The Australian market is unlikely to suffer like the US market, writes Mark Armstrong.
WITH clearance rates below 60 per cent, the share market on a downward trend and talk of interest rates trending up, many property investors may well be afraid of making any big decisions.
On top of this many property markets around the globe have suffered major corrections in value and many investors are asking themselves: ”is the Australian market going to suffer the same fate?”
I have had it put to me many times that if the US market can suffer such a drastic revaluation of property, then surely the Australian property market crash is just around the corner.
But I don’t think the Australian market is going to crash. It will of course follow market cycles and will go through corrections of 5 to 10 per cent as it is experiencing at present. In addition some areas may be more affected than others, but according to RP Data’s home value index the Melbourne property market has only adjusted by 0.4 per cent for the 12 months to April this year.
To understand why we seem to defy global trends we need to look at the differences between markets.
The Australian and US markets differ greatly from a tax and financing point of view but when we dig a bit further we find there are also significant demographic differences.
While culturally the two countries have many similarities, their societies live quite differently. In Australia, more than 70 per cent of the population live in the 10 biggest cities. This ensures a very centralised market where the bulk of the population competes for scarce land close to major infrastructure.
This competition for a finite commodity puts pressure on the value of land and results in a more robust property market.
Because most of the population wants to live in these defined areas it creates a housing shortage.
But Australia does not have a housing shortage – it only has a shortage of housing in areas where the majority of people want to live.
By contrast, in the US only 13 per cent of Americans live in the 10 largest cites. In fact if we take it a step further only 25 per cent of Americans live in the 50 most populous cities. The US has a more decentralised population and, as a result, the pressure on the value of land is less.
America has traditionally had very well established small town communities with schools, transport and entertainment. These small towns often do not have a shortage of land and while this does create more affordable housing it also increases the risk of price volatility.
For Australian property investors a softening in the market such as we are experiencing can result in two quite contrasting reactions – buy more property or reduce debt.
Neither option is absolutely right or wrong. It is the choice between being aggressive or conservative with your investment strategy.
Take for example a homeowner who has $400,000 of debt on their home and has a primary objective of eventually paying off this debt.
In the current market this person could decide to take a conservative approach and funnel all available income to reducing the loan and paying off this debt in around 20 years.
They would be safe in the knowledge that regardless of how the market performs they will have a roof over their head and their debt will be on its way down.
On the other hand if the homeowner took a more aggressive approach they would begin to see opportunities in a weak market. Rather than having a sole focus of reducing non-tax deductible debt they use a strategy of investment and debt reduction.
In this case the homeowner decides to buy an investment property with a view to hold onto it for the long term. They understand that in the short term the property will not achieve a significant amount of capital growth but they will take the opportunity to buy well while the bulk of the market sits on the sidelines.
When the property market bounces back this investor will be in the box seat to harness the benefits of the next capital growth cycle. History shows that the Melbourne property market doubles in value every seven to 10 years and an investor who uses a more aggressive strategy now maybe in a position to sell their investment in the future and use the sale proceeds to wipe out the debt on their home many years earlier than the conservative investor.