It is true that buying a property in any market will generate a lot of wealth as long as you (1) buy the right property and (2) hold it for a few decades. But it is also true that you do not need to rush into the market at the risk of substantially overpaying.
My wife and I planned to buy an investment property this year so we have been monitoring the property market a bit closer than usual this year. Of course, we expect to pay fair market value for a high-quality asset (quality assets rarely sell for less). But we have no interest in overpaying. We are happy to wait on the sidelines until we are able to buy an investment-grade property for a fair price.
What we have noticed this year is that materially overpaying is almost the only way to successfully purchase a property i.e. by a lot more than 10%! I wanted to discuss (speculate) why this might be happening and counsel property buyers to be patient and diligent.
Is demand greater than supply?
It was my initial hypothesis that a lack of supply was responsible for driving property prices higher. That is, that the volume of property buyers exceeds the volume of properties available for sale.
The graphic below include property listing charts for a selection of locations from the beginning of 2010 to date. You will note that property listings in some locations are well below trend, particularly coastal regions. This supports my theory that tight supply is pushing prices higher. However, as you will observe, there are some locations where listing volumes appear to be normal.
Of course, we must remind ourselves that listing volumes (supply) is only one half of the equation. Demand is the other half. It could be that whilst supply is normal, demand could be above average.
Demand is very high
Probably the best indicator for demand is the volume of new mortgages, as depicted in the chart below from the ABS.
The average monthly volume of home loans between 2015 and 2020 was $13.4 billion. This year, the average monthly volume has increased by a whopping 66% to $22.2 billion. By comparison, investor loans have increased by just over 9%. I think we can conclude that demand for property is substantially above average.
As such, whilst supply (listings) is normal in some locations, there’s not enough property for sale to satisfy the strong level of demand and as a result, prices are rising.
Why is demand so high?
Many Australians, particularly higher income earners, are spending less and saving more due to the impact of Covid. This is reflected in the household savings ratio which is at the highest level since the data series began in 1973! This relative improvement in household financial strength might be encouraging more homeowners to spend more money on their home e.g. upgrade or renovate.
Historically low interest rates have almost certainly also contributed to demand. With home loan fixed rates under 2% p.a., money is very cheap!
But why are some people willing to overpay?
We must remind ourselves that property buyers are motivated by different things. The ‘price versus value’ deliberation is not always the most important consideration.
Someone might be prepared to “overpay” for a property for several reasons, including:
- Their assessment of a property’s fair market value is different to yours. Property valuations can be highly subjective. So, it’s possible that you have undervalued a property.
- The property might have a special value. For example, the purchaser might already own the property next door, they might be buying it so that their family can live in close proximity, they might need to buy a property prior to a particular date and so on.
- They might be very wealthy and take a very long term approach. For example, they might think that overpaying by a few hundred thousand dollars is largely inconsequential if they plan to hold the property for 30+ years, particularly whilst money is so cheap.
- They might be driven by FOMO and worry that if they don’t buy now, they’ll have to pay a lot more later.
There might be lots of reasons that someone is prepared to overpay for a property. But that doesn’t mean you have to join them.
Why buying now might be the wrong thing to do
The irrefutable laws of economics dictate that higher property prices will eventually lead to more listings (supply).
And an increase in the volume of listings will satisfy demand and create a more balanced market. Buyers will have more choice and as such there’s less pressure to overpay.
Having witnessed a number of over-exuberant property markets over the past couple of decades, I know too well that it is entirely possible that a higher volume of listings could lead to a small correction. That is, prices for comparable properties can easily come back by 5% to 10%.
In my view, the balance of probabilities is that waiting a few months for a higher level of supply means you will either have to pay the same price as today, or possibly less. But I consider it to be unlikely that you will have to pay more.
What am I going to do (and what I’m advising my clients to do)?
My wife and I continue to monitor the property market and look for quality investment opportunities. We are prepared to buy an investment-grade property and pay a fair market value whenever it arises. But we suspect this may not happen this year. We are not in any rush.
I am advising my clients to do the same. That is, to employ a reputable buyers’ agent to diligently scour the market for quality investment-grade properties without a particular deadline. Do not expect to get a high-quality asset for a bargain price. But, by the same token, it is unnecessary to overpay or compromise on asset quality.
Be careful out there.
