Rain & Real Estate Rainbows

CoreLogic has released their June 2018 house price data, and the results are underwhelming. Here are the highlights:

• Australian dwelling values fell for the ninth consecutive month
• House prices fell in Sydney, Melbourne, Perth and Canberra
• House prices rose in Brisbane, Adelaide, Hobart and Darwin
• Sydney house prices have fallen 6.2% for the year to June – the biggest decline of any Australian capital city
• Hobart house prices have risen 13.8% for the year to June – the biggest gain of any Australian capital city
• The only capital city to experience an increase in unit values was, somewhat surprisingly, Brisbane.

Here’s what’s causing the downturn:

1. It’s noticeably harder to qualify for a loan, meaning there are fewer buyers.
2. Foreign buyers have been scared off by substantial fiscal disincentives, meaning there are fewer buyers.
3. News headlines are forecasting turbulent times, so sentiment is weak meaning there are fewer buyers; and
4. Supply has increased a little, meaning there are more sellers.

This is all well and good, but what does it mean and how should you act?

Highs & Lows

The seemingly never-ending real estate ‘high-pressure system’ that was camped over much of Australia for many years has finally moved on and we are now feeling the effects of a new ‘low-pressure system’ that first hit WA, and has finally made it to the east coast. This new weather system has resulted in ‘cooler temperatures’ (unless you are in Hobart where the market is surely overcooked), with even a little patchy drizzle here and there. There’s been no rain though, and certainly no hail or thunder.

Not yet, that is.

The topic of conversation now seems to be whether the weather is a short-term blip, the new norm for the foreseeable future, or a pre-cursor to a Game Of Thrones style real estate ‘winter’ that will put the freeze on property investors.

As I like to say, I know my head may be bald, but it’s not a crystal ball – so I don’t know for certain what’s going to happen, but what I do know is that you need rain to make a rainbow.

Real Estate Rain

The long boom in Australian real estate was not normal. Real estate used to be a yield (i.e. income) investment, but structural changes to taxation and various buyer incentives that began in the early 2000s changed it so that real estate became a growth (i.e. capital appreciation) investment.

Eventually though, the conditions that facilitate growth naturally dissipate, and, unless new conditions arise to fuel a new growth cycle, the market will experience a period of stability or decline until conditions arrive to kick-start the next period of growth.

However, rather than pause for breath, the Aussie property market experienced the equivalent of an extended Indian summer after an unprecedented run of growth-stimulating events: CGT discount, FHOG, rising populations, a commodities boom, historic low interest rates, foreign buyer boom, lax lending standards, and easy profits from speculating.

Today we have rising interest rates, fewer foreign buyers, more rigorous lending standards, and fewer speculators. It’s understandable, even expected, that prices are softening and they should continue to do so until new conditions emerge.

The Usual Umbrella

Theoretically, when growth subsides, an investment’s yield (i.e. income over expenses) usually makes it affordable to hold until the next cycle begins. That is, the positive income acts as an umbrella to shield the investor somewhat from the impact of declining values.

Aussie real estate is now so over-valued that the after-debt yield is negative so, in the absence of growth, investors are losing money (i.e. expenses greater than income) for the right to lose money (i.e. property values falling). Add in a few interest rate increases, and the number of sellers will increase while the number of buyers decrease, and prices will fall further. The drizzle will become rain. With no income umbrella, a thorough financial soaking is a distinct possibility.

Which brings us to the important point of this article -people think that real estate rain is bad. It’s really not. It’s completely necessary to balance out the previous cycle, to reset expectations, and to set us up for the next period of property sunshine.

In fact, when the sun eventually comes out again, the easing rain tends to result in a rainbow – a profit opportunity from values resetting, with a possible pot of gold to be found (and maybe a leprechaun or two) at its base.

Response

As mentioned, some people believe the present drizzly circumstances are a short interlude in a continuing property boom. That’s unrealistically optimistic. While others feel a few drops of rain is an omen to run for the Ark. That’s unrealistically pessimistic.

What is needed is a reassessment of your strategy to ensure it is suitable for the current climate, and to make appropriate adjustments so that you don’t get caught out in the rain.  Meanwhile, also ready yourself to act so that when the real estate rainbow eventually appears you’ll be able to jump on it.

If I’ve learned anything in the past 20 years of professional investing, it’s that one person’s rain is another person’s rainbow.

What do you think is going to happen to Aussie property prices going forward? Be sure to contribute your thoughts by leaving a comment below.

By Steve McKnight

Steve McKnight, the founder of PropertyInvesting.com, is a respected property investing authority as well as Australia's #1 best-selling business author.