What you need to know about property market cycles in Australia

The strength of our real estate markets this year have surprised many observers, considering the challenges COVID-19 has presented to our economy.

In fact, it doesn’t really matter whether you worked last month, walked around the local park or sat at home and watched the Olympics, for many Aussies their home made more money than they did.

But rising property values and increasing affordability issues have caused many to ask how long this property cycle will last.

To help answer this question, let’s look deeper into property cycles.

In this article, we cover:

What is a property cycle?

While many commentators refer to a “seven-year property cycle” to explain how house prices often move through four phases, these cycles vary in length and aren’t really dependent on a length of time but more on a range of socioeconomic factors.

A simplistic version of the cycle looks like this: As our population grows, there is an increased demand for real estate – both for rental properties from investors and new homes from owner-occupiers.

Slowly, this causes property values to increase because of the forces of supply and demand.

At the same time, builders and developers hop on board and start constructing new dwellings to meet this increased demand.

However, the pendulum tends to swing too far and over time we usually end up with an oversupply of dwellings. This oversupply can eventually result in slumping home values and rent reductions.

What are the different phases of a property cycle?

There are four key phases of a property cycle, as shown in the below graphic.

Phases of property cycle
Source: Metropole Property Strategists

Let’s take a closer look at each of these.

The boom phase

This tends to be the shortest phase of a cycle. During the boom stage, real estate prices increase rapidly – often by more than 20% each year.

Each boom brings a whole new generation of investors into the market and at the same time, would-be homeowners push up demand for houses. Together this leads to increasing property prices. Builders and developers then flood the market with new properties to meet the increasing demand.

The downturn phase

Booms are generally followed by a downturn or slump phase that is often characterised by an oversupply of properties, due to the over-exuberant activity of builders and developers during the preceding boom. This can result in increased vacancy rates and decreasing rental prices. Property prices tend to stop growing and can sometimes drop by around 10% or so in this phase.

The downturn phase typically lasts a number of years, but prolonged booms may be followed by a longer and deeper slump phase, with a greater likelihood of prices falling further.

The stabilisation phase

Eventually, the market moves on. Falling interest rates and pent-up demand during the slump phase set the stage for the next property upturn.

But prices generally don’t suddenly start escalating wildly. Buyers tentatively move back into the market, but since the number of buyers and sellers is in rough equilibrium, property prices remain flat or only move up slowly. This can be a time of great opportunity, yet it is not easily recognised by most investors.

The upturn phase

In time, the cycle moves on and eventually, we progress into the upturn phase when vacancy rates typically slowly fall, rents start to rise and property values begin to increase again.

At this stage of the cycle (which could last three or four years) property is generally affordable, returns from property investments can be attractive and more home buyers and investors begin to enter the market. This is also when many builders and developers begin work on new projects, aiming to have them completed by the late upturn or boom phase of the cycle.

At the end of the upturn phase, real estate prices will have risen substantially and property starts to become less affordable for many Australians.

And…we start all over again.

How long do property cycles usually last?

A property cycle doesn’t necessarily last a fixed period of time. But looking back over recent decades, property growth in Australia has peaked in the following years: 1981, 1987, 1994, 2003, 2010 and 2017, so it’s easy to see why some people feel property cycles last seven years.

And digging deeper into the stats, it is clear that over the past 40 years, well-located capital city properties have seen their values double every 10 years or so (growing at around 7% per year on average, according to the Real Estate Institute of Australia.)

However, at some stages of the cycle values increase, and at other times they stay flat or decrease.

And while most cycles do seem to last between seven and nine years, the length of a particular property cycle can be affected by a combination of factors and influences such as the state of the economy, as well as social and political issues. Then, at times, the government lengthens or shortens the cycle by changing economic and tax policies while the RBA manipulates interest rates to either encourage or discourage borrowing and spending.

For example, the most recent property boom phase, which ended around mid-2017, was prolonged by a lengthy period of falling interest rates. But it eventually came to an end as the Australian Prudential Regulation Authority (APRA) tightened the screws on lending, particularly for investors.

The following graph shows an example of what could happen to house prices over two property cycles.

Two property cycles
Source: Metropole Property Strategists

Does all of Australia follow the same cycle?

While many people generalise about “the property market”, there are many submarkets around Australia. The fact is, each state can be at a different stage of its own property cycle. Even within each state, the markets in different areas are segmented by geography, price points and type of property.

For example, the “top-tier” more expensive end of the market will tend to perform differently to the new home buyer’s market, which is different again from the investor segment or the established property sector.

While different states are usually at different stages of their own cycles, this time around things are different.

In October last year, as we were still coming to grips with coronavirus, all our property markets started booming. Well…all markets other than inner-city high-rise apartments.

This cycle was led by property values in regional Australia rising strongly, as well as first homebuyers taking advantage of many grants and incentives available, driving the cheaper end of our property markets.

Now, the more expensive end of the property markets in our capital cities are amongst the stronger segments and exhibiting boom time levels of capital growth.

What else should I know about property cycles?

Our property markets and the fluctuations of the property cycle are largely driven by fear and greed.

This was evident at the beginning of this year, as rising property values created FOMO – fear of missing out – which is really a form of greed.

Looking back at last year, when we were first concerned about coronavirus, fear held many homebuyers and investors back as they sat on the sidelines waiting for more certainty.

It’s also my observation that Australian property 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.

Again, these swings are driven by fear and greed since “crowd psychology” can influence people’s home-buying decisions, often to their detriment.

You see, home buyers and investors tend to be at their most optimistic near the peak of a property 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 could potentially be the least risk involved.

The fact is, market sentiment is one of the key drivers of property cycles and one of the reasons why our markets tend to overreact, overshooting the mark during booms and getting too depressed during slumps.

It’s usually because either greed or fear tends to kick in.

During the boom phase of the property cycle, home buyers and investors experience FOMO as they see property prices going up all around them. They are worried that they may miss out on the profits the boom has delivered to other property owners.

On the other hand, during the slump phase of the cycle the opposite occurs – FOBE (Fear of Buying Early). Earlier this year, many homebuyers and property investors held back for this reason – they didn’t want to buy a property just to find they could have bought one cheaper a few months later.

The bottom line

At present we are in a property boom, with capital city housing values likely to experience strong double-digit growth this year.

And property price growth is likely to continue well into 2022 and even into 2023, when eventually affordability will slow down our markets.

However, each boom sets us up for the next downturn, just as each downturn sets the scene for the next upswing.

The good news is property slumps are only temporary, while the long-term escalation of property values in our capital cities has been more permanent.


Headshot of Michael Yardney

Michael Yardney is a director of Metropole Property Strategists. He is a best-selling author, one of Australia’s leading experts in wealth creation through property and writes the Property Update blog.

 

 

 

 

Main image source: Jandrie Lombard/Shutterstock.com

This content was reviewed by Sub Editor Tom Letts and Finance and Lifestyle Editor Shay Waraker as part of our fact-checking process.

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