The middle market will hold up best during the next Australian property downturn: Pete Wargent
Yesterday was a hot sunny day in London, where I've been attending auctions.
It's quite clear that in this part of the world the quality suburbs of London remain smoking hot, but the areas away from London are still struggling to gain momentum even after half a decade, although there are signs at long last of an upturn.
Thanks to the UK Government's 'Help-to-Buy' scheme, Bovis Homes today reported a 60% y/y surge in sales as the market is steadily being re-inflated.
Meanwhile back in Australia, RP Data releases figures which show that the most affordable 25% of capital city suburbs have outperformed the remainder of the market over the past decade.
Source: RP Data
It's difficult to avoid make sweeping generalisations here, of course, but this is broadly what we might expect to see at this stage in the cycle, given the below:
In 2008, the official cash rate in Australia threatened to increase back towards the levels seen pre-1993 (it was hiked to 7.25% on 5 March 2008) which was the year of the introduction of the target inflation rate. But since that date, the cash rate has plummeted to record lows.
In fact the cash rate in Australia has fallen from an eye-watering 17.50% in January 1990 to a record recent low of only 2.75% on 7 May 2013. With households able to source incredibly cheap credit at low mortgage rates (as low as 5% or even less today), this has lead to easily the most material gearing up in the history of Australian households.
I'd suggest that anyone who looks at this chart and thinks that homebuyers Australia-wide are preparing themselves for a major and sustained boom in credit growth might be ever-so-slightly optimistic.
We know that Australia, just as in many other countries, saw banks and lenders dishing out 100% mortgages in the period leading up to 2008, so there is likely to be some bad news in the post in the more affordable segments of the market as and when interest rates revert towards the historical mean.
As noted by RP Data, the premium sector of the market tends to be the most volatile, whilst for the past two cycles, the most affordable properties have been the most stable. The problem here is that their chart only goes back to 1998 and therefore does not go back far enough to show what happens to lower demographic suburbs when interest rates rise. Traditionally, and if overseas markets are a useful guide, prices get clobbered as mortgage stress is experienced.
The good news for property die-hards is that Australia has to date been perhaps unique in developed world economies. We have not experienced a recent major property downturn in the capital cities and we haven't had a recession for some 22 years and counting. And long may that economic record continue.
However, property is not a magical risk-free asset class and all countries experience property downturns - and when this happens, markets with a strong proportion of investors are likely to be those which hold up best. I wouldn't want to be holding property in the cheapest markets where people tend to live through necessity rather than through choice.
Instead, I have a strong preference for markets where investors look to at the first sign of a recovery and where foreign funds will flood - close to the centre of the major capital cities.
Some properties in affordable areas will be represent good investments, but be very wary of properties with seemingly attractive high yields and that are in low demand. I've seen properties for sale here in England in small towns for the price of just one pound, and you've probably heard of similar stories from regions of the US.
Finding new hotspots
In recent months I've had some long, drawn-out discussions with an experienced property buyers agent who is in the market daily about this very topic.
Naturally, I understand the theory that instead of buying where everyone else is rushing to buy, you may wish to buy in a regional centre where 'no-one' is buying - in the hope that they might soon do so because of, for example, new government infrastructure, projected employment growth or perhaps a nearby mining project.
The problem with this is that when people migrate to an area to work, they very often do not buy, they rent. And when they do buy (if they remain in the region), they do so to settle based on their earnings which tend to be in line with others in that area.
The only way in which prices are generally going to be pushed higher and ahead of wages growth is if you can anticipate a swathe of speculation which itself generates a larger influx of accelerating debt - and if you get that, you'll usually get new home building, which increases supply and masks the actual price increases (showing instead only median price increases).
Mining towns exhibit many of these traits. Price increases can often be fuelled by investors who may profit if they get their timing right (risky). Those who work in the town often save their money and instead invest it in property in the capital cities.
When will this property cycle end?
RP Data shows that all capital cities have recorded price gains over the past 12 months, values being pushed up by the record low interest rates. Gains have been strong in Sydney, Darwin and Perth, but weak in Adelaide and Brisbane.
When will the cycle end, if indeed in the unlikely event that it ends coterminously in all cities? Impossible to say and anyone who claims to know is fibbing.
It could be in just a couple of months' time when Mr. Rudd calls an election. It could be in 2014 as the RBA starts to hike interest rates. It could be later in 2014 as unemployment starts to ratchet up (job losses also hurt affordable market sectors disproportionately, so let's hope this doesn't happen in Australia). Or perhaps the cycle will even run for 18 months or more.
In any case, whenever Australia's next significant downturn occurs, expect the broad middle market in supply-constrained capital city suburbs to hold up best. They usually do.
Pete Wargent holds a range of finance and property qualifications and is the author of Get a Financial Grip – a simple plan for financial freedom.
