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The Age

Why home values hold up when all else turns down

LAST year the value of Australia's commercial property trusts fell by more than 30 per cent, according to Super Ratings' property index.

This compares with statistics released by RP Data that show the median value of Australian residential property fell by around 3 per cent in 2008, and in the first four months of 2009 has risen by 2.8 per cent. In Melbourne prices have re-bounded by around 4.5 per cent.

When the sharemarket falls, businesses are forced to tighten their belts and put any expansion plans they had on hold. This has a direct flow-on effect to the commercial property sector. Demand for office space, factories and industrial complexes begin to fall, yields begin to reduce and values of commercial property trusts soften.

The residential property market, on the other hand, works counter-cyclically to the commercial market. History indicates that a falling sharemarket has the opposite impact on the residential property market.

After the 1987 sharemarket crash the residential property market in Melbourne grew by 20 per cent each year for the next two years. The same thing happened again in 2000 and 2001 when the sharemarket turned down driven by the effect of the "tech wreck" and September 11. The property market once again grew by 20 per cent each year in 2001 and 2002, a rate that was more than double its long-term average.

When an economy moves towards recession, businesses contract and sharemarkets fall. As business battles to balance falling income with high wage expenses, they lay off a percentage of their workforce that ballooned when the economy was booming and unemployment rises.

To counteract this the RBA lowers interest rates to try to get the economy moving again. As interest rates fall residential property becomes affordable again.

Yes, rising unemployment will have a negative effect on some parts of the property market - particularly in the mortgage belt areas, where debt levels are high and unemployment rates tends to hit harder.

However, if unemployment rises to 7 or 8 per cent, as most economists predict, it simply means it is returning back to the levels we saw in 2001 - the start of the last property boom. For more than 90 per cent of the population who ultimately have job security, property becomes a viable investment option.

Interest rates have fallen by almost half in the past six months and have resulted in a rapid return of affordability for investors. Today an investor can buy a blue-chip piece of real estate and incur holding costs that are about a tenth of what they were 12 months ago.

A downturn in the sharemarket forces investors to change their strategy. Many look to preserve capital by moving assets into cash, but when interest rates fall so does the return on their deposited funds.

The residential property market is the next haven because, unlike other investments that are driven purely by investors, property values are underpinned by home buyers and tenants who are looking to secure a primary need - shelter.

The Australian property market is complex and can be broken down into many sub-sections. When analysing the effects of sharemarket volatility on the property market the first question to ask is "which market are you talking about, commercial or residential?". The conclusions you end up with will vary considerably.

Mark Armstrong is a director of Property Planning Australia, www.propertyplanning.com.au, and The Property School, www.thepropertyschool.com.au