THE RESIDENTIAL PROPERTY MARKET—WHAT STAGE OF THE CYCLE ARE WE IN

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THE RESIDENTIAL PROPERTY MARKET—WHAT STAGE OF THE CYCLE ARE WE IN

 

This note outlines what history has to tell us about the relationship between the cycles of economic growth, equities, and residential home prices.

Some patterns emerge—these are not widely known, because often the focus is more on the short term, and people rarely take the trouble to look back over previous cycles.

The Chart below is from the Reserve Bank and shows the outcome of Australia’s five largest equity market crashes (1929, 1973, 1980, 1987 and 2007).
Picture1

History suggests the following points :

  • The recent fall, in percentage terms, is not unprecedented – it is about the same as in 1973 and 1987
  • The sharemarket recovers over time
  • The recovery tends to take a long time – from 3 years to 6-7 year
  • The deeper the crash, the longer the recovery tends to be – the “small” crash (only 40%!) in 1980 recovered in about 3 years; the biggest crash (60%) in 1973 took almost 7 years
  • The market can stay around the bottom for a number of years (3 – 5 years for the 1987 crash) before commencing a sustained recovery

Reliable house price data does not extend back to 1929.  But the next chart, from ANZ looks at residential house prices and recessions from 1965 to 2007.

Picture2

The vertical axis is a log scale, which means that the slope of the red line reflects the % increase in house prices, not the dollar increase.  For example, the house price index in 1965 was about 3; it doubled to 6 about 7-8 years later.  If it doubled every seven years for the 42 years from 1965 to 2007, then it would grow from about 3 to about 192; if it doubled every 8 years it would grow to about 100 – it is clear that, on average, house prices have doubled every 7–8 years (sometimes faster, sometimes slower).

This chart indicates that some recessions can result in falls in house prices – but any falls have been small and for short periods, and have not affected the medium term trend; possibly because lower interest rates during recessions tend to support property prices.

The next chart adds in the dates of the equity crashes (including the smaller crashes of  1994 and 2000).

Picture3
This suggests that equity crashes have historically been followed by an acceleration in house prices – possibly because investors are reminded of and drawn to the generally steady rise in residential property prices, that contrasts with the dramatic falls that can occur in equity prices.

The next chart (from Residex data) shows house price data in a different form – it shows the year-on-year % change in house prices since 1980 (the black line is Australia; the green line is Sydney).

Picture4

The conclusions are similar to the previous chart (since they are based on similar data):

  • House prices in aggregate have rarely fallen (represented by the line dropping below the horizontal axis) and, when they have, the fall has been small and brief
  • Recessions and equity crashes have historically been followed by periods of good growth in house prices

An additional piece of information is that Sydney prices have been underperforming every year since about 2003

Conclusion

The historical evidence is that house prices have not suffered prolonged or large downturns, even during times of recession, and that both recessions and equity crashes tend to be followed by a pick up in house prices.

Will this time be different?  Not in our view.  As well as the evidence of history, the following factors are relevant:

  • There has been a massive reduction in interest rates, most of which has been passed on to borrowers
  • The government will put through massive fiscal stimulus
  • There is a massive undersupply of housing, which is seeing rents rise to levels that make it possible to borrow for properties and still be cash flow positive.  For example, according to ANZ:
    • Dwelling completions have been running below demand for over 10 years
    • The accumulated excess demand is now over 200,000 dwellings – or 16 months production (if population stopped growing, which it will not); for Sydney the excess demand is 3 years production at current levels!
  • Rental vacancies have fallen from around 4% in 2000 to about 1% now (a vacancy of one week per year would be 2%)

However, mistakes can be made by buying the wrong property, or in wrong location.  For example, on Residex figures, over the last 7 years, Sydney house prices did not double (which is the long term average) but increased only 39%.  In contrast, Perth houses increased in value by 155%.  And within each city there were great variations between suburbs.  Simply looking in your own neighbourhood for investment opportunities can result in expensive lost opportunities.