Contagion

Some parts of the real estate market are experiencing a new feeling they haven’t known for some time: fear. Initial outbreaks, based on media reports, seem confined to overheated parts of the Sydney and Melbourne housing markets. The question is whether the fear will be contained or will it spread more widely?

It’s always hard to pick the point at which market confidence turns. Australia started the year with unrestrained exuberance. Auction clearances were at record highs and off plan sales to speculative investors seemed like an ocean of inexhaustible opportunity, particularly with rising interest from foreign (mainly Chinese) buyers. Repeated warnings about the extent of investor activity, particularly in new apartment sales, or warnings about record low affordability relative to incomes, were brushed off.  Then along came APRA’s rule changes, and banks also shifted their risk appetites down a notch or two, reducing their LVRs and raising interest rates for investment property.

Sometime in the second half of the calendar year, rising notes of caution crept into mainstream media commentary on housing. By October, the likes of Macquarie Bank, Credit Suisse and Bank of America Merrill Lynch were warning of ‘hard landings’. (See here for an example of the bearish comments). Add to this some ‘tutt tutting’ from the celebrity TV financial commentators and the mood seems to have quickly turned from unbridled optimism to caution. 

That itself is a good thing. Opportunity and risk should be weighed carefully, not approached recklessly. The question now is how much more bad news can the market expect, will the bad news be confined to certain parts of the market, and will the market have the maturity to respond rationally?

That there is still bad news to come seems inevitable. I heard last week that traditional financiers expect that 20% of investors buying off plan apartments will be unable to settle on completion, based on the revised lending criteria. If that’s true, a lot of developers will be caught and a lot of investors will be in a bind. This is likely to be confined, however, to just some parts of the capital city markets – especially the flood of new stock of one bedroom apartments, not designed for living in but for investor price points. I can’t see projects aimed at owner occupiers suffering settlement risk: intending occupiers tend to be more discerning, and have more equity. Many investors are however highly geared and have less emotional attachment to their investment as it was never intended to be their home.

Then there are markets which were supported by exceptional but temporary economic conditions. The mining town real estate booms were never sustainable and there are plenty of investors ruing that lesson already. But even large cities like Perth, where the sagging resources economy is reverberating through employment markets just as more stock arrives, are already feeling the pinch. Even the ever ebullient Real Estate Institute has adopted a more somber tone.

Parts of Melbourne, Brisbane and Sydney do appear at risk of oversupply of a particular type of housing product (particularly very small one or two bedroom apartments). Commentators and analysts will learn that all housing units in commencement or approval data are not alike: some will find a market, others will not. If, as seems likely, there is a surplus of small apartments in concentrated locations, prices and rents must inevitably fall. Some people are going to lose money, and our media loves nothing more than hard luck stories. Expect a lot of these from the nightly ‘current affairs’ shows and tabloid press.

More stable parts of the housing market in these cities – in my view new housing and land, well located medium density projects, quality owner occupied apartment projects and the established housing market generally – ought to be treated separately, because they are working on entirely different dynamics. But will they be?

I know of two banks who are actively gaming this scenario already. They’re asking whether a fall in confidence, led by what’s looking like happening in the investment apartment sector, will spread to other parts of the markets, both by type and location? For example, if inner city apartments in Melbourne become the focus of negative market comment, will that rattle markets in established parts of Brisbane? And will it spread to other types of property?

The answer is that no one really knows - and won't until after it happens. Confidence is a fragile thing. It can go from reckless to reclusive in a very short space of time. Fanned by a tabloid appetite for click bait (bad news gets more clicks on line) and a widespread disregard for accurate or detailed reporting, it’s unlikely that there will be much rational analysis or reporting of real estate or housing markets in the coming year.

Having said that, we should be used to it. There hasn’t been much rational reporting for a long time. Real estate markets have been lumped together as if they’re a homogeneous product, and price movements have been reported on a weekly basis to feed a ravenous media and public appetite for poor quality information. That commentary will likely turn from positive to negative but its quality will remain the same: underwhelming.

On the positive side, most of us know that markets move in cycles and they’re rarely as bad as the media might make out, nor are they as risk free as painted to be in good times. Stability never rates much comment but the reality is that the majority of Australians who have owned or are paying off their home will continue to do through the cycles, both up and down. And if you do need to trade, you tend to buy and sell on the same market. If you are buying for the first time, things might improve.

However the potential of contagion plays out, seasoned players will endure it with cool heads and a rational strategy. Amateurs had neither going into this market and are unlikely to have either of those qualities if they need to head for the exits.