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4 things property investors need to know about the market

If you're about to invest property, here are four things you need to know. Source: Getty

Our real estate markets have surprised many on the upside this year– especially the strong resurgence of the Melbourne and Sydney property markets.

But what lies ahead for our real estate markets now?

Will they keep up their momentum, or will tight lending restrictions from our banks starve the market of the finance it needs to grow?

Looking back at how previous property cycles played out - as I delved back into my memory to see what lessons I could learn from past property cycles - I realised that I’ve probably learned more from the many mistakes I’ve made than from the things I got right.

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

The main cause behind these property cycles is that we're human, and we tend to share the general optimism or pessimism of others.

But, 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.

For example, the previous property cycle, which ended in mid 2017 was prolonged by a lengthy period of falling interest rates.

And then it came to an end as APRA tightened the screws on lending, particularly to investors.

Yet 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 per cent from their market peak overshooting on the downside when in general all the fundamentals for Sydney p were sound in 2018 and 2019.

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 just 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. 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 used 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.

More recently Nassim Nicholas Taleb, a finance professor and author, popularised the term Black Swan events for these deviations from the expected.

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.

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.)

X factors throughout the years

The big X factor for 2019 was the "miracle" election win of the Morrison government.

It wasn’t that long ago that many commentators were forecasting a prolonged property slump assuming the Labor Party would win the Australian federal election.

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.)

  • 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 Australian dollar

What will be the coming year’s X-Factor?

Michael Yardney is a director of Metropole Property Strategists, which creates wealth for its clients through independent, unbiased property advice and advocacy. He is a best-selling author, one of Australia's leading experts in wealth creation through property and writes the Property Update blog.

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