land listings halved in the space of 14 months.

In addition to dwelling and land sales reaching their highest levels in seven years during 2013, prices were also increasing. Although capital growth estimates vary widely, the consensus is that price growth was in the single digits and was much lower than levels between 2002 and 2006. Based on settled dwelling sales, the median house price in Perth increased at 9.1 per cent per annum around March but subsequently declined to around 6-7 per cent per annum. More nuanced price measures that endeavour to factor in the characteristics of each home indicated that price growth in Perth was between 4 and ten per cent in 2013. A repeat sales methodology reported by Residex showed that Perth house prices were up 4.2 per cent over the year to October. RP Data, meanwhile, reported a 10.2 per cent lift in Perth house prices based on sales settled as of December. In our view, one of the most up-to-date notional measures of price growth is SQM Research’s vendor sentiment index which showed that asking prices for houses and units in Perth increased 9.1 and 8.5 per cent, respectively, over 2013.

Land prices also increased in 2013, but price growth was masked by a decline in block sizes. The median vacant land price in Perth increased just 2.1 per cent over the year to June 2013. The median price per square metre, meanwhile, increased 5.0 per cent over the same period.

Looking ahead, existing home owners – the largest segment of the housing market – are expected to play a significant role throughout 2014, especially given that first home buyer levels have eased since mid-2013. Although ‘upgrader’ activity was up around 16 per cent in 2013, there is scope for further increases – upgrader activity is still 34 per cent below 2006 highs. With average selling days down around 40 per cent, more existing home owners are marketing their homes for sale and this is likely to continue throughout 2014.

As long as capital growth expectations remain in the single digits, activity by the interest rate sensitive sectors – first home buyers and investors – is expected to move sideways and possibly decline throughout the year. The degree to which FHBs and investor activity eases will be driven by myriad factors, but foremost will be interest rates. The good news for industry is that rates are not expected to increase until early 2015. Therefore, the new dwelling sector will continue to benefit from above average household formation rates throughout the year and into 2015.

There are, however, a number of risks for the sector, foremost being affordability. Another strong year of capital growth could price out first home buyers, especially given easing rental conditions. Meanwhile, price growth could also encourage the hubris that we saw last decade and lead to a destabilising overshooting of prices. And furthermore, we can’t discount the effects of easing migration and slowing economic activity. There is also the political risk that authorities will implement a more heavy handed approach to combat rising prices.

However, on balance, the risk of excessive price growth has somewhat eased in the last 9-10 months. But an overly strong summer of sales and further declines in stock can quickly change the equation.