Types of Risk

What types of risk does a property investor

need to be aware of?

 

Property Cycles

The property cycle is divided into 4 phases

 

The property cycle is a recurring pattern of upturns and downturns in the market for housing influenced by economic, political, social and psychological factors.

Periods of growth are inevitably followed by periods of reduced growth and market ‘corrections’.

While property cycles can vary in length, pace and the height of the peaks and the depths of the troughs, they follow the same long term positive trajectory. Variations around the trend line are to be expected, but it is the overall direction of the trend that is important.

This is why a property is not considered a short term investment or a ‘get rich quick scheme.’

It is worthwhile noting too that while recovery periods typically match the length of time, it takes to go from peak to trough, it is not always the case.

Investors need to commit to sustainable levels of debt that will allow them to ride out the downturns.

Investment in real estate like any other asset class is subject to market sentiment and the performance and management of the economy as a whole. Returns may fluctuate depending on factors such as supply and demand for housing, population growth, interest rate changes by the RBA and government incentives and exogenous shocks to the economy.

Influences on the demand side include:

The business cycle – if the economy is growing, unemployment is low, and consumer confidence is high, as incomes rise more people buy their own homes and more people are in a position to invest. If the economy is slowing and unemployment or underemployment is growing, and consumers are pessimistic about the future they will hold off and wait for conditions to improve, leading to a decline in demand.

 

 

Government incentives through fiscal measures encourage owner-occupiers and investors via grants and stamp duty concessions, negative gearing allowances and capital gains tax discounts. Removal of the same inducements will have a reverse effect. Political uncertainty and imminent elections also inhibit consumer confidence.

 

 

The RBA’s manipulation of the cash rate influences the cost and availability of credit in the economy, and more people are likely to borrow and purchase property either for owner occupier or investment purposes when rates are eased and less so when the policy is tightened.

Prudential regulators such as the Australian Prudential Regulation Authority (APRA) can encourage or discourage borrowing by relaxing or toughening the guidelines for financial institution’s lending criteria.

 

 

Demographic trends such as population growth and the divorce rate will increase or decrease the demand for housing (and the type of housing)

 

 

Media coverage intensifies consumer perceptions and fear of missing out  (FOMO) and it can also drive ‘doom and gloom’. Consumer confidence and emotion govern many decisions.

 

 

 

Influences on the supply side include:

The availability and cost of development sites and materials: vendors will assess the profitability of entering the market as a supplier and calculate the risk and return potential. If they expect costs to increase, they will seek a higher margin as insurance against future erosion of profits.

 

 

 

Bureaucratic red tape and compliance costs influence the profitability of ventures, including the approval process and mandatory infrastructure co-contributions

 

 

 

The cost and availability of finance for developers. If credit is limited and difficult to obtain, a smaller number of projects will get off the ground, typically by more substantial, corporate developers.

 

 

 

Builder expectations, confidence and perceptions of buyer demand influence their willingness to take risks and enter the market.

 

 

 

The property cycle is divided into 4 phases:

 

 

 

 

 

 

 

 

 

 

 

 

Drivers of Demand and Supply Constraints

Demand and supply

 

in the property market

 

are subject to a range

of factors

 

 

 

If you have ever been to a fresh food market, especially at the end of the day, you have seen the free enterprise market dynamic first hand.

Prices are determined by the supply of fresh fruit and vegetables and the demand for them. If demand is low, stocks sit on the shelves, if supply is low perhaps due to adverse weather events, then prices rise, and of course, the opposite is true.

Surplus perishable items or less popular items will come down in price at the end of the day.

To understand the property market is no different; we need to examine the interaction of the demand side drivers and also the constraints on the supply of housing and how they influence prices.

DEMAND SIDE DRIVERS:

POPULATION GROWTH – Australia’s population grew by 1.6 per cent in the year ending 30 September 2018, reaching 25.1 million, according to the latest figures released by the Australian Bureau of Statistics.

As of June 2020, our population is estimated to be 25.71 million.

The population counter ticks over by one person every 1 minute and 28 seconds, on the assumption that there is one baby born every 1 minute and 44 seconds, one person dies every 3 mins and 11 seconds, one person arrives every minute, and 1 leaves our shores every 1 minute and 44 seconds.

POPULATION GROWTH = BIRTHS minus DEATHS minus NET MIGRATION

ABS Live Population Clock

 

 

Net overseas migration added 240,100 people to the population and accounted for 61 per cent of Australia’s total population growth. Natural increase contributed 155,000 additional people to Australia’s population, which was the result of 312,600 births and 157,600 deaths.

Australia’s population to reach 30 million in 9 to 13 years

Based on current trends, Australia’s population is forecasted to reach 30 million people between 2029 and 2033, according to the latest figures released by the Australian Bureau of Statistics (ABS). Population projections are based on assumptions of future levels of fertility, life expectancy and migration, which are guided by recent population trends.

Three series of projections (series A, B and C) have been selected from a possible 72 individual combinations of the various assumptions.

Series B primarily reflects current trends in fertility, life expectancy at birth and migration. In contrast, series A and C are based on higher and lower assumptions for each of these variables, respectively.

STATES: Under all theories, the population of New South Wales is expected to remain the largest with a tally of between approximately 9 and 9.3 million.

Victoria will experience the most significant and fastest increase in population; possibly reaching between 7 and 8 million by 2027.

Queensland’s will continue growing over the forecast period, increasing to 6 million people in 2027.

Western Australia is predicted to increase to 3 million by 2027, while South Australia will see slower growth, to reach 2 million.

And, 67% of Australians live in and around capital cities, and this is anticipated to rise to around 70% in the next few years.

CITIES:

Melbourne is predicted to be the largest city in Australia by 2066 with a forecasted population between 12.2 million and 8.6 million, surpassing Sydney in 2031.

Brisbane will grow in size with an increase from 49% of Queensland’s population to 51% in 2027, becoming the majority part of Queensland’s population.

The population of the Australian Capital Territory is set to increase to between 479,000 and 510,000 people closing the gap on Tasmania’s population, which is calculated to reach between 545,000 and 573,000 people in 2027.

The Northern Territory is expected to increase to between 270,000 and 284,000 people in 2027.

The demand for housing is a product of its necessity and the population size and forecast growth.

It’s also influenced by government policy, incentives, consumer confidence and unfortunately, at times, the media!

 

NET MIGRATION – Australia is a culturally diverse nation – over 200 different nationalities go into the mix with 25% identified as overseas-born on the last Census night. Migration continues to be a significant factor in the growth of our population and workforce. While exhibiting a pattern of variability over time, net overseas migration has remained above 180,000 people since 2006. In the year ending 30 June 2018, there was a net gain from overseas migration of 237,200 people.

“More people are deciding to call Australia home – if not permanently, at least for longer than a year. The lift in permanent and long-term arrivals reflects a perception of Australia as a great place to live and work – a country with a high standard of living and great opportunities….the annual total of 844,800 is also a record high and up 11.4 per cent on a year ago – the strongest growth in 20 months” (Commsec Eco Insights April 2019)

 

At the moment, the pace of population growth from migration is low due to our closed borders. An interesting perspective is that because of our very successful response to COVID-19 and the likelihood of us emerging out of the pandemic restrictions ahead of the rest of the world, Australia is going to be a very attractive option for future immigrants. The effect on our future population totals may be even more pronounced than previously anticipated.

 

 

 

OTHER DRIVERS

DEMOGRAPHIC CHANGES – There are approximately 10 million households in Australia presently. Demographic changes such as the size of those households and the divorce rate influence not only the number but type and size of housing that is being demanded. Single-person households are a growing segment of the population that increases the demand for smaller, higher density accommodation types. The growth in multi-family housing patterns may mean that designs need to change to accommodate the desire for separation and privacy. This segment would also include the ‘boomerang’ generation of young adults who keep coming back and the ones who won’t leave!

MAJOR INFRASTRUCTURE PROJECTS – “More than $123 billion of construction work has commenced since 2015, with a committed forward pipeline of more than $200 billion aiming to build for a population projected to grow by 24 per cent to 31.4 million by 2034″.

 

 

 

Major Infrastructure Projects Kicking Off Development

 

 

 

AFFORDABILITY – many factors will influence a buyer’s perception of affordability. As incomes rise, purchasers are in a more favourable and confident position to be able to service the debt that is usually incurred to buy a large ticket item like a house. In turn, incomes will be a function of ECONOMIC GROWTH and therefore, employment.

INTEREST RATES are the cost of that credit, and therefore as they fall, the affordability factor increases. Similarly, even if demand is present for housing, the AVAILABILITY OF CREDIT will act to dampen demand if lenders tighten their lending criteria. Sometimes this is to ‘balance’ their loan books or is in compliance with the prudential regulator’s (RBA & APRA) directives, whose mandate it is to moderate excesses in the market (business cycle)

“The Australian Prudential Regulation Authority (APRA) is an independent statutory authority that supervises institutions across banking, insurance and superannuation and promotes financial system stability in Australia”. www.apra.gov.au

Remember that economics is a social science because it studies human behaviour. To build models of the economy and predict outcomes, economists have to make assumptions about human behaviour and, by and large, have to work on the basis that consumers are rational. Psychologists would beg to differ!

Attitudes, perceptions and CONFIDENCE are important drivers (or inhibitors) of demand. When the economy is thriving, and the news is good, consumers are buoyed and optimistic about the future, and the reverse is also true. The media plays a role in shaping consumer outlook and confidence, and unfortunately, bad news and sensationalism sell!  The first diagram below is a simple representation of the property market. As prices rise for houses less are demanded, and more is supplied and vice versa.

At P1 Demand for homes equals the Supply of dwellings.

The positive drivers of demand ( increased population growth and net migration, buoyant economic conditions, low unemployment, rising incomes, relaxed credit conditions, higher consumer confidence, consumer expectations) can

SHIFT the DEMAND CURVE to the RIGHT, as shown in the second diagram. 

Assuming SUPPLY cannot be expanded easily or without significant time delays, the result is a

HIGHER EQUILIBRIUM PRICE, or a rise in house prices,  P2

 

SUPPLY SIDE CONSTRAINTS

The supply of housing is the sum of the existing stock plus the level of new construction.

According to a recent report by ANZ, Australia’s housing shortage stands at 250,000 currently, due in large part to the fact that the population projections we thought would take 40 years to reach have been exceeded in the last 16!

https://bluenotes.anz.com/posts/2018/08/The-25-million-person-housing-problem 

 

 

 

 

In a perfectly operating market, supply would simply shift out to the right to meet the excess demand, and all will be in equilibrium again! But we don’t live in a perfect world! The ‘elasticity’ or responsiveness of supply has STRUCTURAL impediments that are hard to change in the short term, including:

LIMITED LAND – remember the definition of resources, they need to be known, accessible and cost-effective. Given most of us ( 67%, expected to reach 70% within a few years) want to live in the metropolitan areas of the capital cities, land releases are LIMITED.

COMPLEXITY of the PLANNING APPROVAL PROCESS – this ties in with the first constraint. The rezoning of land for residential construction is a long-winded and complicated task hamstrung by red tape and bureaucracy.

INFRASTRUCTURE PROVISION – “Investment in economic infrastructure (such as telecommunications and transport networks) and social infrastructure (for example, schools, hospitals and public housing) has a major bearing on the community’s well being” (Commonwealth Government of Australia Parliamentary Research Paper 2014)

Releasing land without the provision of infrastructure is a recipe for disaster both economically (employment opportunities, shops to spend in, transport to get to employment hubs, childcare to make work possible etc.) and socially ( lack of recreation facilities leads to youth crime etc.). Infrastructure is by, and large, ‘big ticket’ items and so given the competing demands on budget resources, opportunity costs and trade-offs, the provision of infrastructure is not easy or unlimited.

INFRASTRUCTURE LEVIES – these are high costs imposed on developers by the government, so they co-contribute to the provision of local infrastructure. Contributions are made per lot for the supply of power and water, kerbing and guttering, street lights, roads, and sometimes upgrading of feeder roads and the installation of traffic lights. Every parcel of land will have built into it a cost component for these co-contributions.