After experiencing a "once in a generation property boom in 2020-21, we're now in the adjustment phase of the property cycle.
Currently our property markets are fragmented and some signature of the property market is still growing well
For context, property prices have surged 29% since the pandemic while wage growth has risen a mere 2.3%.
Research by Metropole shows that Australia’s national median house value has risen by an enormous 540.1% over the past 42 years. This is an average annual growth rate of 7.62%.
There are many influences on the length and extent of property cycles. Short-term factors - which are what most of the media is concerned about and… the long-term influences - which is what strategic investors pay attention to.
After the property price boom of 2020-21, Australia’s real estate markets appear to be cooling - at least for now.
So what happened?
And what does it mean for the future of our property markets?
To help understand what’s ahead and if the property market will crash as some are suggesting, I will outline the dynamics and economics of Australia’s property market, what causes real estate prices to increase in Australia, and how you can ensure your investment outperforms the market averages over the long term.
How does a property cycle work?
We already know that Australia’s property markets move in cycles.
Then each state has its own individual property cycle and there are further cycles within each depending on the area, price point, and even the property type.
Historically, cycles start with a period of rising values, followed by a lull period where prices stagnate or even decline, before starting to increase again.
While you’ll often hear that property cycles last seven to 10 years, the length of an individual cycle varies depending on a combination of economic factors as well as supply and demand, rather than a period of time.
Note: Generally, there will be a period of 2-3 years when the market is flat or when there is a decline in property values.
This is followed by a number of years of low capital growth which in turn is followed by a shorter period of strong price growth that we know as a ‘boom’.
But that's not what happened in the most recent property cycle which started with a bang.
The property boom of 2020-21
While the Covid-19 pandemic shut down life as we knew it, many businesses closed and economies tanked, there was one market that flourished – our housing market.
The pandemic years of 2020-21 saw a once-in-a-generation property boom driven by historically low-interest rates, pent-up demand, and a flurry of government incentives.
In particular, 2021 was an extraordinary year for Australia’s housing market - around 98% of locations around the country recorded an increase in the median property value, with many of those values surging by more than 20%.
Data from the Australian Bureau of Statistics (ABS) confirms that the total value of Australia’s 10.8 million property portfolio skyrocketed to $9.9 trillion in 2021 alone, having risen by a wallet-busting $512.6 billion in just 3 months.
These are some large numbers.
At the same time, the collective wealth of Australia’s homeowners increased by $2 trillion in just one year alone - a sum which is 30% higher than the annual output of the entire Australian economy.
It’s difficult, therefore, to underestimate the extent to which housing wealth has risen during the pandemic years.
And a few emerging sentiment shifts also put pressure on prices.
We saw the pandemic cause Australians to re-evaluate what they want from their home.
Home was no longer just the place to rest; it fast became the place to work, play, and even self-isolate for a period of time.
As a result, many buyers were looking for larger homes with more space… and were even prepared to move out, even to the regions, to get it.
In fact, it was a cycle of property upgrades.
Some tenants upgraded to become first home buyers; many millennials moved out of apartments and upgraded to homes as they started to consider forming families and other Aussies upgraded their homes for more space or to live in the right neighbourhood.
At the same time, many Baby Boomers upgraded their lifestyle looking for high-quality, low-maintenance living, knowing this will likely be their last home while others bought themselves a holiday home.
And the resultant significant rise in housing prices means most existing homeowners are sitting on substantial equity.
But this was a very short property cycle.
Downturn phase of the cycle in 2022
Yes, we’ve moved to the next phase of the property cycle.
Australia’s property market boom appears to have ended, and now we’re onto the downturn phase of the cycle.
Let’s be clear…some property markets, in particular, Brisbane and Adelaide still growing, but their growth is slow, and in other parts of Australia housing prices are flat or slowly declining.
Here’s what has happened.
The boom phase of the cycle that we saw in 2020-21 saw prices soar, but now as a result affordability has deteriorated.
For context, property prices have surged 29% since the pandemic while wage growth has risen a mere 2.3%.
At the same time, inflation is soaring, making it harder for buyers to save that much-needed house deposit - inflation is at a 21-year high at around 6%, and there is more to come.
Speaking of inflation, the Reserve Bank of Australia (RBA) hiked the official cash rate for the second consecutive month in June to 0.85% in an effort to curb inflation - again, we’re yet to reach the peak with further rate hikes expected before the end of the year.
This in turn has caused fixed mortgage rates to more than double to around 5%, from around 2%.
What does all this mean?
Well, in short, buyers need more money to buy a property….but they aren’t able to borrow as much.
And the rising inflation and cost of living mean a deposit is harder to save.
It’s easy to see why we’re entering a downturn, isn’t it?
A rise in new listings in Sydney and Melbourne has taken some pressure out of the market, while there has been a shift and rotation in spending from goods back to services on top of a decline in consumer and home buyer confidence thanks to concern about rising rates, inflation and the future of property values.
As I said, we’re in the downturn phase, and sure, the value of some properties may decrease in the coming year – some by as much as 10% - but that will only be in the short term.
Yet there are still some strong patches in the Melbourne and Sydney property market where A-grade homes and investment-grade properties are still selling well.
It’s a bit like having one hand in a bucket of hot water and another hand in a bucket of cold water and saying “on average I feel comfortable.”
However strategic investors are not phased by this stage of the cycle, they understand real estate is a long-term game and they’re more focussed on the long-term rise in values rather than short-term slumps.
So what has happened to property values in the long term?
Research by Metropole, based on data by the REA Group and the Australian Bureau of Statistics (ABS) shows that Australia’s national median house value has risen by an enormous 540.1% over the past 42 years.
This is an average annual growth rate of 7.62%.
The numbers did, however, vary by state.
Over the past 42 years, Melbourne had the highest average annual price growth for houses at 8.26%.
Sydney was the second-fastest-growing with a 7.98% average annual house price growth, only just ahead of Canberra which enjoyed a 7.9% increase.
The average annual house price grew 7.51% in Brisbane while Adelaide and Perth saw 6.94% and 6.26% increases respectively over the 42-year period.
There were no 40-year figures for Hobart and Darwin but the 30-year average annual house price growth was 7.29% and 5.84% respectively.
Of course, these are just overall averages and within each state here are some locations that have enjoyed significantly more capital growth than these averages, and other locations which have underperformed.
I guess that's how averages work.
At Metropole, we spend a lot of time researching locations that deliver wealth-producing rates of capital growth.
This leads to the question…
What causes property values to increase?
Now we know all about property market cycles and at what stage in the cycle we’re currently in, let's talk about property price rises, and how and why they grow.
I’ve divided this discussion into:
- The short-term factors - which are what most of the media is concerned about and…
- The long-term influences - which is what strategic investors pay attention to.
8 reasons property values increase in the short term
- Interest rates
Obviously, low-interest rates make it easier for buyers to borrow more, as money is cheaper.
But interestingly, the converse isn’t true.
In the past, property values continued rising for some time, despite the RBA raising interest rates
- Supply and demand
Generally, if demand for accommodation outweighs supply, property prices will rise.
But if supply outstrips demand, such as when we go on too many apartment tours, prices tend to decline.
- Availability and cost of land
The lengthy-time taken to release new land supplies and the vast amount of taxes and charges developers must pay to subdivide new estates have positively contributed to housing price inflation in Australia.
- Access to credit
Now I’m not talking about interest rates here, but a borrower's actual access to credit.
Rising interest rates tend to prompt lenders to tighten their lending standards so borrowers can’t borrow as much.
This warning had the desired effect and the share of new loans to investors fell from over 40% during 2014 -15 to less than 30% the next year.
On the flip side, during the pandemic boom, banks eased lending standards in a move designed to free up credit and revive the economy - and it worked, hence the price surge.
- The general economic climate
Here we’re talking about things like inflation and employment levels.
It seems obvious that periods of low inflation and high employment would see an uptick in borrowing as consumers look to spend the extra cash in their back pockets.
And as we know, when buyers fight over property purchases, values are only going to go upwards.
- Consumer confidence
Increasing consumer confidence increases consumer spending.
The aggregate demand curve shifts to the right, indicating an increase in demand for goods over services.
In other words, a robust economic climate and rising property prices cause a “wealth effect “ which leads to higher consumer confidence where buyers think it's the opportune time to spend their spare cash on a property.
- Government incentives for first-home buyers
When the government wants to inject more demand into the market it looks to incentives for first-home buyers.
Just look how well this worked during the Covid pandemic as first home owner grants and incentives boosted jobs in the construction industry as well as in many associated retail industries.
Our new Labor government currently has a few schemes in place for first-home buyers: the Help to Buy program (where the government owns a portion of your property and you pay it off down the track), the Home Guarantee Scheme where you can buy with a 5% deposit or regional first home buyer support.
And what do these incentives do?
It broadens the pool of property buyers, flipping the supply/demand balance and putting pressure on property values.
- Investor appetite
Over the long term, property investors make up about 30% of the housing market.
When the market conditions are favourable this leads to high investor demand and we all know what that leads to.
3 reasons property values increase in the long term
Demographics are the data that describes the composition of a population, such as age, race, gender, income, migration patterns, and population growth.
These factors are significant drivers of what types of properties are in demand and how property is priced.
That’s because the demographics of a population determine not just how many people there are, but how and where they want to live.
And I’m not really talking about population growth – it’s actually household formation that is the key here.
And immigration flows into this also.
Australia’s immigration policy of selecting skilled workers at the family formation stage of their lives is a significant driving factor for our housing markets.
And Covid has caused a structural-demographic change that will affect our housing markets moving forward.
Not only that but the pandemic-induced work-from-home movement has changed the demographics significantly - now, many workers are able to work from the comfort of their own homes and save on commuting, which means they need the extra space.
We’ve seen this trend, in fact, with the sea- and tree-change shift which has occurred over the past 2 years.
- Also read:Boom to bust: What makes property prices rise and fall
- Also read:Sydney and Melbourne suburbs more likely to hold their value
- Also read:Latest property price forecasts for 2022 revealed. What’s ahead in our housing markets in the next year or two?
- Also read:12 inflation jargons explained: Here’s everything you need to know
- Also read:How many investment properties do you need to retire?
The pandemic made people re-evaluate what they want in a home.
Many were upsized to a larger property, some moved further away from the city and others relocated entirely to regional areas.
And the importance of the neighbourhood was reinforced.
For many it’s all about ‘living locally’ – having the ability to meet most of your everyday needs within a 20-minute walk, cycle, or local public transport trip of your home.
- Future population growth
Australia’s population grew just 0.3% year on year in Q3 2021, with growth well below the pre-pandemic average of 1.6% given the closed international border from March 2020, with a staged reopening beginning 1 November 2021.
In terms of heads, this equates to the population increasing by just 68,900 people compared to 380,000 a year prior to the pandemic.
While our population growth stalled through the pandemic, immigration levels are expected to get back to pre-Covid levels by 2023.
This suggests we’ll see a population growth of about 1.5% or 400,000 per year.
That’s the equivalent of adding a city the size of Canberra every year!
But the numbers have already started rising.
Since the phased re-opening of the international border in November 2021 net international arrivals into Australia have already picked up the pace.
The government noted over one million people have entered Australia, including more than 130,000 international students, 70,000 skilled migrants, and 10,000 working holidaymakers.
The government is projecting population growth to lift to 0.7% in 2021-22 and get to 1.2% in 2022-23.
Underpinning the pick-up is net positive migration of 41,000 in 2021-22, 180,000 in 2022-23 and 213,000 in 2023-24.
If we believe Australia’s population is going to keep growing, and it will with a business plan to have close to 40,000,000 people in Australia by the middle of the century, and that our wealthy nation is going to remain wealthy, this will then underpin long-term property values.
- The wealth of the nation
There is a positive relationship between household income (“real income” after inflation) and housing demand.
Australia’s property prices increased at a record pace in 2021 with recent data showing that the national median house price surged 25.7% and units by 7.7% year on year.
And it was this price surge, combined with solid share market gains, which pushed total Aussie household wealth up another 4.5% in the December quarter of last year to a new all-time high of $14.7 trillion.
That’s a 20.2% increase from just the year prior.
And the same can be seen in per capita household wealth which rose 3.9% over the quarter to a new record of $556,541 per person - up 19.9% over the year.
The truth is household wealth and property price increases go hand-in-hand.
You see, Australia’s housing market is worth $10 trillion, whereas we only have $2.5 trillion of debt.
So it’s clear that the massive wealth held in property underpins the housing market and this won’t ever fall far before people start buying again.
The 'wealth effect' explained
Household and individual wealth is a very influential factor for property markets and is very topical in today's markets, so let's drill down into this topic further to show exactly why it drives prices higher.
In every society, the property is generally considered the major store of wealth.
And in Australia gross housing assets account for more than half of total personal wealth.
Owner-occupiers and property investors feel wealthier when prices of existing houses rise - this is called the ‘wealth effect’ which leads to an increase in consumption expenditure.
As a result, aggregate demand, and thus economic growth, occurs which in turn support rising housing prices through a self-reinforcing cycle.
And it’s this factor that also contributed to the recent 2020-21 property price boom.
Many of those lobbying for more affordable housing forget the ‘wealth effect’ of rising house prices.
And I’m not just talking about the importance of the building sector in our economy.
There is a flow-on effect when someone buys a property - they buy new carpets, a television, refrigerators, etc.
Increased property values have a positive effect on the nation’s GDP because when people feel wealthier, they spend more.
The RBA has published a range of research that calculates the benefits of a change in wealth when house prices increase.
The data shows changes in household wealth due to changes in house prices impact the growth of household consumption - in other words, as I said above, people spend more.
In simple terms, they found that when wealth increases as house prices rise, spending grows and helps the economy and when house prices fall spending growth slows.
And I guess that makes intuitive sense.
If a property owner feels the ‘wealth effect’ as their property increases in value, they are inclined to borrow against their wealth and in turn, increase their consumption spending.
What does this mean?
It means the rising housing wealth and the associated growth in household consumption feeds through to the other parts of the economy and creates jobs.
It increases the level of employment which in turn feeds into better-than-otherwise wage increases (better than in a scenario where house price growth is weak or non-existent).
In my opinion, the high house prices in Australia are a reflection of living in the best country in the world with large coastal cities.
There are long queues of people wanting to live in this country - you don't see people queuing up for 20 years to live in Indonesia.
So rather than wishing for cheaper house prices, we should be looking to improve the financial situation of Australians.
Because when house prices fall it leads to a weaker economy, high unemployment, problems in the banking system, and a slumping construction.
And who would want that?
Sure, property affordability may improve, but crashing house prices will not build homeownership rates.
In fact, on the contrary, a house price crash may lead to even lower homeownership rates if unemployment is higher and banks continue to tighten lending.
How to choose an investment which outperforms market averages?
So we’ve discussed the concept of the property cycle, identified the long- and short-term factors that contribute to property price increases, and of course, we already know that investors need to put an effective investment plan in place in order to outperform market averages.
The key to achieving above-average capital growth is buying the right property at the right price, and most importantly, in the right location.
The system that we use at Metropole - which has helped many clients build substantial property portfolios by identifying properties that outperform the averages for growth - is what I call our top-down approach (going from the macro to the micro).
This starts with examining the macro factors affecting our property markets and drills down to the micro-level.
Step one: We start by looking at the big picture – the macroeconomic environment.
Step two: We then look for the right state in which to invest - this is one that will outperform the Australian market averages because of its economic growth and population growth.
Step three: We look for the suburbs within that state which will outperform with regard to capital growth.
We’ve found some suburbs have 50-100% more capital growth than others over a 10-year period so obviously, those are the suburbs we target.
These will be areas where more owner-occupiers will want to live because of lifestyle choices and one where the locals will be prepared to and can afford to, pay a premium price to live because they have higher disposable incomes.
These are often gentrifying neighbourhoods as well.
Step four: Then we look for the right location within that suburb.
Some liveable streets will always outperform others within those streets.
Step five: Likewise, some properties will always be more desirable than others so we look within that location for the right property.
And finally, we only buy at...
The right price, but I’m not suggesting a “cheap” property - there will always be cheap properties around in secondary locations - I mean the right property at a good price.
Great, but how to know which is the right property to buy?
I know what you’re thinking:
That seems simple, but even if I’ve narrowed it down to the right area, suburb, or even the best street, how do I know which is the right property to buy?
Well, we have a 6 Stranded Strategic Approach which would help.
Only buy a property…
- That would appeal to owner-occupiers - Not that we're planning to sell the property, but because owner-occupiers will buy similar properties pushing up local real estate values.
- Below intrinsic value – This is why we avoid new and off-the-plan properties which come at a premium price…
- A high land-to-asset ratio – This doesn’t necessarily mean a large block of land, but it should be one where the land component makes up a significant part of the asset value.
- In an area with a long history of strong capital growth - These areas will typically continue to outperform the averages due to the demographics in the area.
- With a twist – Something unique, special, different, or scarce about the property makes for a good investment.
- Which can be renovated for capital growth - Properties, where you can manufacture capital growth through refurbishment, renovations, or redevelopment, are preferred over waiting for the market to do the heavy lifting. After all, we’re heading into a period of lower capital growth so ‘waiting’ for the market to do the hard work for you isn’t going to get the results you need.
By following our 6 Stranded Strategic Approach, you minimise your risks and maximise your upside.
That’s because each strand represents a way of making money from property and combining all 6 is a powerful way of putting the odds in your favour.
If one strand lets you down, they have 2 or 3 others supporting their property’s performance.
When you look at it this way, buying a property strategically takes a lot of time, effort, research, and something most investors never attain – perspective.
What I mean by this is you can gain a lot of knowledge over the Internet or by reading books or magazines but what you can't gain is experience.
It takes many years to develop the perspective to understand what makes an investment-grade property.
Here’s how I’m preparing for the downturn
- I own the right properties in the right locations – ones that will hold their values
- I have financial buffers in place
- I have expectations rather than forecasts
You see… I recognise that we’re in an interesting time in the property cycle and that a lot will happen over the next decade, but I don’t make forecasts - instead, I have expectations.
Now there’s a big difference between forecasts and expectations.
I expect there to be another recession in the next decade.
But I don’t know when it will come.
I expect the property market to slump over the next few years and the price of some properties will tumble and then the market will pick up again.
But I don’t know when.
I expect inflation to remain high, but I don’t know how high it will get or when it will come under control.
I expect interest rates will keep rising but I don’t know how high they will go or how many rates rise there will be.
And I expect another world financial crisis.
But I have no idea when it will come.
Now, these are not contradictions or a form of a cop-out.
As I said…
There's a big difference between an expectation and a forecast.
An expectation is an anticipation of how things are likely to play out in the future based on my perspective of how things worked in the past while a forecast is putting a time frame to that expectation.
Of course, in an ideal world, we would be able to forecast what’s ahead for our property markets with a level of accuracy, but we can’t, because there are just too many moving parts.
Sure, there are all those statistics that are easy to quantify, but what is hard to identify is exactly when and how millions of strangers will act in response to the prevailing economic and political environment.
Then there will always be those x-factors that crop up.
So I plan for the worst but expect the best.
And I invest with a long-term perspective.