The easy money era in property is over

For most of the last 20 years, investing in property hasn’t been rocket science. Prices have generally risen, even when dire predictions of major price falls due to Covid were considered fait accompli.

Steadfastly, stubbornly our housing prices kept climbing, to the point we now - relative to incomes – have some of the most expensive real estate in the world.  

That confidence underwrote a lot of very average decisions by homebuyers and investors, who rode price gains to cover up fundamental flaws in their investment strategy.

That may be about to change, to the extent that ‘average’ will no longer get people through. Savvy investors and home buyers will still find opportunities, but I suspect a combination of multiple factors – self-inflicted and external – will mean that many others will find themselves going backwards if they apply BAU (business as usual) thinking.

Consider the future landscape: consumer confidence (measured by ANZ-Roy Morgan) just reached the lowest point since 1973 when records started. We are now in a rising interest rates cycle (which only six months ago looked very benign).

Fuel prices – thanks to the war on Iran – have shot up at the bowser to previously unthinkable levels. Some are even unable to access fuel at any price. This is flowing through to everything – from plastic piping (made from oil) to farmers getting crops moved, to transport companies who fill supermarket shelves. Nothing will be untouched – meaning inflationary pressure and more upward pressure on interest rates.

Electricity prices are also rising well beyond inflation: the cost of transition to renewables was massively underestimated, and those costs are being passed to already stressed household budgets.

They are also impacting a wide cross section of businesses that rely on electricity – from your local barista to the baker who makes your bread, to manufacturers, recyclers, and many others. No business is immune.

Then there’s the impact of artificial intelligence (AI).

Economy-wide job losses are already being felt in tech and white collar administrative and service sectors. This is just the beginning of what will surely play out as a long term change in the nature of employment.

The once celebrated ‘knowledge worker’ may find their knowledge is easily replaced by AI, which works faster, 24 hours a day, doesn’t need an office, and certainly needs no parental leave, sick leave, annual leave or compassionate leave. Some estimates suggest more than 40 per cent of Australia’s administrative and support service roles could be replaced by AI by 2030. That’s just four years away.

The net result of all this? Consumer confidence is falling, and household budgets are under duress: consumers will stop spending, but the inflationary pressures baked into our economy (fuel and energy in particular, plus the high costs of housing) will mean little relief because interest rates will stay high.

Property prices won’t rise forever

This is not the landscape where property buyers should bank on prices rising forever.

Here’s a simple hypothetical to illustrate the point.

Let’s say a couple bought a property three or four years ago for $500,000. They had a deposit of say $75,000 and a loan of $425,000, which at 5.5 per cent meant repayments of around $2,414 a month. Life’s been good these last few years – employment certainty, a reasonable economy, growing demand for many things. Their property is now worth $725,000. Their loan is still $425,000 (nothing of the principal is repaid in the early stages of a loan), but their equity (their former deposit) is now worth $300,000. Happy days! Their original $75,000 is now worth $300,000 – quadruple the original amount they had saved!

Emboldened and confident, our couple decide they need a bigger property. They pay $1,200,000 and can deposit $263,750 (which is their equity of $300,000 less an allowance of 5 per cent for selling costs, taxes, legals etc on their previous home). Their loan is therefore $986,250. Let’s now say their loan rises to 6.5 per cent which is $6,244 a month – an extra $3,830 each month they need to find.

They’re OK with this though, and go without some holidays and other things to meet their repayments.

But one partner worked for a high-end tech company in new CBD headquarters, and gets made redundant. High tech companies aren’t hiring – thanks to AI – so finding a new job isn’t easy. This, plus general cost of living pressures and the prospect of even higher interest rates means our couple decides to sell.

But it seems they’re not the only ones selling. There are more sellers than buyers, and what buyers there are, are careful. No crazy bids. Strict budgets.

Our couple’s property for which they paid $1.2m for a couple of years earlier now sells for $1.1m.  That doesn’t sound like a huge deal, but look what it’s done to their equity – the ONLY thing that matters from an investment point of view.

The $1.1m sale, less say 5 per cent selling costs, and less their loan which is still $986,250, leaves them with equity of $58,750.

The $300,000 equity they had is now worth less than $60,000 – one fifth of what they had. It’s even less than the deposit they started with years earlier.

Now these are obviously just very general numbers, but are today’s risk-oblivious buyers doing calculations like this? What of the people who bought on just 5 per cent deposits under the Albanese Government’s new home buyer initiative?

The point being, the investment climate has changed but many people’s attitudes haven’t adjusted to a new reality.

There will still be good buying (and sometimes, even better buying when everyone is selling) but judicious assessment of the risks, critical judgement of the asset and future potential, and maintaining control of debt will separate the winners from the losers.

The best that informed readers of API Magazine can do is encourage their kids, friends or family to swap the rose coloured glasses for some reading glasses and pay close attention to details and future risk scenarios. Average strategy just won’t cut it.