Property booms are made to bust

Some sectors of the Australian property market surprised on the upside this year, particularly the Melbourne and Sydney property markets.

But four years of strong capital growth and the prospect of interest rates rising in the future is causing many to question how long this can continue. In fact, there are some who are warning the “boom” will bust.

So do I think the market is going to bust? Of course there is not one property market, but will these hot property markets turn in due course?

Of course they will, but not for a few years yet.

What will that look like?

I must be honest and say I have no idea – it really depends on how strongly the markets perform in the next few years, what happens to interest rates and how the supply and demand ratio end up. But what I do know is that markets moves in cycles and all booms pave the way for the next downturn.

Before I explain my thoughts further, let’s put things into context by looking at some statistics…

Source: CoreLogic

As you can see, it’s really been a two horse this race this time around, with the Sydney and Melbourne property markets strongly outperforming all other markets, thanks to their robust economies and strong population growth.

It’s a fact that 57% of our population lives in New South Wales and Victoria combined (32% and 25%, respectively) and these two states accounts for 54% of Australia’s economic activity.

Currently around 1400 people are moving into Melbourne each week – and it’s not because of the weather. It’s because of all the full-time jobs that are being created. Similarly, around 1100 people move into Sydney each week.

Remember, all these people need to rent or buy a home.

And this is nothing new. The graph below shows how these two property markets have pulled away from the rest of Australia over the last eight years since the Global Financial Crisis.

Source: CoreLogic

If our property markets have had such strong growth, why did some investors not fair well?

What these figures don’t show is how fragmented our markets really are.

This is not just between Melbourne and Sydney and the other capital cities. In each of our capital cities there are multiple markets, segmented by geographic location, types of property and price points. And some segments are out performing, while others have had minimal growth or are losing value.

The news reports of record auction clearances, long queues at open for inspections, and properties being snapped up within days of them coming onto the market relate to homes and established apartments in the middle ring, more affluent suburbs where there is a shortage of supply and strong demand from owner-occupiers and investors.

On the other hand, the story is very different in the inner CBD and new apartment markets, which are plagued by an oversupply of inferior quality stock; as well as in many of the outer “blue collar worker” and first home owner suburbs where poor employment prospects and lower consumer confidence have subdued the markets.

Unfortunately many of the investors who lost out over the last few years bought off-the-plan properties close to or in a capital city CBD.

The following startling figures show that on completion, over 40% of the off-the-plan properties purchased made in Perth, Brisbane or Melbourne were valued at less than their purchase price.

In other words, almost half of the investors who bought properties off the plan in these capital cities had negative equity on completion of their building rather than making a gain like they had expected.

Source: CoreLogic

I’ve found investors are getting themselves into trouble in one of three ways:

1. Buying the wrong property. The market is being selective and not all properties are going up in value at the same rate. Currently I would suggest less than 5% of all the properties presently for sale are “investment-grade”.

2. Paying too much. Sure there are few bargains to be found today in the hot property markets, at least not if you are looking for the right property. But that doesn’t mean you should overpay. If you do, you are giving away some capital growth, as well as paying more stamp duty and mortgage interest.

3. Not having a finance strategy. And one that helps you buy “time” to allow the market to work its magic. For example, by having a financial buffer in an offset account to cover unexpected contingencies.

So back to the question: When will the boom bust?

As I explained before, I’m not sure. But the same fundamentals that have driven up property values over the last few years are likely to keep driving up prices (albeit more slowly) for some time to come.

It is likely that Melbourne and Sydney house prices values will again rise substantially in 2017 driven by affluent owner occupiers upgrading their homes and investors chasing capital growth.

But the level of house price growth will depend upon what the RBA does to interest rates. And it now seems that we could be at the bottom of the interest rate cycle and they could start to move upwards in 2017.

Future property price growth will also depend upon local economic growth and local market factors.

On the other hand, the boom has already busted in the inner-city high-rise, off the plan and new apartment markets in Melbourne, Brisbane and Perth where the significant oversupply of apartments will stifle capital growth and rental growth for up to a decade.

The bottom line

It’s a myth that property values double every seven to 10 years.

While they say a “rising tide lifts all ships”, clearly some property markets have enjoyed massive growth over the last few years, but there are certain properties that have had minimal growth.

I like to explain it this way: while the overall property market is comfortable, it’s a bit like me putting my left hand in a bucket of cold water and my right hand in the bucket of hot water and saying “overall I feel comfortable”.

Some segments of the property market are hot and others are cold and the fragmentation of these markets is unlikely to change over the next year or so.

This means home buyers and investors will have to undertake careful due diligence and make sure they buy the right type of property.

Look for a property:

1. That will be in continuous strong demand by owner-occupiers (to keep pushing up its value) and tenants (to help subsidise your mortgage);
2. In the right location—one that has outperformed the long-term averages and likely to continue to do so because of the demographics in the area;
3. One that has a level of scarcity; and
4. A property to which you can add value through renovations or redevelopment so you can “manufacture” some extra capital growth and increase your rental reruns and depreciation allowances.

Then buy it at the right price and hold it as a long-term investment and reap the rewards.

Michael Yardney is a director of Metropole Property Strategists, which creates wealth for its clients through independent, unbiased property advice and advocacy. He is a best-selling author, one of Australia’s leading experts in wealth creation through property and writes the Property Update blog.