The Property Volcano

With the exception of Hobart, where property prices continue on their bull run, elsewhere around Australia, and in Melbourne and Sydney in particular, real estate has an unpleasant stink about it at the moment.

Depending on how pessimistic you are, and from where you get your news, we are either in the early stages of a mild property hiccup, and feeling the effects of an inevitable correction, or at the dawn of a cataclysmic crash.

My own opinion, for what it’s worth, is that the property market is like a volcano. For much of the time, it can be happily climbed and the view from the top is spectacular. However, infrequently there can be an eruption, and when that happens, you don’t want to be anywhere near it.

Keeping the analogy going, after a long period of calm and peace, the Aussie property volcano has recently ‘come alive’ and can now be seen venting a plume of ash, steam, and a fair bit of rotten egg gas – hence the stink.

It’s presently no cause for panic, but it might be if things get worse.

A Dose Of Reality

Unless you paid a silly price for something recently, I wouldn’t call what we’re experiencing in the property market right now as anything other than mild and normal turbulence.

Take Sydney for example, where median house prices in March 2018 (latest data available from the REIA) have retreated a little over 4% from their peak in June 2017.

Sure, that’s unpleasant, but when you take into account that between September 2016 and March 2017 (nine months) Sydney house values rose by 11.2%, it follows that giving back just over a third of the recent gain isn’t cause for alarm.

And even if there were a property crash and values across the board declined by a substantial 25%, which is enough to mean that any 80% LVR loan taken out recently would be against a property that is now in negative equity, the table below reveals how many years of growth we would be ‘giving up’ by indicating the approximate date that property values were last at that price:

Source: REIA, PropertyInvesting.com

For Melbourne, Sydney and Hobart, the price retreat would just be handing back the recent round of appreciation. It would be more severe in other cities that did not experience a price boom in the past three or so years.

Even a 50% decrease would see us return to values as they were more or less a decade ago, and hardly affordable in the sense of property prices pre-2000 (when the median house in Sydney was around $300,000 – which was considered expensive in its day!).

Rumbles

Can anyone predict what the property volcano will do next with complete certainty? No. Like volcanoes, in real estate, there is a fair amount of theory about what should happen, but no one knows for sure because mother nature (or the herd mentality) cannot be tamed.

That said, I’m seeing some signs that have me feeling like there is more downside risk of further price falls, as opposed to upside optimism that prices will quickly recover, including:

Falling Rents

I saw a report in the Financial Review last weekend indicating that rents are now falling in Sydney. If rents fall, prices will eventually follow because real estate will become less affordable and the amount purchasers can borrow will decrease.

Since so much of the nation’s media is based in Sydney, journalists tend to report what is happening there as if it is happening everywhere, and so the Sydney prices sniffles can mean other areas catch a property cold.

Less Liquidity

It’s getting a lot harder to borrow as much money as even a few months ago, with valuations being squeezed to the low side, and at the same time lenders now want to know whether or not you had sauce on your pie at lunch, and if you did, how did you pay for it?

Okay, perhaps that’s a bit dramatic, but it is not far off the level of inquisition some borrowers are enduring today, where previously there was none. Don’t expect things to get better anytime soon. As the Royal Commission winds up, I predict it will take even longer to get a loan, and harder to borrow as much money as before.

Fewer borrowers with less cash at their disposal will put downward pressure on property prices.

Increasing Interest Rates

Even though the RBA is sitting pat on their benchmark cash rate, and despite some lenders actually reducing their headline interest rates to attract customers, the general trend is now set for interest rates to increase because the cost of borrowing on world markets has risen. Faced with a choice of lower profits or higher interest rates, it’s no surprise that more and more lenders (starting with the smaller ones) are choosing the latter option.

As I’ve written not long ago, interest rates won’t have to rise too much for there to be a profound impact on Australian households. We’re so hocked up to the eyeballs in debt, just a half-to-one percent increase is going to tip a considerable number of mortgage holders into mortgage stress. As more people have to sell, there will be even more downward pressure on property prices.

Contagion

When (not if) interest rates increase by that half-to-one per cent, households will have less discretionary money to spend on everyday goods – from coffee to holidays, and the economy will increasingly groan under the weight of our debt burden.

Dare I say it? At that time we will enter the recession that will be the inevitable consequence of so much debt-fuelled consumption. It will be the late 1980’s all over again, except that interest rates at circa 7 to 8% today will have the same impact as interest rates at 17 to 18% did back then (because we have so much more debt today).

What Am I Doing?

Well, exactly what I’ve been telling you to do for quite a while now.

• I’ve sold some property I don’t think is helpful to own in less optimistic times.
  
  
• I’m critically analysing my property portfolio to ensure it is being managed well
  
  
• I’m making offers on good deals if I see them come up (there aren’t many, but they are starting to be more prevalent), and otherwise, I’m being patient and boosting my cash reserves.
  
  
• I’m actually not holding any ‘net debt’ right now because the name of the game is to maintain my borrowing ability so that I can jump on the next great deal.

Takeaways

Wrapping up, here is a summary in the form of five takeaways:

1. The possibility of financial loss is increasing, and that means investment risk is increasing too. The correct response is to be more prudent, cautious and diligent. Now is not the time for wild, or super speculative, property investing.
   
   
2. Debt is getting harder to get. In my case, even though it is a little more expensive than the headline interest rates being advertised, I’m happy to hang on to an existing debt facility that was written under more favourable conditions than what might be offered today.
   
   
3. It doesn’t quite carry the same punch as the Game Of Thrones catchcry, but Spring is coming, and with it, the peak time to sell. If supply increases without demand picking up, expect prices to fall.
   
   
4. A little price slippage isn’t panic stations. Property prices would have to fall by more than 10 to 15% off their peaks to get me nervous, and we are a long way away from that just yet. Still, if a price fall of that magnitude would cause financial heartburn for you, then maybe you should consider cutting your losses so you can live to fight another day. Don’t assume you will get today’s price tomorrow, in a soft or down market.
   
   
5. Better and better deals are coming on the market, but vendors are still hoping for more or less top dollar. Presently it is development and renovation opportunities that have become more prolific, but often these are still being marketed at inflated prices by vendors who have just realised they won’t make their expected profit, or can’t get the finance to proceed with construction. Be patient. Give it time.

That’s it from me. See you in September.

Until then, remember that success comes from doing things differently.

– Steve

P.S. If you’re interested in watching one of the development projects in my USA Property Fund get built then check out the webcam feed at the bottom of the left-hand menu at www.PassiveIncomeFund.com

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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.