At present there is a significant amount of property market commentary happening in the press. Topics such as housing affordability, negative gearing, capital gains discounts, housing bubbles, rental stress, APRA regulations, RBA policy and record prices are appearing daily in all forms of main stream media. As is usual with our reports, we will do our best to explain what’s actually happening.

The first thing you need to understand, and we have explained this many times, is that there are many localised property markets in Australia that make up the Australian real estate landscape. There are however two dominant property markets, Sydney and Melbourne, and they are causing concerns for regulators due to their recent strong performance. The rest of the property markets in Australia (and their performances) can be neatly divided into two categories. They are those who benefit from the strong activity in Sydney and Melbourne and those who do not.

Given our close proximity to it, we will use Melbourne as our example. Geelong, the Surfcoast, Bellarine and Mornington Peninsulas and other regional centres have all seen capital gains and strong activity because of the sentiment, increased equity and price differential that the Melbourne property market has generated. The regional areas all look cheap by comparison to Melbourne and this has created significant activity and money flow into these areas.

The same thing is happening in Sydney and the property markets that are benefiting are as far away as Hobart and lifestyle areas of Queensland, as the dominant Baby Boomer demographic pursue their lifestyle plans. Examples of those who are not benefiting are Perth, Adelaide and Darwin as they, for various reasons, do not attract the population flow and economic activity that Melbourne and Sydney do. So the problem that is faced by the federal government and regulators is that they often only have national solutions to issues that are mainly relevant to just Melbourne and Sydney.

Most of the rhetoric that we are seeing in the press is about these two dominant market places and essentially it is a supply and demand argument. Prices rise because people want to live where others also want to be. Australia in general has plenty of supply, it is just that a lot of the available supply is not where people want to live, for a variety of reasons, but mainly due to employment opportunities. What also needs to be remembered is that Sydney and Melbourne are both now global cities which attract significant international interest, mainly for the safe, high quality lifestyles they offer. It is estimated that Melbourne added around 108,000 people in the last financial year and approximately 880,000 over the past decade. Add to that a current demand for properties from investors who have access to affordable finance and are starved for investment alternatives with a fully priced share market and low fixed interest options.

A lot of the debate we are seeing is around possible solutions to a lack of opportunity for those who wish to enter or re-enter the property market. Most prominently, first home buyers or current renters. Property investors and negative gearing have been a major target of criticism. Negative gearing gets blamed as an incentive for investors to compete with first home owners. This is a pricing argument rather than a housing supply argument given that most investors will immediately make the property available for rent. There are two reasons why it is unlikely to change, firstly it is a source of housing that that the government does not have to provide or manage and secondly it is a strong wealth creation tool for Mum and Dad investors who are heavily invested in this space. Many think that most of these negatively geared properties are being bought by high net worth individuals or families, but that is simply not the case. Mum and Dad investors understand residential real estate, unlike the complexities of the share market where most of its movement is governed by forces they don’t understand and cannot control. The ability to walk up and touch your asset is rarely commented on but should never be underestimated. Even if that property, at a minimum, proves to be a forced savings scheme, many small time investors will be satisfied.

Other commentary has focussed on the general level of debt held by Australian property owners. Not only the amount but also the type of debt, in particular interest only loans. Measures being considered by regulators include limiting the banks in the amount of interest only loans they can lend as a percentage of their total loan book. Again this is targeted at loans to investors to which interest only loans are popular. There is also some concern that banks are lending money to people who can only afford to pay back the interest and not the principle, therefore not reducing their overall debt. The evidence is only anecdotal but it is something regulators want to contain.

The concern from property market critics is that if property prices all of a sudden fall significantly, then the amount of highly leveraged property owners will cause a significant rate of mortgage defaults which in turn will have significant ramifications for the rest of the economy. So what are the likely causes of this potential price fall and in reality, what are the likely chances of this occurring?

For house prices to significantly fall there needs to be a considerable drop off in demand for Melbourne and Sydney properties. We do not believe that these cities will all of a sudden become unpopular. Population growth is a strong economic driver and there is no appetite by governments to dramatically contain this. As global cities they are actually quite small in terms of population. According to Wikipedia they are ranked at 81 (Sydney) and 84 (Melbourne) in the world in terms of their population size against other major cities of the world.

If anything is going to subdue a property market it will not be caused by more regulation or regulator tinkering, it will be by a significant change of sentiment caused by a trigger, usually international, event. If we look back in history, with the exception of local interest rate rises, this has generally been the case. In the past decade we can site the GFC in 2008 and the European debt crisis in 2011-12 as good examples of significant sentiment change that resulted in general caution in the market. In the absence of a trigger event it is difficult to see this current property cycle coming to a dramatic, negative conclusion. It is more likely, in our opinion, to land softly due to a raft of minor constraints working together to subdue the market.

We hope you found this report informative and if we can ever be of any assistance in any real estate matter, please do not hesitate to call.