Why property prices have a natural floor

By Rich Harvey, CEO and Founder www.propertybuyer.com.au

The colder weather has turned some prospective purchasers off the property hunt but the astute investor and determined home buyer are still out there scouring the market for deals.

During winter some property buyers tend to slow down their search, some agents take a short break or vendors decide to wait till the spring time to sell.  However, it is also a good time to take advantage of decreased competition and see if you can pick up a property at below market price.

One of the leading economic forecasters BIS Shrapnel released their report “Residential Property Prospects 2006 to 2009” and believes that house prices in Sydney may soften further despite the significant drop in prices since the 2003 boom. They indicate that prices are likely to recover during 2008-09 with subdued increases.  Price increases will be limited by potential interest rate increases brought on by inflation pressures in the economy- which is running at the top end of the Reserve Banks target range of 3% pa.

However the good news for investors is that rents are likely to increase substantially over the next three years.  Vacancy rates in Sydney are now at around 2.6% (ie just over 1 week vacancy) but are likely to fall further to below 2%.  Rental growth of 10% pa is predicted for Sydney, while for Melbourne and Brisbane, rent growth of between 6% and 8% is expected.

Overall BIS Shrapnel expect most Australian housing markets to be static over the next few years.  While Perth is experiencing strong demand backed by the resources boom at present, it is expected to fall in behind other capital cities soon.  Areas that will provide exceptions to this trend include Brisbane and SE Queensland and some regional centres of NSW.

As an economist in my previous working life I have found that BIS Shrapnel tend to be very conservative with predictions and these are heavily predicated on movements in interest rates.  Their reports are very general and take a “macro-economic” view of the property market.  Smart property home buyers and investors will take into account these macro factors but will also “ground-truth” their research and find properties that represent good value.  The key to finding “good value” is understanding real estate fundamentals, ie the key drivers of the market.  This is a topic I will cover in more detail in future newsletters.

Macquarie Bank also released their view of the property market “Real Estate Market Outlook” in late June and generally provide a view of “stabilisation” in the Australian residential property market.  They predict:

• Perth’s booming market will slow,
• Sydney rents will rise and prices stabilise over the second half of the year,
• Developers will be seeking to buy value in preparation for next recovery phase.
• Investors will remain subdued until rents have risen sufficiently and they can see potential capital gains
• Luxury property will remain fairly immune to the slump.

One notable comment made in the report is that falling prices are not always followed by an immediate upswing.  Modelling by Macquarie Bank shows that residential property values tend to stabilise for two or three years before prices start to rise again.

This modelling supports the general economic principal that there is a natural “floor” with residential property prices.  Property owners are generally reluctant to sell property for less than what they paid.  In fact most owners expect their property to gradually rise in value over time (which has been proven by median prices doubling every decade in every capital city over the last 100 years). If the property market goes through a downturn, (as in the current market) owners adopt a long-term view and hold on throughout the cycle with the expectation that recovery is a few years away.

If an owner gets into financial trouble they usually do anything they can to keep a roof over their head.  Before selling a property, owners get comparable sales from agents to help determine their selling price and make an informed decision.  While in the sharemarket prices of shares are known by the minute, properties are traded more slowly and infrequently.  Banks typically lend a standard 80% of property value and in some cases are willing to lend up to 100% on property.  All these factors help underpin the natural floor in the property market.

Why is this important I hear you ask?  If property prices remain resilient and trend upward for the long term, then investors must adopt a long term view and not panic when the market turns.  These changes in market cycles provide opportunities to buy well, add value and grow your property portfolio.