Great Ocean Report – December 2018

There is an incredible amount of property market commentary in the media at present and as usual, we will try and separate the facts from the smoke and mirrors.

To set the scene we need to discuss some principles of property markets. Firstly, they are cyclical but they are not uniform. Secondly, they are self-perpetuating. Thirdly, things are never as good or as bad as they seem. These may not be classically trained, economist’s definitions but they will help you understand what is happening.

To illustrate the first principle, a brief recap. Each cycle over the last 35 years have had different drivers that fuelled it and those that slowed it down. Each time, like now, sentiment was overly optimistic on the rise and overly pessimistic on the fall.

Let’s use the Melbourne property market as an example. We have had 5 cycles in the last 35 years. After a very overly optimistic 1980s, in January 1990 interest rates peaked at 17.5% (which seems unbelievable in our current long term low interest rate climate) causing “the recession we had to have” according to the then Treasurer Paul Keating. The overly optimistic were caught out and the early 1990’s saw a flat period caused by high interest rates and the overly pessimistic predicting Armageddon. Many people sat on their hands and did nothing. Those that did act were rewarded with staggering growth between 1997 and 2003. In November 2003, two things happened. Interest rates were raised and dummy bidding at auctions was outlawed. Auction clearance rates plummeted because if you were the only interested party at an auction, you didn’t have to bid. (Which is exactly what is happening now with the investors are no longer competing against the owner occupiers). Property market Armageddon was predicted and with people uncertain how far interest rates would rise, the bidders thinned so single interest or no interest auctions were common. It didn’t take long to pick up again and we saw the market rise to a peak in Spring 2007.

Then the GFC hit in February 2008. Armageddon was predicted. (Who remembers Steve Keen on 60 Minutes selling his property in readiness for Doomsday?) Interest rates were slashed and immigration laws were changed to encourage foreign investment. Foreign money, particularly Chinese money, poured into the Melbourne property market and with Australians FOMO (fear of missing out) fully engaged, the market took off again. Then in 2010-11 the European debt crisis hit and again Armageddon was predicted and the overly pessimistic waited for the world to end. Surprisingly it didn’t end and the current cycle kicked off in 2013 and saw strong property growth until late 2017, when the overly optimistic started to find that they couldn’t get money from the banks anymore and the most public sign of the health of the property market, auction clearance rates, started to fall, accompanied by the predictions of property market Armageddon once more from the overly pessimistic. Which is where we are today.

To highlight the first point, property markets do cycle but they do not have uniform drivers. Even without common drivers, the cycles still roll around and interestingly seem to be getting shorter. Real estate is not meant to be a short term investment. If you bought a house in Melbourne at the peak of the first cycle in 1990 at the median price you would have paid $141,000. If all you did was maintain it and despite 5 threats of property market Armageddon, today it would be worth the median price of $834,000.

“Oh but it’s different this time” say the overly pessimistic, well as we can see from above it is always different and we still managed to somehow get through.

The second point is that these cycles are self-perpetuating. By this we mean everyone does what everyone else does. Fear and greed. Just like in the stock market, the overly optimistic push it too far when things are going well and the overly pessimistic make people too cautious when the cycle turns. We remember selling beach houses in the early 1990s. It was tough work as potential buyers were advised by their accountants (and their friends at dinner parties) that they were poor investments and they were bound to lose money. Those who ignored their accountants because they just wanted a house near the beach for their family to enjoy, were rewarded handsomely between 1997 and 2003 when prices tripled. The overly cautious either never bought a beach house for their family to enjoy or paid double or triple later on.

The third point, that things are never as bad as they seem, reinforces the first two points but is also a further comment on market sentiment. Let’s look at the current fundamentals. Interest rates have been stuck at 1.5% (cash rate) for a record 2 years. This is very unlikely to change significantly anytime soon although the banks are incrementally nibbling away because they can. The unemployment rate for Australia for October was at 5%. The Reserve Bank in its November statement is predicting this will fall to 4.75% by 2020. Australia will continue to experience strong population growth and people simply need somewhere to live. According to the Australian Bureau of Statistics population clock, Australia is adding a new person every 83 seconds. Over the past year Australia added 388,000 people. There are positive and negatives with this but the reality is that Australia is well placed to support its property market.

Driven by the overly pessimistic, market sentiment has turned and yes there will be some price softening in areas where supply builds up or the property type is more discretionary rather than essential (it is why the affluent suburbs come off 10-20% in a downturn in sentiment because they are often decisions made for vanity rather than necessity) but Armageddon will continue to elude us. The current tightening of credit to the overly optimistic will actually help the sustainability of the market, which is a very good thing. At writing we are 12 months from the Melbourne market peak and according the Core Logic the median house price has dropped 4.3%. Hardly Armageddon.

If credit tightening is our major issue, which it appears to be, be assured that the banks will find a way to increase their loan books as soon as they can. They are public companies beholden to share holders who want returns. They have executives that are incentivised to grow their businesses. Even the Reserve Bank Governor Philip Lowe has concerns about lending standards being too restrictive. Watch this space, they will find a way.

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

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