Update: Since writing this blog the government has announced that it will abolish ‘responsible lending’ rules in March 2021 which means lenders may no longer have to review borrowers living expenses. This change will increase borrowing capacity and increase the supply of new loans. And this will stimulate the property market in 2021 which will fuel prices increases. (See this article in The Australian for more)
In May, I wrote a blog after CBA released its bearish ‘worst case’ forecast for the property market. It predicted a 32% drop in prices! I outlined in my blog why I thought that was rubbish and prices would not fall by more than 10%. To date, according to various data sources, property values have not slipped by much more than 2% to 3%, which is barely noteworthy.
CBA revised its forecast on 9 September admitting they got it wrong.
Now that the virus is under control in Melbourne (and also nationally), I thought it was an opportune time to share my forecast for next year. It is my view that prices in well-established, inner-city, blue chip suburbs will rebound strongly in 2021 and deliver double-digit growth.
I set out the reasons for adopting this view below.
Covid has hurt low-income earners and younger people the most
Unfortunately, lower-income earners have been more financially vulnerable to the impact of Covid. They tend to work in occupations that do not lend themselves to working from home. In addition, industries such has hospitality, travel and tourism have been severely impacted, especially in Melbourne. As such, Covid has disproportionately affected lower income earners to a much greater extent.
A high proportion of middle and higher income earners are likely to either recover their income back to pre-Covid levels very quickly or haven’t been impacted at all.
In fact, there is a large cohort of people that are in a stronger financial position today. That’s because their income has been unaffected, their discretionary spending has reduced e.g. less eating out and no holidays and interest rates are at all-time lows. As such, many people have either accelerated debt repayments or accumulated more savings.
The best evidence of the financial strength of this cohort is reflected in the credit card spending data compiled by the banks. This data gives us a real-time indication of how much people are spending by category. Overall consumer spending is up 5% compared to last year. This demonstrates the unaffected cohort more than makes up for the people that have lost their jobs and income. This thematic is likely to translate to the property market too, especially in blue-chip suburbs.
Low rates will inflate property prices
It is a generally accepted economic principal that lower interest rates result in increased asset prices. For example, if a company can source capital at a lower interest rate to fund growth, its profits will be higher and as such, its shares will be worth more.
This concept applies to property too. If money is cheap, then it costs less to hold an asset and holding all other factors constant, its value will appreciate.
I wrote a blog in May that highlighted that it is cheaper to own a property than rent it. This defies logic and is likely to encourage more people to buy rather than rent, assuming their financial situation allows it. As such, demand for property is almost certainly going to increase.
The RBA has said that it does not expect to increase the cash rate for at least 3 years. However, many economists predict that interest rates will remain lower for a much longer period of time. This interest rate expectation will further fuel demand.
Supply shortage will drive prices higher
This year national property listings have averaged below 300,000 for the first time since August 2010. The fall in listings is even more severe in some blue-chip suburbs where volumes are averaging 30-50% lower compared to previous years.
This stands to logic as the Melbourne property market has been closed since stage 4 lockdown restrictions were enforced at the beginning of August.
Listings will eventually increase but probably only gradually over the next 6 to 9 months. The reality is that most people won’t feel confident putting their property on the market until after several months of buoyant results. Its herd mentality.
Therefore, by the time stock levels have normalised, which is probably mid to late 2021, most Australian’s would have financially recovered from the impacts of Covid and there should be enough demand to soak up the higher volume.
Until then, the market will be driven by a shortage of the supply of properties for sale. Demand will outstrip supply and drive prices higher.
Prepare for a government spending spree
There has been a lot of discussion about the September ‘fiscal cliff’ when JobKeeper and loan repayments pauses were set to mature. Both of these measures have been extended. I’m confident that there won’t be any mass selling of property as a result of Covid.
The Federal government will release its budget on 6 October 2020, and we should be prepared for a spending spree. I expect that JobKeeper will be in place for as long as it’s needed e.g. hospitality operators in Melbourne will likely need it longer than most. The government will spend big on infrastructure to create jobs. And its likely there will be targeted campaigns similar to the UK’s “Eat Out to Help Out” scheme.
A few weeks ago, the Australian government sold $21 billion of bonds that mature in 10 years for an interest rate of around 1% p.a. And the RBA indicated today that it could commence QE which could drive the governments borrowing cost (rate) down to circa 0.50% p.a.!
Whether you subscribe to Modern Monetary Theory or not, the fact is that money is cheap! It doesn’t cost governments a lot in interest to borrow to stimulate their economies. Most economists acknowledge that the cost of not helping the economy recover from Covid is far greater than the future burden of higher government debt.
Population growth will bounce back strongly
When it becomes easier to imagine a world without Covid, even if we don’t anticipate that occurring until late 2021 or 2022, I think overseas imagination will bounce back strongly. I think Australia will be seen as a very safe place to immigrate to, especially when compared to the UK and USA.
As such, demand for immigration over the next 10 years, will probably be materially higher than it was pre-Covid. If this turns out to be correct, the resultant increase in economic activity and demand for property will start to be reflected in prices.
In the short-run, Covid has wiped out overseas migration, and that’s a negative thing. However, in the long run, Covid could be its largest stimulus.
Beware of temporarily overinflated values
If the volume of property listing remains very low for an extended period of time, it might result in some properties selling for prices well above their intrinsic value. Such results could subsequently attract a flow of new listings. And that could see prices quickly dip back to more realistic levels. This is a risk that is present in a market that is driven by very low supply.
If you are wanting to buy an investment-grade property, you should always be willing to pay fair market value. But don’t let FOMO drive your property decisions. Low supply rarely persists for longer than six months. Don’t be impatient and overpay.
Investment-grade markets may perform better
Most property price predictions relate to capital city median house values, not investment-grade locations. This commentary relates to blue-chip locations.
It is possible that prices for properties in suburbs dominated by lower-income earners could under-perform. Because of the way Covid has affected the income earners differently, it could result in a two-speed property market.
In the long run, it doesn’t matter
If you are buying a property and intend to hold it for 10 or more years, it doesn’t really matter how prices will behave over the next one to two years. The most important matter is what you buy, not when you buy.