Where are we in the property cycle?
Many property investors would give their second garage to find out the answer to this question.
After 12 months of booming real estate markets around Australia there is now talk about slowing price growth and even falling house prices.
In fact, a few of the regular property pessimists are even predicting the property market will crash in 2022.
By the way…they’re wrong!
But all this makes it a good time to learn a little about property cycles.
Looking back at how previous property cycles played out, I delved back into my memory to see what lessons I could learn from past property cycles and realised that I’ve probably learned more from the many mistakes I’ve made than from the things I got right.
Now there’s a powerful lesson in itself!
Of course, we all know that markets move in cycles.
Economic growth is not a straight line, and neither is property price growth.
Essentially the property cycle is the measurement from a peak in property prices through a slump, then a flat period, and back to the next peak again.
Trying to interpret the cycle is what leads commentators to make predictions or forecasts. But they usually get it wrong.
Typically the cycle is depicted in 4 stages.
The boom is followed by the downturn, which is followed by the stabilisation phase, which leads to an upturn, which in turn sets us up for the next property boom.
I’ve drawn it as follows:
I’m often asked how long between one property cycle and the next and while many market commentators refer to a “7-year property cycle”, it is rarely seven years.
In fact, average Australian capital city prices have had multiple cycles over the last 20 years with booms around 2003, 2007, 2010, and 2017 – which was the last time property prices peaked on the east coast of Australia before this current property cycle.
Earlier this year house prices once again reached the previous peaks of 2017 and have now surpassed them.
The fact is, the length of a property cycle has nothing to do with the number of years.
Cycles are driven by a series of socio-economic factors, but over the years I’ve noticed that the nature of our property cycles is changing and seem to be getting shorter.
Also, the cycle is better seen in terms of the rate of property growth, as not all downturns or bust phases have price declines, some just experience a slowing.
Of course, the cycle can also vary from city to city.
And there are even cycles within cycles within each capital city.
The current property cycle has been quite unusual as almost all housing markets around Australia, both capital cities and regional locations, have exhibited strong price growth in 2021.
But again, not all parts of the property market are in sync – just look at how poorly CBD high-rise apartment towers and apartments near universities have performed.
What factors influence the property cycle?
The main factors driving the property cycle are:
Interest rates and the availability of funds to buy property is major driver of property demand.
When money is cheaper (interest rates are low) this is positive for property markets. Clearly, the availability of finance (or lack of it) has been a major influencer over the last few years
The Economy – business confidence, employment prospects, jobs growth, and wages growth all create demand.
The availability of supply of property to meet this demand.
Demographics – in particular, household formation (again affecting demand.)
So how do we know where we are in the property cycle?
Learn from the past
I don’t think anyone can be a proficient property investor until they have invested in and survived at least two properties cycles.
History tells us that this cycle generally lasts for about seven years with three to 3 to 1/2 years of a slowdown and a flattening out of house prices, followed by 3 to 1/2 years of rising prices and so on and so on.
But it varies from state to state – for example, Brisbane and Perth both missed the previous big upturn in the property, when Melbourne and Sydney experienced in a boom 2016 and 2017 17
As a history student of history, you learn that cycles are driven by human emotion – fear and greed as well as the availability of credit, more than changes in interest rates.
Just look at what APRA’s changes in 2014 to 2017 did to investor activity and how that slowed down the property cycle
In the past Sydney has generally been the first market to fall and to rise, followed by Melbourne and then the rest of the country behind that. And each market operates inside its own dynamics, which can dictate the rise and peak of the cycle and its severity.
Interestingly the current property boom is different from any other cycle I have seen for almost 3 decades. Almost every property market around Australia has had strong growth over the last year – other than that in the CBD apartment market.
2. Don’t be fooled by the numbers
But here’s where it gets tricky. If it were just a case of simple sums add seven and abracadabra you’ll know exactly what the market is doing there wouldn’t be tales of financial hardship experienced particularly by investors during property slumps.
It looks like the current property cycle will be considerably shorter than the 7 years, as we had seemed to miss the stabilization stage of the cycle and jumped straight into the boom stage from October 2020 moving forward.
And of course, property price growth has been stronger than we’ve seen for about three decades and this level of growth is unsustainable in the long term considering the slow growth in wages and therefore affordability.
3. Understand the triggers
Now that we’ve determined that it’s not just a simple case of doing the sums, the next step to mastering the property cycle is understanding what triggers the peaks and the troughs.
The most obvious factor is interest rates.
When interest rates fall, and money credit is easily available, property values grow strongly as has happened over the last couple of years.
This leads to FOMO – the fear of missing out and a herd mentality where people rush into by just because of everybody else’s.
On the other hand, when interest-rate start to rise a nervousness and cautiousness creep into the market.
All prior slumps have been the result of either a significant increase in interest rates or the tightening of the availability of credit by our regulators.
Rising interest rates don’t only make mortgage repayments less affordable, but they also affect general business confidence.
Migration, from overseas and between states, is another key factor.
The Federal government recently announced that will reopen our international borders and fast-track our immigration program particularly for skilled migrants, and this will impact underlying demand, fueling our property markets.
Economic factors can help send the property market into decline when we have our cyclical economic downturns, but similarly strong economic growth leads to jobs growth, wages growth, and often population growth and this helps the market reach record heights.
Now…here are 4 key lessons I wish I’d learned earlier in my investment journey about property cycles:
1. The economy and our property markets move in cycles
And the main cause behind these cycles is that we’re human and tend to share the general optimism or pessimism of others.
As I’ve already explained, it’s a common fallacy that Australian property cycles last 7 – 10 years.
Cycles vary in length and are affected by a myriad of social and economic factors and then, at times, the government lengthens or shortens the cycle by changing economic policies and particularly by manipulating interest rates or the availability of credit.
Back in 2016-7 APRA and the RBA fiddled with the availability of credit – either the cost of money such as interest-rate or the availability of money such as tightening the screws to “manage” our property cycle, but of course last year the lockdowns forced by Coronavirus put the nascent property cycle on pause.
Then over the last few years historically low-interest rates have made holding on to properties very cheap and the markets have boomed
It’s my observation that investment markets often “overshoot.”
That is, they move by more than changes in the fundamental influences would seem to require – on the upside as well as the downside.
Take the Sydney property market which experienced significant growth (overshooting its fundamentals) during the previous property cycle, and then dwelling values in Sydney dropped 15% from their market peak overshooting on the downside when in general all the fundamentals for Sydney property were sound in 2018 and 2019.
And now Sydney’s property market has grown by close to 30% this year
2. The market is usually wrong about the stage of the cycle
“Crowd psychology” influences people’s investment decisions, often to their detriment.
Investors tend to be most optimistic near the peak of the cycle, at a time when they should be the most cautious and they’re the most pessimistic when all the doom and gloom is in the media near the bottom of the cycle when there is the least downside.
Market sentiment is one of the key drivers of property cycles and one of the reasons why our markets overreact, overshooting the mark during booms and getting too depressed during slumps.
Remember that each property boom sets us up for the next downturn, just as each downturn sets the scene for the next upswing.
3. There is not one property market
While many people generalise about “the property market” there are many submarkets around Australia.
The fact is, each state is at a different stage of its own property cycle and within each state, the markets are segmented by geography, price points, and type of property.
For example, the top end of the market will perform differently to the new home buyer’s market or the investor segment, or the median-priced established property sector.
And while there is an oversupply of poor quality rise off-the-plan apartments in Sydney, Brisbane, and Melbourne, there are more buyers looking for well-located homes than there are good properties on the market in the middle ring suburbs.
4. The importance of asset selection.
Understanding all this information about property cycles is useless unless you own the right assets in the first place.
A grade homes and investment great properties are less likely to fluctuate in value when the property market turns.
If you own the right then it trying to pick cycle timing is nowhere near as important as riding the cycle and holding your assets in the long term.
Remember property investment is a long-term asset in the long-term trend for centuries has been a steady increase in value, despite the short-term fluctuations in ups and downs.
5. We need to allow for the X factor
When most Australians hear about ‘the X-factor’ they think about a talent show on TV.
However, ‘the X factor’ is also talked about in the less glittery world of economic forecasting.
Economists refer to ‘the X-factor’ when an unforeseen event or situation blows all their carefully laid forecasts away.
I first came across this concept many years ago when distinguished economics commentator, Dr. Don Stammer, used to try and predict the X Factor for the forthcoming year in the January edition of the now-defunct BRW magazine.
Of course, by definition the X factor is unforeseen, so you can’t really predict it.
But it was a little game he used to play and then review his prophecy 12 months later.
And it is a game I also took up many years ago and have had fun with over the years.
These X-factors can be negative (the aftermath of the Global Financial Crisis of 2008) or positive (the China-driven resources boom of 2010-12) and it can be local or from abroad (the US subprime mortgage crisis of 2008.)
The big X factor for 2020 was the Coronavirus lockdowns
The Delta strain of the Coronavirus was the X factor for 2021.
If you think about it, at the beginning of this year we thought we had this coronavirus thing licked and everything was going to be under control and life would be back to normal.
Then look what happened!
These X factors affect the economy at large, which of course affects our property markets, but our property markets also have their own specific X factors – unforeseen events that affect the best-laid plans and predictions like APRA’s unprecedented restriction of bank lending to investors.
So the lesson is while it’s important to take a long-term view of the economy and our property markets, you also need to allow for uncertainty and surprises by only holding first-class assets diversified over a number of property markets and having patience.
Trying to predict the X-factor is futile: if it’s been predicted, it’s not the X-factor, but let’s have a look at a list of major past X-Factors (many of these are the thoughts of Dr. Stammer, who now writes for The Australian.)
In 2019 was the “miracle” election win of the Morrison government. Leading up to the election many commentators were forecasting a prolonged property slump assuming the Labor Party would win the Australian federal election.
2017 – Donald Trump assumed office as 45th President of the United States, while back home APRA’s macro-prudential controls brought a halt to the rising Sydney and Melbourne property markets.
2016 Despite many commentators predicting rising rates, Australian interest rates kept falling, prolonging the property cycle and allowing property prices to surge in Sydney and Melbourne
2015 Negative interest rates in Europe
2014 Collapse in oil prices during severe tensions in middle east
2013 Confusion on US central bank “taper” of bond purchases
2012 The extent of investors’ hunt for yield
2011 Continuing problems with European government debt
2010 European government debt crisis begins
2009 The resilience of our economy despite the GFC
2008 The near-meltdown in banking systems
2006 Big changes to superannuation
2004 Sustained hike in oil prices
2001 September 11 terrorist attacks
1997 Asian financial crisis feat
1991 Sustainable collapse of inflation
1990 Iraq invasion of Kuwait
1989 Collapse of communism
1988 Boom in world economy despite Black Monday
1987 Black Monday collapse in shares
1986 “Banana Republic” comment by Paul Keating
1985 Collapse of $A after MX missile crisis
1983 Free float of the Australian dollar
Now it’s your turn to play the game and predict the coming year’s X-Factor.
What’s the market going to do next?
Recently ANZ has updated its property forecasts for the next 2 years
In its latest update, ANZ stated house price growth will slow over the next year to 6% after median house prices boomed 21.9% over the year to September.
The bank suggested that rising house prices will deter some home buyers, while APRA’s decision to ensure new borrowers can service a mortgage if interest rates jump 3% will put a brake on lending.
While I generally concur with ANZ’s forecast for 2022, I can’t see a good reason for house prices to fall in 2023 unless APRA intervenes and tightens the availability of credit.
Sure housing market growth will slow – the current levels of growth are unsustainable in the long term – but our improving economy and the opening of our international borders next year will underpin demand for housing.
Now is the time to take advantage of the opportunities the current property markets are offering
Sure the markets are moving on, but not all properties are going to increase in value. Now, more than ever, correct property selection will be critical.
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