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Now is a great time to buy property. Here’s why…

property buy now

In mid-2021, I wrote this blog: “Don’t buy a property in this market…” because, at that time, many property buyers were over-paying for property just to get into the market. I call it the FOMO premium, for lack of a better term (more about this below). My thesis was that since it’s never wise to allow fear (e.g., FOMO) to influence financial decision making, it was better to not buy property in 2021 if it meant having to overpay.

We all know that the market has cooled somewhat this year. It is now my view that this is a much better market to buy in, if you can find the right asset, of course.

What drove the property boom in 2020 and 2021?

The median house price in the eastern capital cities grew by between 12% and 16% p.a. compounding over the 3 years ended March 2021. I believe this growth was driven by two predominant factors:

  1. Long-horizon mean reversion; and
  2. FOMO premium.

The market was mostly making up for lost ground

The chart below illustrates the historic compounding capital growth of the median house price in Melbourne, Sydney and Brisbane for the periods ending March 2022. The “long-term” figures reflect growth over the past 42 years i.e., 1980 to 2022.

Whilst recent growth in property prices was well above the long-term average and therefore unsustainable, longer-term growth rates are still below the long-term averages with only two exceptions:

  1. Sydney’s growth rate over the past 10 years exceeds the long-term average by 1.60% p.a. However, growth over 15 years is in line with the long-term average. Therefore, it’s possible that Sydney prices have over-corrected over recent years and could enter into a flatter cycle for the few years; and
  2. Brisbane’s growth rate over the past 5 years has exceeded its long-term average. It is noteworthy however that growth over 10 and 15 years is still below average, so this market is probably still undervalued and could continue to grow strongly to revert to its mean.  

This updated chart demonstrates that property markets tend to move in two distinct cycles: a flat cycle followed by a growth cycle. To a large extent, this is what happened in Melbourne and Sydney after posting house price declines over the 3 years prior to the beginning of Covid. As demonstrated, the 5-year growth is still below average.

The FOMO premium

Australia’s reaction to Covid throughout 2020 and 2021 fueled demand for property:

  • The cash rate was ostensibly cut to zero. The RBA lent cheap money to the banks which they used to fund very low fixed rate loans, often at rates below 2% p.a.
  • Higher income earners were able to preserve their incomes because their occupations were able to be conducted from home, unlike lower-income earners that worked in retail, hospitality and travel, for example.
  • Due to the lockdowns, higher-income-earners spent less and saved more – they enjoyed much larger levels of surplus cash flow.
  • And finally, people were spending more time at home which invited them to reflect on whether their home adequately suited their lifestyle needs.

These factors conspired to create a lot of demand for property, particularly from higher income earners who considered upgrading their home (i.e., demand was mainly fueled by owner-occupiers, not investors).

In early 2021, the common buyer sentiment tended to be, “low interest rates will drive property values higher so we must hurry to buy now before it’s too late”. As such, buyers were willing to pay a premium to successfully purchase a property thinking that it’s better to pay a bit more now, than a lot more later. This is what I’m calling the “FOMO premium”.

The FOMO premium was temporary, of course, and disappeared towards the end of last year.

Buying when conventional wisdom suggests otherwise is often challenging

The best time to buy an asset class is when its unpopular to do so, because it means there’s less competition from other buyers. This gives you more time to complete any due diligence (less pressure) and less competition means that the risk of overpaying for property is greatly reduced.

Unfortunately, human beings are often influenced by social proof. That is, observing other people doing what we plan to do gives us confidence that it’s the right thing to do. We are hardwired to follow the pack. That is why it feels unnatural to do the opposite.

At the moment, property market sentiment is quite negative. Also, many economists are predicting that property prices will fall by around 15%. Therefore, the conventional wisdom is that it’s not a good time to buy.

But I want to delay purchasing in case prices fall further…

I’m a presenting a case (above) that the price rises over the past two years were mainly driven by mean reversion, which is fundamentally sound and sustainable. Property prices were making up for lost ground and not getting into bubble territory. The FOMO premium also contributed a small amount towards this growth, which has since evaporated, so prices might retreat by 4%-6%, but price falls of 15%+ are very unlikely (statistically, the probability of that occurring is about 2%-3%).

Most importantly, no one can tell what the market will do in the short run. Statistically, it’s more likely that prices will fall a little, but not a lot. Waiting has risks too because large price drops may not eventuate, so you’ll miss opportunities.

Secondly, investment-grade assets rarely sell at bargain prices. Auction clearance rates are in the low-to-mid 50%’s which suggests it’s a buyers’ market. However, I have attended a few auctions of investment-grade properties in recent weeks and very good results were achieved. Quality property assets will almost always out-perform the general market so if you want a good quality asset, you must be prepared to pay fair value in any market.

Finally, I’d much rather buy a wonderful property at a fair price than a fair property that at a wonderful price. So, if you’re getting a bargain, you must ask why? It could be that it’s a compromised asset and won’t make a good long-term investment. Or you could be lucky.

Stock levels will be the main challenge

Pete Wargent notes (in his blog) that CoreLogic highlighted that total property listings are 27% below their 5-year average.

I think it is likely that listings will fall further because higher interest rates and inflation readings will fuel more bad news in the media, which will deteriorate consumer and property sentiment. Therefore, unless owners are obligated to sell their property this year, it’s likely that most owners will postpone selling until market sentiment recovers. There might be some motivated sellers (due to financial hardship), but these are unlikely to be in investment-grade locations.

Fewer listings will make it challenging to find an investment-grade asset and I see this as the main challenge. There’s not much you can do about that other than have patience.

Doing the opposite

Investing is a little like parenting in that if you feel good while doing it, then you are probably not doing it right. Doing things such as investing in undervalued assets, bucking conventional wisdom and so on all feel uncomfortable. But that discomfort is often a good sign that you’re making the right decision.

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