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The Sunday Age

Keep your eye on the prize

The residential property market is unique because it's the only one driven by necessity as well as the desire to make money. You don't need to invest in shares to have a reasonable quality of life-but you do need a roof over your head.

Unlike the sharemarket, where fluctuations are driven purely by investors, residential property is driven by homebuyers as well as investors. These two groups generally have different objectives, and they don't always participate in the market at the same time. This creates three distinct market phases.

For investors in particular, knowing which phase the local market is in at any given time can mean the difference between taking a calculated risk and flying blind.

Phase One: homebuyer-led growth. During this phase of the property market cycle, the national and local economies grow strongly and businesses lift production to keep up with demand. They hire more staff, so the national unemployment figure is low.

When people feel secure in their jobs and know the economy is growing, they're more likely to spend on consumer items and run up the credit card. They're also more likely to enter the property market and buy their first home or trade up to something bigger and better.

Figures from Bureau of Statistics show that Melbourne's median house price grew by 18 per cent in 2007. Homebuyers were primarily responsible for this increase. Investors focused their attention on the sharemarket, which was still providing high returns.

The flipside of all this homebuyer and consumer spending was that it drove up inflation. By March 2007, inflation had grown to 4.2 per cent; substantially beyond the Reserve Bank's oft-quoted comfort limit of 3 per cent. As a result, the Bank increased the official cash rate four times between August 2007 and March 2008.

The combination of higher interest rates and higher property prices forced many homebuyers out of the market by mid-2008.

Meanwhile, investors remained on the sidelines because higher interest rates made it more expensive to borrow money. In their eyes, residential property didn't represent good investment value at that time.

Phase Two: market-wide adjustment. During this phase, the residential property market goes through a cooling-down period. Activity slows down, and so does price growth. As in Phase One, this adjustment reflects the wider economic situation. Influenced by the global credit crunch and the slowing of Australia's mining boom, businesses started to scale back productivity and curtail recruitment activities in late 2008. In some cases, they laid off staff who had been employed during the previous growth phase.

Although the unemployment rate stood at 5.4 per cent in March 2009, the figure was just 4.1 per cent a year earlier. The increase came off a very low base, so it's important to keep things in perspective. For employers, Phase Two represents a rebalancing between turnover and staffing costs; a way of evening the scales. It's a normal part of the business cycle.

Feeling less confident about job security, consumers begin spending less and the economy slows further. As Phase Two rolls on, the Reserve Bank begins cutting interest rates to stimulate the economy by encouraging consumer and business spending.

In the current market cycle these cuts have been particularly steep, resulting in a 4 percent drop in the cash rate between September 2008 and February 2009.

Phase Three: investor-led growth. As a by-product of falling interest rates, borrowing money becomes cheaper and residential property becomes a more affordable and attractive proposition for investors.

At time of writing, the property market is in a transition between Phases Two and Three, and will probably remain so until 2010. This is an ideal time for investors to learn more about residential property as an asset class, and observe market activity and price movements in their location of choice. This way, you'll be well-positioned to make a move before the broader mass of investors-giving you a strong competitive edge.


TIP BOX

• Investors and homebuyers are active at different times, creating a three-phase market
• Phase One is a growth period driven by homebuyers
• Phase Two is a market-wide adjustment period
• Phase Three is a growth period driven by investors.


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