Boom town glad rags tell only part of the story

Wednesday 18 Nov 2009

Look beyond the promising headlines for a lasting, stable investment.

There's every sign that Melbourne's property market is on the way up.

The interest rate cycle is turning, auction clearance rates are up, and the median house price hit a record $480,000 in the September quarter.

But I'd like to put something into perspective. In recent weeks, headlines have been proclaiming the start of this growth phase as a "boom", and this bothers me.

A boom implies the existence of its opposite, which is a bust – and "boom and bust" does not accurately describe the nature of Melbourne's property market.

Residential property is a real asset, not a paper asset, and it's the only one that serves a dual purpose by providing a lifestyle and financial investment.

Everyone needs somewhere to live, but not everyone needs or wants to invest in shares – so residential property has a widespread and ongoing level of demand that stabilises the market.

This makes it a relatively stable asset compared with paper-based assets such as shares.

In Melbourne, as in most capital cities and large regional centres, the notion of booms and busts simply doesn't ring true. (Places it might apply are smaller towns based on single industries such as mining or tourism with a more volatile economy.)

The current growth spurt in the residential property market is not a boom but, rather, a logical phase in the overall cycle.

It has been my observation that the residential property market grows for around two years following a sharemarket correction, as spooked investors seek to place their funds in a more stable asset class.

Look what happened after the "tech wreck" and September 11. Figures from the Real Estate Institute of Victoria Statistics show that Melbourne's median house price grew by almost 20 per cent in 2001 and again in 2002.

When the sharemarket recovered, investors began to go back, and property prices moderated.

Today, the pattern is repeating. After the 2007 sharemarket correction, I predicted several times in this column that a residential property market recovery would follow.

The sharemarket correction lasted until mid-2009, and now residential property is going through a growth spurt that looks set to last throughout 2010 and into 2011.

Another reason I dislike the boom-and-bust concept is that it's often used in a blanket fashion; implying that all property grows (or falls) in value at the same rate, at the same time.

This is not the case. After the current growth phase reaches its peak around the first half of 2011, there will be a noticeable split in growth rates.

Properties that will continue to grow strongly will be those in demand from homebuyers and investors alike.

These properties will be in areas with high employment rates and reasonably low debt levels.

They will be in short supply relative to demand, and will have a high land-to-asset ratio – that is, the bulk of the asset will appreciate, not depreciate.

In most cases, these properties will be in the inner and middle suburbs.

By contrast, growth will tail off in areas where demand is primarily driven by one sector of the market – such as first home buyers in the outer suburbs, and investors in inner city multi-unit developments.

These areas have a lot of building activity, so there's no consistent shortage of supply to drive price growth.

Debt levels are often high, and in some cases a large proportion of residents are employed in a single industry.

This makes them more vulnerable to job loss and mortgage defaults – increasing supply and softening prices.

What's more, many of these properties have a low land-to-asset ratio, so the bulk of the asset is depreciating.

As an investor, it's vital to take a long-term view. Look beyond the exhilarating headlines and choose property that will continue to perform strongly after the current growth spurt.

In summary

The residential property market is relatively stable.

Growth spurts generally follow sharemarket corrections.

Not all properties will grow strongly after the current growth phase.

Choose wisely for long-term investment performance.

- Mark Armstrong - Director of Property Planning Australia