A Property Investor’s Guide to Property Market Cycles in Australia

What’s ahead for our property markets?

Are they really moving into the next phase of the property cycle?

Following a once in a generation boom in 2020-21 driven by falling interest rates at a time of strong demand, our property markets fell into a slump in 2022 as interest rates rose.

However, it now seems that our housing markets are looking for a floor as “asking prices” are increasing around the country, the rate of decline in house prices is falling in some areas, while median house prices are increasing in other locations, particularly Sydney.

In other words, the property market is doing what it always does – it is working its way through the market cycles driven by various factors such as interest rates, consumer confidence, supply and demand, economic conditions, and government policies.

By understanding these cycles and their different phases, investors can make better-informed decisions, so let’s look deeper into property cycles.

Understanding Property Cycles: A Deeper Look

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

The four distinct phases of a property cycle are influenced by population growth, employment, income levels, and access to finance.

Each phase has unique characteristics that influence property values and investment opportunities.

The Boom Phase

During the boom phase, which tends to be the shortest phase of a cycle, strong demand from investors and homeowners drives rapid increases in property prices.

Several factors contribute to this demand, including low-interest rates, a strong economy, population growth, and favourable government policies.

This phase typically attracts a whole new generation of investors into the market. At the same time, would-be homeowners push up demand for houses stimulating construction activity and leading to a surge in new properties entering the market.

Key characteristics of the boom phase include:

• A rapid increase in property prices, often exceeding 20% per year
• Low unemployment rates and strong wage growth
• High consumer confidence and optimism
• Increased construction activity and new property developments

The Downturn Phase

Following the boom, the market enters a downturn or slump phase, usually characterized by an oversupply of properties due to excessive construction activity.

As demand cools, vacancy rates increase, and rental prices decrease.

In some cases, property prices may drop by around 10% or more.

Interestingly the recent property slump of 2022-23 wasn’t brought on by an oversupply of properties but was initiated by a lack of affordability and then exacerbated by rising inflation and interest rates trashing consumer confidence.

Key characteristics of the downturn phase include:

• Stagnant or decreasing property prices
• Rising unemployment rates and slowing wage growth
• Reduced consumer confidence and pessimism
• Decreased construction activity and property development

The Stabilisation Phase

The stabilisation phase occurs as interest rates fall and pent-up demand accumulates.

During this phase, property prices remain relatively flat, and market activity stabilizes.

Buyers and sellers cautiously re-enter the market, and the number of transactions increases.

This phase can present opportunities for investors who recognize the potential for future growth.

Key characteristics of the stabilisation phase include:

• Flat or slowly increasing property prices
• Stable employment and wage growth
• Improving consumer confidence and optimism
• Balanced supply and demand in the property market

The Upturn Phase

As the market enters the upturn phase, vacancy rates decline, rents increase, and property values rise again.

This phase can last three to four years and attracts more buyers and investors.

Builders and developers also commence new projects, aiming to complete them during the late upturn or boom phase.

Key characteristics of the upturn phase include:

• A steady increase in property prices
• Continued improvement in employment and wage growth
• High consumer confidence and optimism
• Increased construction activity and property development

Influential Factors on Property Cycle Length

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, 2017, and 2022, 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.

The length of a property cycle can be affected by various factors, including:

• The overall state of the economy, including GDP growth, inflation, and unemployment rates
• Government policies, such as tax incentives, zoning regulations, and infrastructure projects
• Central bank interest rate policies and access to finance
• Population growth and demographic shifts

The most recent property boom, which ended around early 2022, was prolonged by a lengthy period of falling interest rates, but it eventually came to an end when a lack of affordability kicked in and this was only exacerbated by a swag of interest rate rises.

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

Regional Variation in Property Cycles

While the media tends to generalise “the property market”, there are many submarkets around Australia.

Each state in Australia can be at a different stage of its property cycle, with markets segmented by geography, price points, and property types.

Even within each state, various submarkets perform differently depending on the specific market segment.

For example, the “top-tier” more expensive end of the market will tend to perform differently in 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, during the last property boom almost every property in Australia increased in value.

However, now each State is running its own race depending on local economic conditions and supply and demand.

The Role of Fear and Greed

Fear and greed are powerful drivers of property market cycles, often leading to irrational decision-making and market overreactions.

The emotions experienced by homebuyers and investors can amplify the effects of market cycles, causing them to overshoot or underperform.

During the boom phase, FOMO (Fear of Missing Out) drives demand as people worry about missing the profits that others have enjoyed.

This can lead to a buying frenzy, causing property prices to increase at unsustainable rates.

Conversely, during the downturn phase, FOBE (Fear of Buying Early) can take hold, as potential buyers fear purchasing a property only to see its value decline further.

This phenomenon can result in prolonged periods of stagnation and suppressed market activity.

The problem is “crowd psychology” tends to 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.

Strategies for Investing in Different Phases of the Property Cycle

By understanding the characteristics of each phase of the property cycle, investors can adopt appropriate strategies to maximize returns and minimize risks.

Boom Phase Strategies

• Focus on high-quality, well-located properties with strong growth potential
• Be cautious of overpaying for properties as prices can be inflated
• Consider diversifying your investment portfolio to mitigate risks

Downturn Phase

• Identify undervalued properties with long-term growth potential
• Be patient and wait for the right opportunities, avoiding panic selling
• Focus on rental yield and cash flow to maintain a positive cash position

Stabilisation Phase Strategies

• Look for properties with strong fundamentals in areas with potential for growth
• Take advantage of market stability to secure favourable financing terms
• Use this period for property research and building a strong network of professionals

Upturn Phase Strategies

• Focus on properties with strong owner-occupier demand to benefit from rising prices
• Invest in areas with upcoming infrastructure projects or favourable zoning changes or gentrifying suburbs
• Keep an eye on market indicators and be prepared to adjust your strategy as the market shifts

What’s ahead for Australia’s property markets?

?We’re clearly moving into the next phase of the property cycle, but there are both headwinds and tailwinds for our markets to contend with.

The Positives for the Property Market

1. Decline in household size

The Reserve Bank of Australia (RBA) has observed a 1% decline in average household size since the beginning of 2020, which has contributed to an increased demand for housing, partially offsetting the negative impact of reduced immigration during the pandemic.

2. Returning immigrants

Net immigration surged to 320,000 in 2022, up from just 5,940 in 2021, resulting in increased demand for approximately 125,000 additional dwellings.

Immigration is expected to remain strong in 2023, further contributing to housing demand.

3. Low rental vacancy rates

Capital City rental vacancy rates are below 1%, driving an increase in rents, which may attract more investors to the property market.

4. Government support

Initiatives such as the option for first-home buyers to opt for land tax in New South Wales and other government support programs are boosting demand for property.

5. Low listings

Property listings are currently 25-30% lower than a year ago, which may contribute to a recovery in property prices.

6. Interest rates

It is likely that interest rates are at or near their peak, which may provide support for property prices.

7. Auction clearance rates

These rates have improved from their lows and generally correlate with property price trends.

The Negatives of the Property Market

1. Impact of variable rate hikes

The full impact of variable rate increases may not be felt for another 2-3 months, as it takes time for RBA hikes to affect actual mortgage payments.

2. Fixed-rate loan expirations

Approximately 880,000 fixed-rate loans will expire in 2023, potentially resetting mortgage rates from around 2% to 5% or 6%.

3. Future interest rate hikes

Although some economists believe rates are close to peaking, others predict the cash rate may rise above 4%.

4. Rising household debt servicing payments

These payments have already reached their highest level in over a decade, and further rate hikes could push them to record levels, removing roughly 5% of household cash flow in relation to income.

5. Deteriorating economic conditions

Weaker global growth, rate hikes, and exhausted pent-up demand from the pandemic may lead to increased unemployment and further mortgage stress in Australia.

6. Reduced home buying capacity

Despite a potential halt in rate increases, the hit to home buying capacity remains, particularly for those with a 20% deposit and average full-time earnings.

Conclusion

Understanding the cyclical nature of property markets in Australia is crucial for investors to make informed decisions about when and where to invest.

By recognizing the different phases of property cycles and the factors that influence them, investors can capitalize on opportunities and minimize risks.

Keeping emotions in check and adopting appropriate strategies for each phase can help to ensure long-term success in the property market.

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