What’s ahead for property in 2023?

What’s ahead for the Australian property market?

It’s likely that high interest-rate and inflation will keep eating away at the average Australian’s household budget for some time making the property less affordable, so the question I hear many property investors asking is “what is going to cause property values to increase moving forward?”

Now this is nothing new.

• After the boom of the late 1980’s the media was full of messages that property values just couldn’t get any higher and parents were worried that their children (today’s baby boomers) would never be able to afford to buy a home – see how wrong this was.
• In the early 2000’s we experienced a property boom that left many commentators wondering: “what on earth could make property values get any higher?”
• After the property boom of 2014-16 the media was full of messages about how unaffordable properties were and prices just couldn’t get any higher – but after a lull and a couple of false starts we had a once in a generation property boom in 2020-21.

Of course Australia is a big country and there are many remote locations where properties remain very affordable – the problem is that no one really wants to live there.

In general, we tend to want to live in many of the same choice locations in our big capital cities.

But if prices are expensive there, what will cause the value of well located properties to keep rising?

I believe demographics (such as population growth, family formation, how we want to live and where we want to live) as well as the wealth of the nation will be the main long-term drivers of our property market and will be much more important than the short-term fluctuations created by interest-rate rises, inflation or government intervention.

And while forecasting is difficult, especially about the future, history is instructive so let’s look at what happened in the past, even though that’s only part of the way to look at the future of Australian property.

     Tips: SPOILER ALERT: I see 2023 as the year when our property markets will RESET and a new cycle will begin. Read on…

Structural shifts

We recently experienced a “once in a generation property boom” in 2020 and 2021 where the value of almost every property in Australia increased by 20% -30%.

I’m old enough to have experienced a few of these booms which are usually underpinned by some significant structural shift.

The first significant boom I experienced in the 1970s was driven by:

• High Inflation but just as importantly…
• In the 1970s, more women entered the workforce and banks started accepting their income for serviceability, giving the average household twice as much borrowing capacity.

This allowed people to borrow up to a 95% loan-to-value ratio and this increased availability of credit led to a significant property boom in the late 90s.

In the early 2000s, Australia enjoyed a mining boom that created significant wage increases, not just in Western Australia but around Australia, again giving people the capacity to borrow significantly more money and leading to another major property boom.

In the late 2000s after the Global Financial Crisis Australia experienced another mining boom that drove our economic growth.

At the same time, Australia became a preferred destination for significant foreign investment in residential real estate, as foreign investors saw our housing markets as relatively cheap and our economic and political environment as stable compared to other countries.

Once again, this structural change pushed up the value of the residential real estate as overseas investors often outbid locals for many properties.

That brings us to the latest substantial property boom in 2020 -21 when we once again experienced a significant structural change as interest rates dropped to historic lows giving borrowers significantly increased borrowing capacity and this, together with a raft of government stimulus packages, came at a time of significant pent up demand and created that once-in-a-generation property boom and increased the total value of residential real estate around Australia by over $2 trillion.

But that’s now over and I don’t think we’ll see a significant structural shift again for quite some time.

The next significant structural change is likely to occur when the Baby Boomer generation dies off and transfers around $6.2 trillion worth of wealth they hold in their residential properties to their families.

So that brings us back to the question of what, if anything, will drive future property price growth.

The rising tide that lifted all ships in the last boom has now gone, as has the period of rising household incomes and low interest rates that we enjoyed over the last decade, meaning our property markets will be much more fragmented moving forward and capital growth will be dependent on local factors including demographics, gentrification, neighbourhood and wages growth of the people in these locations.

Remember the property cycle

Of course, it’s important to remember that our property markets move in cycles and while the long-term trend is up, there are also periods when property values fall and periods where house prices remain flat – even for years.

However, the following chart from Domain confirms how the upswings are significantly more substantial than the downswings.

The following chart from Stuart Wemyss of Prosolution Private Clients shows how over the last 42 years, on average:

• Melbourne property values increased by 8.2% per annum
• Sydney property values increased by 7.9% per annum
• Brisbane property values increased by 7.6% per annum

Of course, there isn’t one Melbourne, Sydney or Brisbane property market – there are markets within the market.

There are houses, apartments, townhouses and villa units.

These are situated in the CBD, inner ring suburbs, middle ring suburbs and outer suburbs.

And then of course there are multiple regional property markets around Australia.

And each of these has its own drivers of property price growth.

So in reality looking at these long-term trends is interesting but not very instructive.

Especially when you look at the next chart from Stuart Wemyss which shows that each state has its own individual property cycle and every capital city market experiences a number of years of flat or no growth at all.

The following chart by Kate Forbes, National Director of Metropole Property Strategists shows the long-term resilience of our property markets despite all the challenges thrown at them.

So let’s look at some of the drivers of property booms and busts.

8 reasons property values increase in the short to medium 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 always true. In the past, property values continued rising for some time, despite the RBA raising interest rates

2. 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.

3. 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.

4. 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.

5. 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.

6. CONSUMER CONFIDENCE

Increasing consumer confidence increases consumer spending, especially on significant purchases such as a new home or an investment property.

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.

On the other hand, low consumer confidence slows down our property markets.

7. GOVERNMENT INCENTIVES

When the government wants to inject more demand into the market it looks to incentives, especially for first-home buyers to broaden the pool of property buyers, flipping the supply/demand balance and putting pressure on property values.

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

8. 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, which describes the composition of a population including population growth, structure, migration patterns and income 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.

So it’s not really about population growth as much as it is about household formation which is the key here.

And immigration flows into this as well.

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, as is our education system importing hundreds of thousands of international students.

Of course, Covid caused a structural-demographic change that will affect our housing markets moving forward.

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

And the importance of the neighbourhood was reinforced.

For many it’s all about ‘living locally’ – having the ability to meet most of your everyday needs within a 20-minute walk, cycle, or local public transport trip of your home.

2. FUTURE POPULATION GROWTH

While our population growth stalled through the pandemic, the government has now increased visas to skilled migrants and there are now forecasts of total population growth of about 1.5% or 400,000 per year.

That’s the equivalent of adding a city the size of Canberra every year!

Currently, Australia’s population is around 26 million people, and it’s forecast to grow to 29,000,000 people by 2030.

Most of these extra 3 million people will live in our capital cities, in particular Melbourne, Sydney and Brisbane.

3. THE WEALTH OF THE NATION

If we believe Australia’s population is going to keep growing, and it will with a business plan to have close to 40 million people in Australia by the middle of the century, and that our nation is going to remain wealthy, this will then underpin long-term property values.

There is a positive relationship between household income (“real income” after inflation) and housing demand.

But moving forward, population growth will be not distributed evenly around Australia, and while our overall wealth will grow, it’s likely that the rich will keep getting richer, meeting the main drivers for house price growth will not be distributed evenly.

In other words, to maximise your investment returns it will be important to buy properties in our major capital cities where the majority population growth will occur, and then in those areas of the city where wages and wealth will grow faster than average.

So what’s ahead for property values?

 The recent property boom was very unusual.

All types of properties in almost any location around the country increased in value substantially.

Moving forward our property market will be much more fragmented.

If you think about it, certain demographic segments will find the rising cost of living due to inflation and higher rents or higher mortgage costs at a time when wages are not keeping up with inflation will either stop them from getting into the property markets or severely restrict their borrowing capacity.

This will have an impact negatively on the lower end of the property markets which will also be affected by the fact that many first-home buyers borrowed to their full capacity and will have difficulty keeping their mortgage payments up at the time of rising interest rates or when their fixed rate loans convert to variable rates.

In other words, there will be little impetus for capital growth at the lower end of the property market

That’s why I would only invest in areas where the locals’ income is growing faster than the national average.

These tend to be the “established money” areas or gentrifying suburbs.

Think about it… in these locations, locals will have higher disposable incomes and be able to and are likely to be prepared to pay a premium to live in these locations.

Many of these locations are the inner and middle-ring suburbs of our capital cities which are gentrifying as these wealthier cohorts move in.

There are great investment opportunities in these suburbs in houses and townhouses.

But it’s much more than that…

Moving forward neighbourhood will be more important than ever. 

Sure during Covid, many Aussies tried to escape the clutter of our capital cities, but now the way we are choosing to live is changing again.

The desire to live on a good sized block of land with a white picket fence and plenty of space with the family has changed is people are once again happy to trade big backyards in the outer areas for small courtyards or balconies as they search for a more convenient lifestyle

For many people, an ideal neighbourhood would mean most facilities will be a 20 walk, cycle or drive away.

In urban planning circles, it’s a concept known as the 20-minute neighbourhood.

In my mind, convenience and options will be the key to desirable locations where people will pay a premium to live.

While new neighbourhoods in the outer suburbs may adapt, they will not have as many choices or options as we see in our inner and middle-ring suburbs.

Sure, they may build a Coles or a Woolworths, but they most likely will not have a Coles and a Woolworths and an Aldi or even an IGA.

They may also get a new bus stop or train line, but they will not have access to both a bus and a train and potentially a tram, ferry, or bike option to get around.

A coffee shop or restaurant or two will also be a must, but the choice of 10 or 15 different options will have considerably higher appeal.

Gastro breweries, boutique shops, art galleries and entertainment precincts will be the icing on the cake.

All at your doorstep – or at least no more than 20 minutes away.

As the size of our accommodation gets smaller, demand for options in a great neighbourhood will rise and people will be prepared to pay a premium to live or rent in this type of location.

Understanding these factors forms part of the research data we use at Metropole to help our clients find investment-grade properties or A-grade homes for owner occupation.

As has happened in the past, moving forward the various suburbs in our cities will show a dramatic range in performance, and in my mind, there’s no doubt that proximity to lifestyle locations will remain a big drawcard.

As well as access to popular education catchments.

This is true of both primary and secondary school catchment zones, which have in general outperformed the market and are likely to continue to do so.

Education is a long-term consideration and, whether you are planning a family, have children already enrolled in school, or are an investor looking to attract long-term, quality tenants, it may be beneficial to consider school catchment zones when you are determining suburbs of interest.

And this general trend has again been confirmed by a paper by the Australian Housing and Urban Research Institute, which found that both in percentage terms and in absolute terms over the long haul suburbs located reasonably close to the CBD, where demand is high, close to employment and where the most people want to live and where there’s no land available for release, outperformed the outer suburbs.

One of the significant changes to occur in Australian cities over the past 50 years, and which has pushed up inner- and middle-ring suburb property values, is gentrification and this will continue to be a capital growth driver of locations that outperform.

House vs apartments

Over the last decade, capital growth has, in general, been stronger for houses than apartments so many are wondering if are apartments still a good investment.

But these are big picture “overall” stats and include inner-city high-rise apartments, townhouses and older apartments in 3-storey walk-up blocks.

And they’ve each performed differently.

In general family-friendly low-rise apartments in lifestyle neighbourhoods have still performed well, and more young families have chosen to live in townhouses to be able to afford to live in desirable neighbourhoods, while high-rise CBD apartments have performed very poorly.

Of course, if you can afford a house in a good location, then that’s probably the way to go.

But if your budget doesn’t allow you to buy a house in the right location, I’d rather own a townhouse, villa unit or “family-friendly” apartment in a good suburb, rather than a house in the outer suburbs in a poorer socio-economic location.

I’ve already explained that around 80% of your investment’s performance will be due to its location and about 20% due to owning the right property in that location.

For many investors, apartments offer an affordable entry point into the property market.

What about investing in the fast-growing outer suburbs?

 While many outer suburbs are growing quickly, this is generally physical growth rather than capital growth.

However, median price measures in these areas can be misleading, as the type of property being transacted changes over time with many new homes being built.

Also, the lack of scarcity in the type of properties built in the outer suburbs as well as the fact that there is always the possibility of another estate being built nearby.

Ample supply is the enemy of capital growth.

And as the concentric circles in the following graphic show, the further out from the centre of a city you go, the more supply there is.

Go to any major city in the world – London, Paris, Vienna, Los Angeles – and you’ll find that wealthy people tend to live within a 15 – 30 minutes drive from the CBD or near the water.

Why is this so?

The cynics would say because they can afford to.

And in part that’s true.

In general the more established suburbs with better infrastructure, shopping and amenities tend to be close to the CBD and the water and that’s where the wealthy want to and can afford to live.

And they’re prepared to pay a premium to live there.

Of course, achieving strong, consistent capital growth over the longer term requires multiple drivers and in my mind, there is no question that the best locations to invest for long-term capital growth are the inner and middle-ring suburbs of our major capital cities where the jobs are, where most people want to live and where there is no land available for release. 

What research do you need to do to find these locations?

Firstly, it’s important to always start with macro factors (big picture) and then drill down to the micro (property) factors.

That’s because your property’s location will do 80 per cent of the heavy lifting and then choosing the right property in that location will account for about 20 per cent of its performance.

When I changed my investment research criteria from looking at what happened in the past to forecast what is likely to occur in the future, I improved the performance of my investment selections and those of my clients’ considerably.

Rather than doing the type of research most people do and looking at how a location has performed in the past, I look at the factors that will drive the location’s performance in the future and these include:

• Demographics and population growth
• Economic and employment growth, which leads to wages growth and the ability to afford properties
• Infrastructure growth
• Supply and demand

I also look for multiple growth drivers because we have all recently seen the end result of those investors who chose areas with a single growth driver or single economy, such as during the mining boom.

Similarly, I see people who say they’re going to buy in areas where a big hospital is being built, but again this is only a single growth driver, and in my mind, isn’t sufficient to make the area one that will outperform in the long-term.

The lesson I’m trying to get across is that there need to be multiple growth drivers to underpin your property’s long-term performance.

This means that if one or two of these falter for a while, there are other factors supporting your property’s performance. 

The most commonly reported data seems to be auction clearance rates and median prices – how useful are they?

UNDERSTANDING AUCTION CLEARANCE RATES

While auction clearance rates are a good “in-time indicator” of buyer and seller sentiment, the trends are more important than actual numbers.

Other than in Sydney and Melbourne, auction clearance rates don’t give as good an indication of the general sense of the local market considering around 10 times the number of properties are put up for auction in the two big cities than in the smaller capitals each weekend.

The fact is, despite the preliminary auction clearance rates being reported promptly every weekend, to get the right information from these figures it’s increasingly important to apply a few adjustments.

Firstly the number of auctions being conducted is important and it’s important to understand who the data provider is and how they collect their data.

The various data providers collect their auction data in part by the agent’s phoning in their results and partly through a team of telecallers contacting agents.

Not surprisingly, agents tend to report their successful auctions results earlier meaning the first set of auction clearance rates skew on the high side.

Most data providers report preliminary results on Saturday night or Sunday and then release a final estimate on the following Thursday.

The difference in terms of clearance rates is on average around 3-5 percentage points in Sydney and Melbourne.

Then the time of year also makes a difference in auction results.

Buyers and sellers come and go from the market at slightly different times, producing a regular ebb and flow to clearance rates as the balance of power shifts.

They seem to be more buyers around heading into Autumn and Spring, pushing up auction clearance results during normal market conditions – obviously this year things have changed due to the coronavirus lockdown.

WHAT ABOUT MEDIAN PRICES?

 While median house prices are one of the most cited property market statistics, choosing where to invest based on median price growth can be very misleading.

As with any single measure, there are some shortcomings that investors need to understand in order not to be misled about what’s really happening to house price values.

The median house price is essentially the sale price of the middle home in a list of sales where the sales are arranged in order from lowest to highest price.

While median prices are a useful tool for understanding the price changes of properties that have transacted in a market, a 10% increase does not necessarily mean that your property is worth 10% more.

In fact, your property could have dropped in value during this time.

What it does reflect, however, is an activity in the market.

Look at it this way…

• If a number of multi-million dollar homes came onto the market and all sold the last month this would raise the median price – however, the value of your more moderately priced home may not have changed at all.

• Similarly, a falling median price in an area could really just indicate that there were more sales occurring at the cheaper end of the market than there are at the expensive end.

if a suburb has houses of variable quality, the median house price is not very useful because some properties are simply more valuable than others.

• If a suburb has very similar housing, such as renovated older homes on large blocks or a newer suburb where most of its housing stock was built over a few years, the median house price would be more relevant.

Changes in median price statistics are more meaningful in determining property price growth in some areas than others.

For instance, suburbs where the properties are largely homogenous and therefore of similar pricing are likely to see the median price as a more accurate reflection of true value changes.

And suburbs, where many properties transact on a more regular basis, will also be more statistically meaningful than in areas where homes are tightly held, sell infrequently and are significantly different from one another.

Similarly, some suburbs are far too large for the number to be meaningful – with good and bad locations on different sides of the main road that don’t perform similarly being lumped together.

Likewise relying on median price changes at a capital city level is too broad and can be misleading.

Medians are also misleading when a suburb has two distinct markets.

This is common in bayside suburbs where houses near the beach fall in one price range and are very different to house prices further inland.

Median price changes can also be misleading in many of the new outer suburban areas where the type of property sold a number of years ago, vacant land, has now been replaced by new homes.

And of course, gentrification with locals renovating their properties can change the nature or quality of the properties and therefore median house prices.

STATISTICS ARE MORE RELIABLE IF LOOKED AT OVER THE LONG TERM

 Investors should pay less attention to short-term trends and understand that median prices (as with all statistics) are more useful when viewed as a change in trend over a longer time frame and not over a month-to-month period.

This helps you get a better understanding of an area’s performance.

Median prices are really best used as an indication of the composition of sales rather than a good indicator of changing property values.

That’s why I also look at data such as sales volumes, and market depth and investigate ‘like for like’ recent sales evidence to estimate current property values. 

You’re probably aware that property investment is part science and part art.

The art component is the market intelligence that comes from decades of experience in buying and investing on the ground.

And this is crucial because relying solely on the scientific approach (the data) isn’t enough.

The statistics alone won’t allow you to differentiate between a good floor plan or a poor layout, a desirable neighbourhood compared to a less desirable location with negative stigma or an aspect that receives abundant natural light compared to a poor orientation, etc. 

There is no doubt that it’s important to understand the property fundamentals and research property data, and the longer back the data research goes the more accurate the data is likely to be in forecasting future trends.

The problem is data is often wrong or to put it correctly…the way investors interpret data is wrong.

Let’s be frank… you can make it say almost anything you want.

I’ve seen too many property investors find a property that they like, once they become emotionally attached to it and then find the data to confirm their decision.

That’s called “confirmation bias” – they’re using data backwards rather than in the right way. 

SO WHAT RESEARCH AND STRATEGY SHOULD YOU USE?

I use a “Top Down Approach“. 

This starts with examining the macro factors affecting our property markets and drills down to the micro level.

I start by looking at the macro-economic environment – the big picture of how Australia’s economy is performing.

Then I look for the right state in which to invest – one that will outperform the Australian market averages because of its economic growth and population growth.

Also, I only invest in the capital cities and not in regional areas, because that’s where the bulk of the jobs will be created and where most people are going to want to live in the future.

Then within that state, I look for the right suburb or group of suburbs – ones that have a long history of outperforming the averages.

You see…I’ve found that some suburbs have 50 to 100 per cent more capital growth than others over a 10-year period.

And, as I’ve explained, it’s all about demographics, as these suburbs tend to be areas where more owner-occupiers want to live because of lifestyle choices and where the locals can afford to and will be prepared to pay a premium to live because they have higher disposable incomes.

In general, they’re the more affluent inner- and middle-ring suburbs of our big capital cities, so I check the census statistics to find suburbs where wage growth is above average.

Then I look for the right location within that suburb.

Some liveable streets will always outperform others and in those streets, some properties will always be more desirable than others and outperform investments by increasing in value.

Then within that location, I look for the right property, using my 6 Stranded Strategic Approach, which I will explain in a moment. And finally, I only buy at…

The right price, but I’m not suggesting a “cheap” property – there will always be cheap properties around in secondary locations. I mean the right property at a good price.

My 6 Stranded Strategic Approach

Once I’ve found the right location the next phase of my research is to find the best property for me to buy using my 6 Stranded Strategic Approach, which involves the following steps:

1. I only buy a property that appeals to owner-occupiers. Not that I plan to sell my property, but because owner-occupiers will buy similar properties pushing up local real estate values. This is particularly important in the current market when the percentage of investors in the market is likely to diminish.
2. I only buy a property below its intrinsic value – that’s why I avoid new and off-the-plan properties, which come at a premium price.
3. I buy properties with a high land-to-asset ratio – that doesn’t necessarily mean they have a large plot of land, they can be apartments with a high attributable land value under them.
4. In an area that has a long history of strong capital growth and that will continue to outperform the averages because of the demographics in the area. I also look for a property with a high land-to-asset ratio – where the land component (the part that increases in value) makes up a significant part of the property’s value.
5. I also look for a property with a twist – something unique, special, different or scarce about the property, and finally…
6. I only buy a property where I can manufacture capital growth through refurbishment, renovations or redevelopment rather than waiting for the market to deliver me capital growth.

You need to plan

So while the property markets will create significant wealth for many Australians, statistics show that 50% of those who buy an investment property sell up in the first five years.

And of those who stay in the investment game, 92% never get past their first or second property.

That’s because attaining wealth doesn’t just happen, it’s the result of a well executed plan.

Planning is bringing the future into the present so you can do something about it now!

Just to make things clear…buying an investment property is NOT a strategy!

It’s important to start with the end game in mind and understand what you need and what you want to achieve.

And then you have to build a plan, a strategy to get there.

The property you eventually buy will be the physical manifestation of a whole lot of decisions that you will make, and they must be made in the right order

That’s because property investment is a process, not an event.

By Michael Yardney
Originally published by Property Update