What you need to know about property cycles

Real estate markets in Australia have surprised many people this year. The resurgence of the Melbourne and Sydney property markets in particular over recent months has sparked many to ask if this is the beginning of the next property cycle. But what does that mean?

Here I’ll share with you some key points to help you understand property cycles.

What is a property cycle?

Many commentators refer to a “seven-year property cycle” to explain how house prices move through four phases. A simplistic version of the cycle looks like this: As our population grows, there is an increased demand for real estate – both 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 eventually results in slumping home values and rent reductions. 

What are the different phases of a property cycle?

There are four key phases 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 the 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, 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 eventually 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 sometimes drop by around 10% or so in this phase. 

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

Property Cycles downturn
Source: Jat306 (Shutterstock)

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 don’t suddenly start escalating wildly. Buyers tentatively move back into the market, but as 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 list?

A property cycle doesn’t necessarily last a fixed period of time. But looking back, property growth in Australia has peaked in the following years: 1981; 1987; 1994; 2003; 2010, 2017.

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 policies, particularly by manipulating interest rates.

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 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.

And while there is currently an oversupply of off-the-plan high rise apartments in Sydney, Brisbane and Melbourne, there are more buyers looking for well-located homes than there are good properties on the market in many of the middle-ring suburbs in these cities.

What else should I know about property cycles?

It’s 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.

Take the Sydney property market, which experienced significant growth (overshooting its fundamentals, in my view) during the previous property cycle. Dwelling values dropped 15% from their market peak, overshooting on the downside when, in general, all the fundamentals for Sydney property were sound in 2018 and 2019.

Source: Taras Vyshnya (Shutterstock)

That’s because “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 (Fear Of Missing Out) 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 home buyers 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

Each property boom sets us up for the next downturn, just as each downturn can set the scene for the next upswing.

The good news is property slumps up until now have been temporary, while the long-term escalation of property values in our four biggest capital cities has been more permanent.

That is happening again at present, as the Melbourne and Sydney property markets appeared to bottom out in June this year, and now seem to be moving into the next phase, which is being confirmed by more buyer interest, higher auction clearance rates and rising property values.

And the cycle starts all over again.

About Michael Yardney

Micahel 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)

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