Following a 25% surge in house prices in 2021, Australia’s property market appears to be slowing down, with several economists predicting significant price drops and even a potential market crash.

The sentiment surrounding house prices has shifted noticeably in recent weeks. Many are growing increasingly apprehensive about the trajectory of the Australian property market in 2022-2023, with looming concerns about a possible market downturn.

Property Market Crash From Another Outlook

Diverging from the typical news headlines, this article aims to provide a fresh perspective on the looming topic of a property market crash. Rather than simply reiterating the news, I’ll delve into the foundational principles governing any market: demand and supply. By the end of this piece, you should be equipped with the insight to form your own opinion on whether we’re on the brink of a market crash.

To set the stage, let’s first recap what’s predominantly being reported in the media.

Australia’s colossal residential property market, valued at $10 trillion, is bracing for its most pronounced interest rate hikes since 1989. After over a decade, the Reserve Bank of Australia (RBA) has embarked on its tightening journey. This move is beginning to unnerve consumers, many of whom are grappling with some of the highest debt burdens globally.

Consequently, Australia’s two major and notoriously costly housing markets – Sydney and Melbourne – have already entered a phase of adjustment. This shift has prompted some economists to interpret it as the initial signs of a property market crash. Diana Mousina, a senior economist at AMP Capital Markets, has projected that “Sydney and Melbourne could experience a decline of up to 20%.”

Moreover, data from CoreLogic’s home value index reveals that Australia’s priciest cities, namely Sydney, Canberra, and Melbourne, are at the forefront of this downturn.

Shane Oliver, Chief Economist at AMP Capital, has voiced concerns that the rate hike will severely dent consumer confidence. Particularly vulnerable are recent borrowers saddled with substantial debt, who might soon find themselves in a situation where they owe more than the value of their homes. Such borrowers might also encounter challenges in meeting their mortgage commitments, potentially pushing them into mortgage stress in the upcoming months.

Tim Lawless, CoreLogic’s Research Director, echoed these sentiments, stating that the unexpected magnitude of the rate increase could potentially suppress demand and housing activity even further. He noted, “Furthermore, rising interest rates will diminish borrowing power, influencing serviceability evaluations for potential borrowers, which could dampen housing demand.”

As a result, first-time homebuyers operating on tighter budgets may need to reconsider their approach to avoid common pitfalls.

In essence, the collective insights point to a straightforward prediction: due to the climbing interest rates, property prices could plunge by up to 20% in the coming year, especially in the country’s major urban centres.

Property Market Crash – Not All Markets Are The Same

But it’s worth mentioning that there are markets within markets, and we aren’t going to see a property market crash in all of them. There isn’t one “Melbourne property market” or one “Sydney property market”. There are houses, apartments, townhouses, and villa units located in the outer suburbs, middle ring suburbs, inner suburbs, and in the CBD.

And they’re all behaving differently.

While the “average” price fall prediction is 20%, prices of some properties might drop only 5-10% or even 25%, and some properties could even see a price rise. For instance, at the time of writing this article, prices in Melbourne and Sydney are falling, but Adelaide and Brisbane prices are on the upswing. Interest rates have risen across all states, yet their effects vary. Why?

Thus, it’s crucial to delve deeper than merely relying on the information presented in the news. By doing so, we can grasp the underlying factors that influence property prices.

From there, you can gauge whether a property market crash is imminent and subsequently decide your next steps: whether to sell, buy, hold, or simply observe.

We must understand that all these predictions concern AVERAGES. However, a savvy investor never places complete trust in these general figures. While there might be risks in specific suburbs or types of properties, opportunities abound in other market segments – be it in pockets, suburbs, or states.

Let’s dive in.

Demand & Supply Principle

The law of supply and demand is a foundational economic principle. It delineates the interplay between the supply of and demand for a product or service, and this interaction’s effect on its price.

When a particular product or service is in high demand, its price tends to go up. This is a result of the principle of scarcity; when an item is scarce relative to its demand, individuals are willing to pay more, hence driving the price upwards.

Conversely, if there’s an abundance of a product or service but not enough demand for it, its price typically drops. This is because, with an oversupply, items remain unsold, leading to a decrease in their perceived value and therefore their price.

Using the above understanding of supply and demand, if we can pinpoint the factors that boost or diminish the demand and those that amplify or curtail the supply of properties, we’d be in a position to “forecast” future property prices. It’s crucial to reiterate that these influencing factors can differ across markets. For an accurate prediction, it’s essential to closely study and understand the specifics of the market you’re interested in.

Factors Affecting Property Prices & Property Market Crash

In order to analyse these factors, I am using the PESTLE framework.

A PESTLE analysis is a well-known framework that studies the key external factors that influence demand and supply. These factors are: Political, Economic, Sociological, Technological, Legal, and Environmental.

Let’s have a look at each factor:

Political:

Governments have the ability to decrease or boost demand since they can make substantial alterations to regulations and laws governing the property market.

The implementation of higher or lower stamp duty, land tax, Capital Gains Tax, etc., can either diminish or amplify demand.

In general terms, higher taxes tend to decrease demand, as they directly impact affordability.

Conversely, any program, grant, or concession that facilitates property acquisition will augment demand, at least in the immediate future.

Nevertheless, in the long run, these forms of government support can propel prices upwards, leading to affordability concerns and subsequently reduced demand over time.

Economic factors:

Inflation and currency value play a significant role in this context. With inflation growing at its fastest pace in 20 years, Reserve Banks worldwide must employ interest rates as a tool to manage escalating costs.

Put simply, a higher interest rate translates to less money in consumers’ pockets by day’s end. Reduced disposable income diminishes demand as people buy less due to affordability concerns. Decreased purchasing leads to lower prices and subsequently reduces inflation.

Inflation holds a pivotal role in the economy, given its impact on currency value, the cost of living, and consumer confidence. Therefore, central banks worldwide take inflation management seriously, often resorting to interest rate adjustments.

Several factors contribute to elevated inflation, including a high savings rate, impulsive spending habits, labor and materials shortages, rising wages, global supply chain disruptions, fuel crises, and political instability. All of these elements have a profound effect on both businesses and individuals’ financial circumstances.

Presently, there is an unprecedentedly low unemployment rate, with job opportunities readily available to those seeking employment. However, many businesses are grappling with survival as the costs of materials and labor continue to escalate, and passing these additional expenses on to customers is often unfeasible.

This challenging situation has had a profound impact on industries like construction, leading to the closure of numerous construction companies. Even major corporations such as Probuild and Condev, employing hundreds of individuals, suppliers, and subcontractors, entered administration in early 2022.

As more businesses face insolvency, job losses rise, resulting in reduced demand due to financial stress. Additionally, heightened unemployment rates contribute to a surge in loan defaults and forced property sales.

Conversely, individuals could be adversely affected by job redundancies, mortgage-related stress, affordability challenges, and reduced access to credit.

Furthermore, while interest rates may return to levels seen a couple of years ago when borrowers could manage, the total loan amounts people currently hold are significantly higher than a few years ago, primarily due to a 25% increase in property prices since 2021. Essentially, a 4% interest rate on a $1 million loan is less burdensome than a 4% rate on a $1.25 million loan. This situation has resulted in mortgage stress for numerous homeowners and investors.

These factors predominantly impact the demand side, but it’s also crucial to consider the supply side.

Some property owners and investors may also experience mortgage stress and be compelled to sell their properties. Forced selling can result in a surplus of supply when demand is minimal, leading to significant price drops. While it’s a challenging situation for sellers, it presents excellent opportunities for investors and homebuyers with sufficient cash and credit.

Diminished demand for property purchases places additional pressure on the rental market, consequently driving up rental prices. This presents an enticing opportunity for astute investors to acquire properties at lower purchase prices while yielding higher returns. These elevated returns on investment pique the interest of investors, ultimately leading to heightened competition for properties with substantial return potential, which can, in turn, exert upward pressure on prices.

Social factors:

Buyers’ confidence has markedly declined due to the rate hikes by the Reserve Bank of Australia (RBA), and this trend is already reflected in property prices. The “fear of missing out” (FOMO) that was prevalent in 2021 when prices were rapidly rising has waned. These factors collectively contribute to a diminished demand.

Conversely, population growth driven by immigration, whether it’s from one Australian state to another or from other countries to Australia, is poised to boost demand, particularly in the rental markets, in the short term.

Technological:

The absence of domestic production, coupled with a heavy reliance on imports, has compounded issues surrounding material shortages and global supply chain disruptions, particularly affecting construction materials. Elevated construction costs have subsequently led to affordability challenges, which, in the long term, can contribute to reduced property prices as demand decreases.

Furthermore, protracted delays, costly site-related expenses, and a high rate of insolvencies in the construction sector, particularly in the residential segment, have significantly eroded home builders’ confidence. This has resulted in decreased demand for new construction projects and increased interest in existing properties (building vs. buying in 2022).

However, if population growth surpasses the rate of housing supply, property prices are poised to rise.

Environmental:

Floods and bushfires not only result in increased construction and insurance costs but also influence people’s decisions to purchase or relocate to suburbs with reduced or no risks of these natural disasters. These events can have a significant impact on property demand and preferences, leading individuals to seek safer areas.

Legal:

Some builders may resort to cost-cutting measures to mitigate the rising expenses within their fixed contracts, aiming to avert insolvency. In simpler terms, this could result in higher defects and more challenges for new home builders when their projects are completed.

Typically, builders may exhibit reluctance to promptly address issues (or may not address them at all). Furthermore, the resolution process can be protracted and stressful, potentially leading to legal disputes.

These factors collectively contribute to reduced demand for the construction of new houses. Consequently, while it may decrease the cost of new construction, it can place upward pressure on the prices of existing houses.

Summary!

I’m glad you’re still here after all these boring (but super important) economics lessons!

I have written this article to show that interest rate is not the only factor that affects property prices, and if you understand how demand and supply work, you will be able to find great investment opportunities. It is always a good time to buy if you know what you are doing! But you need to invest in your knowledge and skills first. As Robert Kiyosaki always says, investing is not risky; the investor is risky!

So, in summary, follow these steps before doing anything in the property market, and hopefully, you will find good deals.

Four Steps Before Decision Making

First step: Pick your market (state, suburb, pocket) and start your due diligence for that PARTICULAR MARKET. Don’t focus on “average” data for a state or suburb as there are markets within markets, and they are not the same.

Second step: Understand all factors that impact demand in that market.

Third step: Understand all factors that impact supply in that market.

Fourth step: Based on your objective (whether you are deciding to buy, sell, hold, etc.), analyse if supply/demand is on your side in that market in the short term and long term, and decide what is right for you.

A key point to remember here is that sophisticated investors don’t buy at the market peak or when the market is hot. They SELL when the market is at its peak (based on their prediction) and find great opportunities when the market is at its bottom (again based on their prediction) or when it is still falling.

Accordingly, adjust your strategy in a way that suits your market conditions and train yourself to see opportunities in hard times.

Leave your thoughts in the comment section and let us know how you see the property market outlook in 2022 or how you are going to react in this market. Are you going to buy, sell, hold, or wait and see?

Good luck!

Amir Sehat

Disclaimer: The information provided in this article/website is of a general nature and is not intended to influence readers’ decisions regarding investing or financial products. Readers should always seek their own professional advice, considering their individual circumstances, before making any financial decisions.