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Key takeaways
We’re now 16 months in to a new property cycle.
Early in 2023 our housing markets reset, and property values started rising, despite that fact that the RBA kept raising interest rates.
Currently our property markets are fragmented and some locations and certain properties are outperforming with regards to capital growth
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 and I explain them at length in this detailed article
We’re now 16 months in to a new property cycle.
Early in 2023 our housing markets reset, and property values started rising, despite the fact that the RBA kept raising interest rates.
So what happened?
What changed?
And what does it mean for the future of our property markets?
To help understand what’s ahead and if the property markets will keep rising or crash as some are still 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 all 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 as vendors put more properties on the market for sale, before starting to increase again.
While you’ll often hear that property cycles last seven to 10 years, and while that may be the case for individual state property markets, the following chart from Michael Matusik shows that since 1980 the “overall Australian property market” peaked every 4 years or so.
Of course, 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, yet it would appear that the time between peaks is getting shorter.
This makes sense given the way we receive information these days and how fast news spreads.
Gone are the days of a weekly or even monthly real estate report in the printed press.
News is at our fingertips 24/7.
Quarterly house price growth reports have now morphed into daily indexes.
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%.
The Australian Bureau of Statistics (ABS) confirmed that the total value of Australia’s 10.8 million properties at the time skyrocketed to $9.9 trillion in 2021 alone, having risen by a wallet-busting $512.6 billion in just 3 months.
Now these are some large numbers.
At the same time, the collective wealth of Australia’s homeowners increased by $2 trillion in that one year alone – a sum which was 30% higher than the annual output of the entire Australian economy.
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
It wasn’t long before we moved to the next phase of the property cycle.
Australia’s property boom ended in 2022, as prices soared and affordability deteriorated.
For context, as you can see in the table below, property prices surged by around 26% overall and much more in certain locations, while wage growth rose a mere 2.3%.
At the same time, inflation was soaring making it harder for buyers to save that much-needed house deposit.
This table shows how the various property markets performed since the onset of Covid 19.
The property market reset of 2023
It’s no secret that the Australian housing market has faced its fair share of challenges over the past couple of years but it’s now clear the property market bottomed out early this year despite the fact that interest rates were still rising then
Of course house prices are driven by many factors, not just interest rates.
More important is consumer confidence and supply and demand.
Currently, demand for housing is booming, driven by a surge in migration and the return of international students.
The recently released National Accounts showed that Australia’s population has grown by around 620,000 people in the past financial year.
That’s the highest number in history and a hundred thousand more than what the May federal budget projected.
And these people all need somewhere to live.
This increase in population is competing with locals in the rental market, driving rents higher and spilling into property prices.
In contrast, the growth in dwelling supply is lagging, with building approvals for new homes at a decade low.
And despite some commentators predicting property prices would plummet by 15, 20 or even 30 per cent based on rising interest rates, the Australian property markets have shown remarkable resilience.
While the cash rate can be a good short-term indicator of price growth, other factors – including population growth and supply of dwellings to market – have had a more significant impact on dwelling values.
Until supply responds to demand, the upturn seems likely to continue.
So what has happened to property values in the long term?
Research by Metropole, based on data from 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.
However, as you can see in the following chart from financial analyst Stuart Wemyss of Prosolution Private Clients each state and territory runs its own property cycle dependent on it’s own economic cycle.
This chart shows that while “the overall”Australian property market peaks every 4 years or so, States tend to have much longer periods between cycle peaks and these are often followed by long periods (often many years) of flat or no price growth.
This chart illustrates that property markets have moved in two distinct cycles over the past four decades, being either in growth phase or flat parts of the cycle.
However, over longer periods of time, property capital growth is relatively stable – most markets have produced circa 7.50% p.a. growth over the past 40+ years (which is approximately 5% p.a. plus inflation).
This leads to the question…
What causes property values to increase?
OK – so now that you 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
1. 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 and much the same happened in the last few years .
2. 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 towers, prices tend to decline.
Of course, currently there is strong demand, in general related to surging immigration, and we’re just not building enough accommodation to meet the demand.
This has led to rising property values in skyrocketing rents.
3. 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.
There are currently moves afoot to speed up the development process, as the government wants developers to produce 1.2 million new dwellings in the next five years.
However, it seems very unlikely these targets will be reached
4. 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.
When our Banking Regulator APRA was concerned about the rapid growth in lending to property investors which led to steep increases in property prices in 2014, it instructed the banks and other lenders to be more cautious and set stricter criteria for determining whether borrowers could repay their loans if interest rates were to change.
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.
5. 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.
6. 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.
Last year consumer confidence was at historic lows, we were scared about rising inflation, rising, interest, rates, and economic uncertainty.
On the other hand, I believe that in 2024 consumer confidence will increase as inflation is coming under control and interest rates have peaked, and this will be a strong positive for our housing markets
7. 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-19 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.
8. 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
1. Demographics
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.
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 (even though this trend is now reversing.)
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.
2. Future population growth
Australia’s population growth has been skyrocketing.
The recently released National Accounts showed that Australia’s population has grown by around 620,000 people in the past financial year.
That’s the highest number in history and a hundred thousand more than what the May federal budget projected.
This record 2.8% expansion in the 15 plus age group of our population is placing a great strain on our housing markets.
The latest federal budget projected that Australia’s population would grow by 2.18 million people (equivalent to a Perth) over five years, driven by record net overseas migration of 1.5 million (equivalent to an Adelaide)
The latest Intergenerational Report projected that Australia’s population would grow by 14.2 million people over 40 years, which is equivalent to adding a combined Sydney, Melbourne, Brisbane and Adelaide to the nation’s current population.
This population growth would be driven by net overseas migration of 235,000 a year.
Australia’s housing shortage is the direct result of nearly 20 years of high net overseas migration, which is projected to continue for decades.
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.
3. 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.
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.
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, 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 supports 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.
Note: It means the rising housing wealth and the associated growth in household consumption feed through to the other parts of the economy and create 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, after using a Top Down Approach to choose the right location, we need on the ground information, a Bottom Up Approach that I have called my the 6 Stranded Strategic Approach to find the right property.
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 ups and downs of the cycle
- 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.
Note: 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.
Note: 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 rate rises there will be.
And I expect another world financial crisis.
Note: 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.
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