Where are we in the property cycle?

Although the Australian property downturn of 2008 came as a shock to many investors, recessions are not a new concept. They are an inevitable part of the economic cycle; intermittent periods of growth and decline that have occurred throughout history. They impact all markets and industries including property.

While well-located properties in Australia have doubled in value every eight to 10 years, capital appreciation is obviously not constant each year. Property values tend to rise and fall in cycles, in some years there will be strong growth and in others there will be no growth or negative growth.

So where are we in the property cycle now and is it the right time to buy more properties?

Before I answer that question let’s look a bit closer at the property cycle to make sure we are on the same page.

A simplistic version of the cycle goes something like this…

As the economy improves and our population grows there is an increased demand for property, which pushes up prices and rents. Initially property values increase slowly as owner-occupiers and investors return to the market, often competing for the same type of property. Builders and developers eventually hop on board and start constructing new dwellings to meet the increasing demand at a time when rising prices make property developments more profitable. Over time property values keep rising, often at a faster pace and developers build more and more properties, which eventually leads to an oversupply resulting in slumping property values and rent reductions.

Yes, as many investors learned over the last few years, while property values may rise significantly in some years, they can also fall as demand disappears.

Putting a timeframe to these cycles is not easy because they do not occur because a number of years have passed. They are created by a combination of factors and influences such as the state of the economy, interest rates, social and political issues. In the past it was said that property cycles lasted 10 years. My observation is that the cycles seem to be getting shorter. Looking at the graph below, it shows that over time the average property prices increases significantly (green line).

But the red line shows that at some stages of the cycle property values increase and at others they stay flat or decrease. At various stages in the cycle property values exceed the underlying long-term trend (such as in boom times) and at other stages fall short of this long-term underlying value, such as during property slumps.

The pendulum always seems to swing too far.

History shows that the property cycle consistently passes through four phases: the boom, the downturn, the stabilisation stage and the upturn, which leads onto the boom of the next cycle. Let’s look at each in turn.

The boom phase tends to be the shortest phase of the cycle. During the boom, property prices increase rapidly – often by more than 20% per annum. While many home owners take the opportunity of buying properties during the boom as they see property values rising and a whole generation of new investors come into the market at this stage driven by property seminars, the press, TV shows and the like.

As the boom continues greed starts to kick in, as does speculation. This was evident during our last property boom when many investors bought properties off the plan. They hoped to on-sell their properties at a profit, many never really intending to settle on these, because often they didn’t have the means to. Unfortunately, many were caught out and didn’t make the profits they anticipated.

Fear also drives property booms as home owners and investors see property prices going up all around them. They are worried that they may miss out on the profits the boom has delivered to other investors.

Not understanding the dynamics of a property cycle, many of these beginner investors become overconfident at a time when they probably should be the most cautious and they overpay, just to get into the property market, pushing up property prices to levels that are (in the short-term at least) unsustainable.

At this stage of the cycle properties often sell for more than their asking price as eager buyers compete with each other to snap up any property that comes onto the market. Vendors also become greedy pushing up asking prices and this just feeds the property boom.

As the boom moves on many builders and developers flood the market with new properties to meet the increasing demand, but over time they flood the market with too many properties. This excess supply of properties is one of the factors that eventually brings the boom to an end.

Another reason property booms typically come to a halt is when, in an attempt to slow down the property markets and keep a lid on inflation, the Reserve Bank increases interest rates and the banks limit credit.

This leads to…

The slump phase, which is often characterised by an oversupply of properties due to the over exuberant activity of builders and developers. Too many properties on the market at a time when there are fewer buyers causes property prices to drop, vacancy rates to increase and investment returns to fall.

A prolonged boom phase tends to be followed by a longer and deeper slump phase and a greater likelihood of property prices falling.

During the slump, property is out of favour in the media and investors often struggle with decreased cashflows, higher interest rates and stalling values. They often consider selling their properties. When they do this in a falling market with few buyers, they exacerbate the slump.

This is also the stage when many new home buyers find themselves in trouble. They often over commit themselves during the boom by purchasing properties they could not afford. And now as interest rates have risen, some have difficulty keeping up mortgage payments and the only way out for them is to sell their properties at depressed prices. This often leaves them severely out of pocket and with a residual debt.

The stabilisation phase
Our property markets don’t usually jump from a period of negative sentiment to the next upturn. There is usually a short phase where the various economic factors catch up with each other – they stabilise or get back into equilibrium. This eventually leads to the…

The upturn phase
During the upturn, vacancy rates slowly fall, rents start to rise, and property values start to rise, slowly at first. This phase creates great opportunities but these are not usually easily recognised by most investors.

At the beginning of the upturn phase of the property cycle interest rates are usually low and it is easier to get finance. Property values generally start increasing in the inner, more affluent ring of suburbs and those close to the CBD or the beaches, driven initially by owner-occupiers looking to upgrade their homes. Over the next few years increasing property values ripple out to the middle ring suburbs and eventually, sometimes after a number of years, to the outer ring suburbs.

By the middle of the upturn property is generally affordable and returns from property investment are attractive. Investors begin to enter the market. In particular professional investors take advantage of the opportunities of the upturn phase, but beginning investors are not yet convinced that property is a good investment.

This is the time that many builders and developers buy properties and commence development projects to have them completed by the late upturn or boom phases of the cycle.

In time investors slowly get back into property as conditions seem more favourable. They see property values increasing and are concerned that they may miss out if they don’t buy a property. This is also the time that many first home buyers enter the property market.

Property values usually increase gently during this stage and do not rise sharply until the boom phase of the cycle. At the end of the upturn phase of the property cycle real estate prices have risen substantially and property is becoming less affordable. As prices rise investment returns decrease and we move into the next property boom.

And we start all over again.

Okay, back to the original question: where are we in the property cycle?

It is important to understand that there are local, as well as national, property cycles. Each state is at a different stage of its property cycle.

Darwin has been booming for quite some time with its median price increasing by 14.92% over the last year and must be near its peak.

In the meantime Melbourne led the nation into the early upturn stage of the property cycle with its median price increasing by 14.25% over the year to December 2009 according to Residex. 

Sydney has emerged out of its five year slump and into the early upturn stage of their property cycles of the cycle with Residex reporting a 12.82% rise in the median house price in the harbour city over the last year (2009). Canberra’s median property price grew by 8.15% while the Adelaide median price increased by 7.14%, and Hobart’s median price increased by 5.22%

Perth hasn’t joined the eastern states in the upturn phase yet. Its median price only increased by 0.8% over the 2009 year.

But as they say… that’s not all folks… because within each state there are cycles within the various suburbs.

Traditionally the more affluent suburbs perform well at the beginning of the property cycle and that’s exactly what has happened this time around. A sound economy and a strongly performing share markets has meant that the more affluent have been upgrading their homes with a large number of people chasing the same small group of properties, pushing up values in some of the east coast’s more affluent suburbs by over 15% last year.

As the inner ring suburbs perform well, the price differential between these suburbs and their neighbouring suburbs increases. Soon buyers look for ‘bargains” in these adjoining suburbs and the increase in property values ripples out to the middle ring suburbs. This trend has been particularly evident in Melbourne, Sydney and Brisbane over the last six months or so, with property values increasing in the middle ring suburbs.

The increase in property values has also drawn astute property investors back into the markets, taking the place of the first home buyers who have dropped out of the market. However many beginning investors are still hesitant at this early stage of the property cycle, and are waiting for more signs of certainty.

Of course while they are waiting many have missed out on significant property price growth. If they had bought a well-located house or apartment in any capital city other than Perth the value of their property would have risen significantly over the last year.

I’ve often said that until you have invested through a full property cycle, you don’t really fully appreciate the property markets and our property markets are behaving normally, working their way through their individual property cycles. Within each state the property markets are fragmented with some suburbs, in particular the more affluent near city and bayside suburbs, performing strongly while other suburbs, particularly the outer “mortgage belt” suburbs, languish.

These cycles mean there are great opportunities out there for property investors who are selective and think long-term. Are you ready to catch the next property wave?

Michael Yardney is the director of Metropole Property Investment Strategists, a best-selling author and one of Australia’s leading experts in wealth creation through property. For more information about Michael visit www.metropole.com.au and www.PropertyUpdate.com.au.