Real Estate Investment:Today

Australian Property Cycles: Current Stage & Prospects

After the property price boom of 2020-21, Australia’s real estate markets appear to be cooling – at least for now.

So what happened?

What changed?

And what does it mean for the future of our property markets?

To help understand what’s ahead and if the property market will crash as some are suggesting, I will outline the dynamics and economics of Australia’s property market, what causes real estate prices to increase in Australia, and how you can ensure your investment outperforms the market averages over the long term.

How does a property cycle work?

We already know that Australia’s property markets move in cycles.

Then each state has its own individual property cycle and there are further cycles within each depending on the area, price point, and even the property type.

Historically, cycles start with a period of rising values, followed by a lull period where prices stagnate or even decline, before starting to increase again.

While you’ll often hear that property cycles last seven to 10 years, the length of an individual cycle varies depending on a combination of economic factors as well as supply and demand, rather than a period of time.

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Note: Generally, there will be a period of 2-3 years when the market is flat or when there is a decline in property values.

This is followed by a number of years of low capital growth which in turn is followed by a shorter period of strong price growth that we know as a ‘boom’.

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But that’s not what happened in the most recent property cycle which started with a bang.

The property boom of 2020-21

While the Covid-19 pandemic shut down life as we knew it, many businesses closed and economies tanked, there was one market that flourished – our housing market.

The pandemic years of 2020-21 saw a once-in-a-generation property boom driven by historically low interest rates, pent-up demand, and a flurry of government incentives.

In particular, 2021 was an extraordinary year for Australia’s housing market – around 98% of locations around the country recorded an increase in the median property value, with many of those values surging by more than 20%.

Data from the Australian Bureau of Statistics (ABS) confirms that the total value of Australia’s 10.8 million property portfolio skyrocketed to $9.9 trillion in 2021 alone, having risen by a wallet-busting $512.6 billion in just 3 months.

These are some large numbers.

At the same time, the collective wealth of Australia’s homeowners increased by $2 trillion in just one year alone – a sum which is 30% higher than the annual output of the entire Australian economy.

It’s difficult, therefore, to underestimate the extent to which housing wealth has risen during the pandemic years.

And a few emerging sentiment shifts also put pressure on prices.

We saw the pandemic cause Australians to re-evaluate what they want from their home.

Home was no longer just the place to rest; it fast became the place to work, play, and even self-isolate for a period of time.

As a result, many buyers were looking for larger homes with more space… and were even prepared to move out, even to the regions, to get it.

In fact, it was a cycle of property upgraders.

Some tenants upgraded to become first home buyers; many millennials moved out of apartments and upgraded to homes as they started to consider forming families and other Aussie’s upgraded their homes for more space or to live in the right neighbourhood.

At the same time, many Baby Boomers upgraded their lifestyle looking for high-quality, low-maintenance living, knowing this will likely be their last home while others bought themselves a holiday home.

And the resultant significant rise in housing prices means most existing homeowners are sitting on substantial equity.

But this was a very short property cycle.

Downturn phase of the cycle in 2022

Yes, we’ve moved to the next phase of the property cycle.

Australia’s property market boom appears to have ended, and now we’re onto the downturn phase of the cycle.

Let’s be clear…some property markets, in particular, Brisbane and Adelaide still growing, but their growth is more slow, and in other parts of Australia housing prices are flat or slowly declining.

Here’s what has happened.

The boom phase of the cycle that we saw in 2020-21 saw prices soar, but now as result affordability has deteriorated.

For context, property prices have surged 29% since the pandemic while wage growth has risen a mere 2.3%.

At the same time, inflation is soaring, making it harder for buyers to save that much-needed house deposit – inflation is at a 21-year high at around 6%, and there is more to come.

Speaking of inflation, the Reserve Bank of Australia (RBA) hiked the official cash rate for the second consecutive month in June to 0.85% in an effort to curb inflation – again, we’re yet to reach the peak with further rate hikes expected before the end of the year.

This in turn has caused fixed mortgage rates to more than double to around 5%, from around 2%.

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What does all this mean?

Well, in short, buyers need more money to buy a property….but they aren’t able to borrow as much.

And the rising inflation and cost of living mean a deposit is harder to save.

It’s easy to see why we’re entering a downturn, isn’t it?

But wait, there is more.

A rise in new listings in Sydney and Melbourne has taken some pressure out of the market, while there has been a shift and rotation in spending from goods back to services on top of a decline in consumer and home buyer confidence thanks to concern about rising rates, inflation and the future of property values.

As I said, we’re in the downturn phase, and sure, the value of some properties may decrease in the coming year – some by as much as 10% – but that will only be in the short term.

Yet there are still some strong patches in the Melbourne and Sydney property market where A-grade homes and investment-grade properties are still selling well.

It’s a bit like having one hand in a bucket of hot water and another hand in a bucket of cold water and saying “on average I feel comfortable.”

However strategic investors are not phased by this stage of the cycle, they understand real estate is a long-term game and they’re more focussed on the long-term rise in values rather than short-term slumps.

So what has happened to property values in the long term?

Research by Metropole, based on data by the REA Group and the Australian Bureau of Statistics (ABS) shows that Australia’s national median house value has risen by an enormous 540.1% over the past 42 years.

This is an average annual growth rate of 7.62%.

The numbers did, however, vary by state.

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Over the past 42 years, Melbourne had the highest average annual price growth for houses at 8.26%.

Sydney was the second-fastest-growing with a 7.98% average annual house price growth, only just ahead of Canberra which enjoyed a 7.9% increase.

The average annual house price grew 7.51% in Brisbane while Adelaide and Perth saw 6.94% and 6.26% increases respectively over the 42-year period.

There were no 40-year figures for Hobart and Darwin but the 30-year average annual house price growth was 7.29% and 5.84% respectively.

Of course, these are just overall averages and within each state here are some locations that have enjoyed significantly more capital growth than these averages, and other locations which have underperformed.

I guess that’s how averages work.

At Metropole, we spend a lot of time researching locations that deliver wealth-producing rates of capital growth.

Which leads to the question…

What causes property values to increase?

Now we know all about property market cycles and at what stage in the cycle we’re currently in, let’s talk about property price rises, and how and why they grow.

I’ve divided this discussion into:

  • The short-term factors – which are what most of the media is concerned about and…
  • The long-term influences – which is what strategic investors pay attention to.

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8 reasons property values increase in the short term

  1. Interest rates 

Obviously, low interest rates make it easier for buyers to borrow more, as money is cheaper.

But interestingly, the converse isn’t true.

In the past, property values continued rising for some time, despite the RBA raising interest rates

  1. Supply and demand 

Generally, if demand for accommodation outweighs supply, property prices will rise.

But if supply outstrips demand, such as when we go on too many apartment tours, prices tend to decline.

  1. Availability and cost of land 

The lengthy time taken to release new land supplies and the vast amount of taxes and charges developers must pay to subdivide new estates have positively contributed to housing price inflation in Australia.

  1. Access to credit

Now I’m not talking about interest rates here, but a borrower’s actual access to credit.

Rising interest rates tend to prompt lenders to tighten their lending standards so borrowers can’t borrow as much.

When our Banking Regulator APRA was concerned about the rapid growth in lending to property investors which led to steep increases in property prices in 2014, it instructed the banks and other lenders to be more cautious and set stricter criteria for determining whether borrowers could repay their loans if interest rates were to change.

This warning had the desired effect and the share of new loans to investors fell from over 40% during 2014 -15 to less than 30% the next year.

On the flip side, during the pandemic boom, banks eased lending standards in a move designed to free up credit and revive the economy – and it worked, hence the price surge.

  1. The general economic climate

Here we’re talking about things like inflation and employment levels.

It seems obvious that periods of low inflation and high employment would see an uptick in borrowing as consumers look to spend the extra cash in their back pockets.

And as we know, when buyers fight over property purchases, values are only going to go upwards.

  1. Consumer confidence

Increasing consumer confidence increases consumer spending.

The aggregate demand curve shifts to the right, indicating an increase in demand for goods over services.

In other words, a robust economic climate and rising property prices cause a  “wealth effect “ which leads to higher consumer confidence where buyers think it’s the opportune time to spend their spare cash on a property.

  1. Government incentives for first-home buyers

When the government wants to inject more demand into the market it looks to incentives for first-home buyers.

Just look how well this worked during the Covid pandemic as first home owner grants and incentives boosted jobs in the construction industry as well as in many associated retail industries.

Our new Labor government currently has a few schemes in place for first-home buyers: the Help to Buy program (where the government owns a portion of your property and you pay it off down the track), the Home Guarantee Scheme where you can buy with a 5% deposit or regional first home buyer support.

And what do these incentives do?

It broadens the pool of property buyers, flipping the supply/demand balance and putting pressure on property values.

  1. Investor appetite

Over the long term, property investors make up about 30% of the housing market.

When the market conditions are favourable this leads to high investor demand and we all know what that leads to.

3 reasons property values increase in the long term

  1. Demographics

Demographics are the data that describes the composition of a population, such as age, race, gender, income, migration patterns, and population growth.

These factors are significant drivers of what types of properties are in demand and how property is priced.

That’s because the demographics of a population determine not just how many people there are, but how and where they want to live.

And I’m not really talking about population growth – it’s actually household formation that is the key here.

And immigration flows into this also.

Australia’s immigration policy of selecting skilled workers at the family formation stage of their lives is a significant driving factor for our housing markets.

And Covid has caused a structural-demographic change that will affect our housing markets moving forward.

Not only that but the pandemic-induced work-from-home movement has changed the demographics significantly – now, many workers are able to work from the comfort of their own homes and save on commuting, which means they need the extra space.

We’ve seen this trend, in fact, with the sea- and tree-change shift which has occurred over the past 2 years.

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