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September 15, 2015

What are the worst performing properties when a correction hits our biggest cities?

Property prices in our two biggest cities have enjoyed some solid to excellent price growth over the past couple of years.

Sydney has been a standout with the combination of low interest rates, improving economic performance, positive consumer sentiment and confidence, a strong jobs market, population growth and a long period of soft property prices resulting in a property price boom. Melbourne, on the other hand, has been a consistent performer since the turn of the millennium.

But what happens when the current cycle slows and the market finishes this current uplift? Which properties will fare better than others in terms of value corrections?

Having analysed the property market over numerous property cycles now, I’ve seen the property values move through their cycles and I’ve seen many a market in a boom and plenty go bust along the way. It’s the natural cycle in any supply and demand-driven economy. When your goods are in high demand the value increases; when that demand decreases prices are affected.

In terms of pending correction, it’s never easy to know exactly when it will happen or the severity of it. Will it be a bust or just a softening? Will it be market-wide or just some pockets or types of properties? This will all depend on the broader economic market. If we head into a recession and it affects jobs and unemployment right across a city, then it’s likely that the whole market will correct, as would be the case if another global outbreak of economic instability occurred. But I’m not seeing either of these events as an immediate threat to property values.

The more immediate threats are:

Rising interest rates. We’re at record low interest rates and when money is cheap to access, asset appreciation often occurs, as we believe we can afford the repayments at these lower levels.

Consumer sentiment/confidence. Of late there’s been a FOMO (fear of missing out) mentality among buyers, all concerned they’ll be priced out of the market, which has resulted in too many buyers digging deep into their last pennies to secure a property.

Bryce Holdaway

Bryce Holdaway

Supply improvements. In slow markets it’s not easy for a property development to get off the ground, whether it’s a new subdivision or a unit complex. Getting funding post-GFC has been a challenge, with banks wanting to see a lot of pre-sales beforehand to give them enough confidence in getting their money back once the development is completed. When markets are hot, the pre-sales of land and also off-the-plan units are a lot easier, which means supply does improve. However, the risk here is that many projects and subdivisions get the baseline support they need to get off the ground, but then take about two years to actually be built, so the supply floods the market at the latter stages of the uplift cycle and causes more pain in some areas as an oversupply of property is then evident.

So, what are the property types most at risk of losing value when the property cycle moves to a correction phase? The science is never exact, but I’m confident that history will repeat itself and if it does there are two types of property that I wouldn’t want in my portfolio:

Off-the-plan/multi-unit/apartment properties. You always take a risk when buying these types of properties, because you’re betting on them being worth what they were sold to you for, usually around one to two years before they’re actually completed. However, your price risk intensifies when the market is hot, because if the market demand softens, just when all the supply comes online, then the risk of the property being undervalued is great and there’s no easier property type to bring to market en mass in large numbers than these types of units/apartments. Anyone speculating on this type of accommodation could be in for a real shock to their financial position if tens of thousands or, in extreme cases, hundreds of thousands of dollars are wiped off the value of their property when it’s finally built. With so many others in a similar position and so much stock available for sale at the same time, deciding what to do next is going to be very tough.

New house and land subdivisions. Human nature says we want the best for ourselves and our families (and our house says a lot about us), so it’s no wonder that when most Australians go house shopping we end up justifying spending as much as we can, which works perfectly into the sales process of those selling the land and building the properties. With 70 per cent of all property sold to owner-occupiers, the underlying value of property is controlled by this market, yet if they overspend and get themselves into financial difficulty and become forced sellers just as more land is being released and houses completed, it’s a perfect storm for property values in these areas to fall. How far they fall will be the result of how many people over-extend themselves, their job security, how quickly and by how much interest rates rise and finally the level of supply at that time. Investors who’ve bought into the house and land story without doing their homework will suffer losses and only time will tell how much these losses will amount to.

While it’s true that too many Australians think property’s a sure investment bet, on the whole investing in residential property can be an excellent way to improve your financial position. However, there are risks and knowing what to buy, where to buy and when to buy are all important considerations when investing such a significant amount of money.

If you’re new to property investing and you managed to read to this point, you’ve just “dodged a bullet”. If you’re thinking of investing or you’re an investor already and are keen to take another step on building out your property portfolio, then my greatest advice is to get educated, do your research or get some professional assistance, as your financial future is on the line.

About Bryce Holdaway

Bryce Holdaway is partner of Empower Wealth, which is a specialist property investment advisory firm, as well as co-host of Location Location Location Australia on Foxtel’s The Lifestyle Channel.