28 January 2011

Will property prices plateau?

In 2010, the media was reporting that house prices will keep rising indefinitely due to population growth and the supposed housing shortage. More recently, they have been saying that there will still be growth, but it will slower. Well it looks like they’ve changed their tune again. No, they are not yet brave enough to predict falls. Here’s what they said:

The Age reported that:

“Australia's home prices are expected to remain flat this year” and that “house prices will plateau this year, at just over $550,000 on average”.


The Australian took it one (albeit tiny) step further:

“National house price expectations have now turned negative, with falls of 0.5 per cent over the next 12 months likely.”

Hahaha, did they put their decimal point in the wrong spot? Half of one percent? I would hardly call that a fall – it sounds more like a plateau to me.

But regardless, here’s the problem with their findings – house prices cannot simply plateau. Look at any chart (shares, economic growth, mixed lolly prices) and you won’t see a horizontal line in sight – markets are either going up or they are going down. That’s just how they work. It’s due to the human conditions of fear and greed.

But here’s the interesting part; it’s this belief that prices have now flat lined, that will cause them to fall. Here’s why:

Potential home buyers will now feel less pressure to buy (witnessed by my better half’s reaction to the above articles - that maybe we could hold off for another year). This causes demand to drop.

For property investors, rental returns are well below what you can make in the relative safety of a bank. Therefore, most investors are not buying for income. In fact, after costs, the majority of Australian landlords are making a loss. But they haven’t minded – firstly because the tax man gave them a nice tax deduction and secondly because the value of their property has been increasing faster than they could lose money. (Anyone see something strange about a loss-making investment continually going up in value?) But now, with predictions of no capital growth, many potential investors would be turned off the idea of negatively gearing into property, which would further reduce demand.

And those investors already in the market, who were relying on capital growth and now realise they will not get it, will become skittish and sell. There won’t be a stampede for the exits, like you might get in the stock market. However, there will be slow jog for the exits as sentiment turns and people start to realise that Australia is not different and that our house prices do not always go up.

Finally, we’ve got the property flippers – these are the people who buy a knock-down job, knock it down and re-build with the hope of selling for a profit. This is fairly easy to do during a boom. But it becomes a much more difficult task when prices stop rising. Again, this will reduce demand. But also, as flipping activity reduces, suddenly all of those vacant blocks that were being built on will become available, increasing supply.

Lower demand and higher supply will trigger prices falls, which will in turn cause even lower demand and higher supply, and so on.

They say there is no warning bell to signal when sentiment turns and the bubble bursts. But I’d say the above headlines claiming that house prices have flat lined is as close as you’ll get.

Comments and queries welcome.



  1. As a potential first-home buyer, I'm very excited about your predictions, Andy. What are your thoughts on inner-city houses, though, where demand is always strong - will those prices fall dramatically too?

  2. Jo - some areas will be affected more than others but I don’t think any area will be spared. As a general rule, the higher the rise during the boom, the larger the fall during the bust.

    Inner-city suburbs often have a higher proportion of investors compared to owner-occupiers. Take Richmond in Victoria for example. 49% of dwellings are owned by investors (compared to the Melbourne average of 24%).

    I would say such suburbs are even more susceptible to a correction, as investors are more likely to be the ones to head for the exits.

    However, before you get too excited, a house price crash of the magnitude I’m predicting will have huge unwanted side effects (just look overseas for examples). So make sure you’re indispensible in your job - because unemployment will rise, and save hard for a deposit in the meantime - because home loans won’t be easy to come by.

  3. I guess the million dollar questions are:
    * How far may prices fall before they turn around again -- ie what do you think would be an appropriate trough to ensure market stability in the long run? And...
    * How long do you expect it to take before that trough is encountered?

    Of course this last question is an incredibly difficult thing to predict, particularly given the QLD / East coast floods meaning certain factors are at play:
    * building/construction industry will be thriving for a while, and
    * I'd expect interest rates to go up as economic spending increases.
    But I would like to know your thoughts...

  4. Good questions David. As you indicate, predicting the market is extremely difficult, due to its irrational nature. But I’ll have a go anyway:

    Bubble theory shows that prices fall back to their long-term trend, and often below it (during the “despair” phase). If the turnaround has already started (which I think it has), prices need to fall about 40% to get back to trend, so a total fall of around 40%-50% is likely.

    As to the duration, unlike the share market, property is slow moving. The property boom lasted around 15 years. I think that the bust will be quicker (because fear is more powerful than greed) and will take around 6-7 years to hit the trough.

    Your thoughts?

  5. Hi Andy,

    I would say that seven years to bottom would be extremely optimistic. The Japanese bubble was similar in magnitude to ours, and it is not clear if they have reached bottom yet after twenty years and 70% falls.

    Some parts of the sydney market have already been falling for quite a few years and are still wildly irrational. eg. this one: http://bubblepedia.net.au/tiki-view_blog.php?blogId=4 sold for less last year than it did in 2004.

    It's possible that we could get down to rational prices in a few years, especially given how high this thing has been pumped. However returning to trend is not necessarily returning to rational. I remember the rule of thumb when a friend was buying an apartment here 20 years ago was that the gross rent yield should be about 5%.

    5% before expenses depreciation and tax is a wildly irrational low rent yield to return to - it's only about 2.5% after expenses and tax, let alone depreciation. After the 40-60% price fall required to reach it for most places near me, it is highly unlikely investors will want to risk their capital for only 2.5%. The 1% they will be able to get in the bank will be more attractive.

  6. Hi bubblepedia,

    It's not often I'm called optimistic when it comes to the aussie housing market!

    So what's your prediction of percent fall (peak to trough) and how long do you think it might take?

    By the way, for those that don't know about it, bubblepedia is a fantastic resource on the aussie property bubble -

  7. Hi Andy,

    I refuse to make a prediction on timing of the fall for a few reasons. Firstly, there is no reason for me or anybody else to think that my prediction is any better than anyone else's. ie. it's worthless. Secondly, there is a madness out there. Try predicting what a friend with their first manic episode will buy at the shops...

    I think anyone who can think independently is qualified to have a stab at how overpriced houses are __for them__. When the crazy masses will wake up is another matter.

    To me a rational rent yield is somewhere between 7 and 12 percent. I currently pay a rent of 1.1% of the price the owner would like to sell the house for (which happens to be anchored at the price he paid over the last decade for it, I probably pay 1.7% of what he could actually get for it). So you can see that for me to buy this house the price the owner is willing to sell it for would have to fall by 80 to 90%! It's a nice house. I'd take it at 80% off. Then again, it's inefficient and a bit too big, so if prices had already fallen 80%...

    Now, it's not impossible that this would happen in only seven years. It seems like it has happened that rapidly before. The Melbourne bubble of the 1890s may have been even more rapid that that. Parts of Ireland and California and Florida seem to have fallen 50% quite quickly this time, but they may still have 15 years to go for all we know! Japan and Switzerland seem to be still falling twenty years out. So I guess I think that 7 years to bottom is optimistic because there is so far to fall, the rise was more than a generation long and the falls in other places at other times have been very long term.

    I live in a nice place though. For lower priced dwellings the numbers are less catastrophic, but it is still stark. Spruikers and crazy bankers can write that rent yields are 4.27364523% all they like, but until they can show me the house fit for habitation that has such a "high" rent yield, I'll measure rent yields on the houses I can see around me which rent for 3% for liveable fixer uppers, or 1-2% for fancy houses. One bedroom flats on drug dealing strips by western sydney train stations I don't know and I don't care.

    So, minimum __real__ price falls for liveable but dodgy houses should be 50%, and for really fancy houses should be 70%. Think of the attitude to Sydney waterfront property. The faith is so strong, that the prices paid are even more whacko, so the losses will be even greater. Ironic isn't it, the better the house the bigger the loss will be.

    As for when these losses should materialise, it may well take longer than I need a house. I don't care. I'll rent while it's cheaper to rent, and buy if it's both cheaper to buy and my accommodation needs are stable at the time. eg. If I have only two adult children left at the time, I'll keep renting even though it might be a little dearer because of the probable wish to downsize soon.

    I think a whole generation of today's 10-20 year olds are going to come around to thinking that it's better to rent than to own. Then they will probably discourage their kids from buying even if it becomes stunningly much cheaper to own than to rent. Funny creatures we are.

  8. Andy

    Enjoy your work , great read, keep it up, Perth is a basket case at the moment yet we are supposed to be the Mining Powerhouse?

    Listings in Perth are up 47%-50% on this time last year , nobody is buying the dream (nor can the afford it)

    Land developers are starting to offer "BONUSES" to get sales $10K Visa Cards Pre paid / $30K Harvey Norman "Gift Vouchers" all designed to hide the fact that they are discounting the land. So our sales stats for land show prices steady because the block is still sold for $300K on paper but the buyer scored a $30K Harvey Norman Gift card ....Keep a eye out for this trick in your state?


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