Let’s look at the different phases of the property cycle
Traditionally, it was said that property markets go through three distinct phases: slump, recovery and boom…and then back we trot to step one.
This is sometimes expressed on a clock face with underlying economic conditions over-layed on each hour of the clock.
Traditionally oversimplified accounts can tell us what to look for at each stage of the cycle in terms of population growth, vacancy rates, movement in rents, employment levels, GDP growth, levels of dwelling construction, time on market, number of listings and sales, what the popular media is saying, the number of ‘seminars’…and so on.
Property investment supremo Michael Yardney has been around and invested through a few more market cycles than I have, and he likes to include a fourth phase in the cycle: the stabilisation phase.
In the modern era, I would add to the list of influencing factors: the availability of finance.
Despite regulatory pressures and a widespread belief that the influence of the internet would put an end to the cyclical nature of markets, it still appears to be the case that in a real estate slump mortgage finance becomes devilishly difficult to source, while in a boom lenders are practically falling over each other in a bid to secure new business.
The ‘ending of market cycles’ is hardly a new concept.
Homer Hoyt, who initially identified the property cycle and its respective drivers when analysing Chicago’s land values in the 1930s, even then concluded by pondering whether a new paradigm of ‘no more cycles’ might be upon us (and we’ve had more than a few cycles since that time).
This suggests that emotional factors are key in perpetuating the cyclical nature of markets.
3 drivers of cycles
In fact, the drivers of a property cycle might be categorised under three broader headings: demographics, financials and emotional drivers.
Of course, it’s never quite as simple as implied, and in a country such as Australia, it is commonly the case that different cities can be at different stages of their property cycle coterminously.
One thing which experienced property heads know is that during each recovery phase there will be a series of articles which detail all of the reasons why this time it will be different and the recovery fail to materialise.
We saw this several years ago, when it was frequently noted that weak credit growth could possibly not help the market to recover and high land prices would halt any potential recovery in its tracks.
The same thing then happens in the boom phase, but this time it’s the property investor and estate agent set which is finding the reasons why this time its different and boom conditions can be justified for longer than has ever been the case before. [sam id=40 codes=’true’]
When property markets do eventually recover – however long that may take (in Britain’s case, for example, well over half a decade) – the tone tends to shift towards allocating blame for rising prices.
Usually housing policy, monetary policy or an influx of foreigners get a Guernsey.
But, as noted, a key factor is also likely to be the willingness or otherwise of banks and non-banks to lend capital.
There is normally a level of truth is each of these points, yet when prices are slumping or falling these same policies seem to be working just fine.
This too suggests that one of the biggest factors in a property market cycle is emotional, and put simply, the herd mentality.
That is, the fear not to get burned when prices are falling and the desperation not to miss out when they are rising.
I covered the major reasons why property markets cycle in this post here.
Property markets in recovery phase
A traditional account of what we should see in a recovering property market would include:
- net migration and population growing
- falling or low vacancy rates
- rents increasing
- dwelling construction gradually beginning to pick up
- rising employment
Do Brisbane and Adelaide fit the bill? Hmm, mostly.
But rental increases have actually been fairly weak in those two cities, and weaker than those seen in Sydney and Melbourne. As for jobs growth? Well, yes in Brisbane, but no in Adelaide.
Clearly, these and a thousand other examples underscore that property markets are plenty more complex than tends to be made out.
This, combined with the high level of transaction costs involved in property acquisition and disposal, is why I suggest that a property purchase needs to be made with a long time horizon in mind.
If you hold a property through a couple or more market cycles, then the fact that consistently timing markets precisely is not possible tends to be overridden by the long-term upward trend in household income growth, particularly if you buy well.
Property markets into the boom phase
The one Australian capital city market which is now widely said to be in its boom phase is Sydney, with Melbourne and Perth hot on the harbour city’s heels. With a market in the boom phase, one might typically expect to see:
-net migration/population growth approaching its peak
-dwelling construction heading to the moon
-vacancy rates falling to very low or tight levels
-time on the market very low
-rents reaching a peak
-employment markets firing
-a low number of listings
-property values rising strongly and thus affordability falling
-a virtual epidemic of property seminars
-an increase in the number of persons per household…
…and a bunch of other stuff.
Sydney ticks most of these boxes, with rents rising by around 4% last year, stock selling very quickly and the lowest level of stock on market that we have seen in years.
As for construction, well, heck yes! Take a look around the city and its suburbs and there are cranes seemingly everywhere from Barangaroo to Broadway, and from Glebe to Green Square.
Where I work at Martin Place, 2013 was the year of the jack hammer. This will be reflected in strong residential construction indices in 2014.
Supply coming online
I note though, that the concept of ‘oversupply’ in a very large capital city is a markedly different beast to its smaller regional centre equivalent. Yes, there are some major new developments underway in the inner south and at Central Park, but the effect of these on the wider established sector of the market will likely be relatively muted.
This was explained in some detail by Michael Oxley in his book Economics, Planning and Housing, where he notes that in large cities where the ratio of new stock to established is necessarily extremely low, the idea that even a major pick-up in construction levels will materially impact the established market is unfeasible.
To some extent, we have already seen this in Melbourne, where at face value vacancy rates appear to be disconcertingly high (with yet more monster inner city developments in the pipeline), yet the established sector market has continued to power along, with median dwelling values up by more than 12% in the last 12 months alone.
Sure, Sydney might construct 25,000 new units in the inner south over the next 5 years – and I certainly wouldn’t recommend investing in the new stock there from a return on investment perspective – but the population of Sydney is approaching 4.6 million, and grew by nearly 64,000 persons in the past year alone.
Not only can new stock be absorbed by such a blistering population growth, the reality is that 25,000 units is a drop in the ocean as compared to a city with a population which is roaring unabated towards 5 million.
The end of the boom phase
It won’t be interest rates which eventually halts the Sydney boom either, because the cash rate is locked down at generational lows. And as noted above, it won’t be construction levels or oversupply either.
What will eventually kill off the Sydney housing market boom will be prices becoming too high and yields falling to unacceptably low levels. Just like the last boom through to Q1 2004, this market frenzy will eventually just run out of puff.
The timings are forever uncertain, but this is what Louis Christopher of SQM Research was pointing out this week when he suggested that Sydney prices could boom by 15-20% in 2014.
There needs to be a trigger to stop the rampant herd mentality in its tracks such as higher interest rates or a spike in unemployment, and at this juncture, there doesn’t appear to be one.
The slump phase
Of course, what follows on from the boom phase of any cycle is the slump, the severity of which tends to reflect the underlying fundamentals of the market in question, as well as the respective strength of the local economy and labour force data. Typically, a slump would be reflected by some or all of the following conditions:
-net migration/population growth sliding towards a trough
-rising vacancy rates
-economic growth at a trough
-time on market high
-high number of listings but low sales turnover
-little or no dwelling construction
-higher stock on market
-affordability and yields improving
In Australia, we are entering our 23rd year without recession, and as such we haven’t had a major property correction in recent years. Of course, we’ve continued to experience slump phases, such as in 2008 and again in 2011, but over the last two decades, steadily increasing household wealth has been reflected in appreciating land values.
Adelaide has been an example of a property market over the last half decade which has largely remained in a slump phase. Prices haven’t fallen dramatically, but broadly they have flat-lined and have softened in real income-adjusted terms.
Impact of recessions
The United Kingdom is an example of a country which suffered a brutal recession from 2008 during and after the financial crisis. Prices in many regional areas fell by 20-40% and have never recovered, yet well-located dwellings in London have emerged entirely unscathed and stronger than ever.
We’ve been hearing a lot about a forthcoming Australian recession for the last half decade or so, but it hasn’t played out. Indeed, the Reserve Bank forecasts suggest that low interest rates will begin to see economic growth accelerate again in 2015.
With global economic growth also generally seeming set to rebound, the key issue for Australia to watch out for is an external ‘shock’.
In particular, the watch out for falling commodity prices (especially that of iron ore), the extent to which these are offset by a falling Australian dollar, and the development of the Chinese economy.
With its data shrouded in mystery and a banking system with more holes in it than a Swiss Cheese, China is one external factor with the potential to destabilise.
I guess an awful lot boils down to your level of scepticism in China’s ability to continue the growth in its industrial production and consumption at rapid-fire pace without blowing up.
The one thing that is absolutely certain is that it won’t be a dull decade ahead!
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