What happens to Property after the Stock Market Crash?
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by Michael Yardney, director Metropole Property Investment Strategists.

The fall out from the stock market crashes around the world will affect everyone in the short term, and in lots of different ways, but the common question I’m getting asked is, “What happens to the property markets now?”

To help answer this question it is worth learning lessons from the past. In particular from the stock market crash of 1987 when a similar fall occurred on the stock market. At that time prices crashed 23% but all on the one day. At the time of writing this article, Australian stock values have dropped 24%, but they have done this over almost 3 months.

It is interesting to note that Australia’s biggest property boom occurred in the late 80’s following the stock market crash of 1987. In fact every time there has been a stock market crash in the last 50 years, Australian residential properties increased in value, but there was always a lag before this happened.

Why this crash is different from the past?

As we try and learn from the past, we should try to compare this stock market fallout with previous ones.

At the time of writing the Australian S&P index had fallen 24%. Interesting in America the S&P index had only fallen 12%. This suggests that the Australian stock market may have over reacted.

Looking back, previous major share crashes were at the end of speculative booms.

In 1987 when stocks were driven to unrealistic levels and again in the dotcom crash early this decade people were buying internet based stocks based on future potential earnings. They paid inflated prices for shares in companies that were never going to make any money.

I remember as a teenager a similar thing happening in the speculative mining boom which ended in the spectacular Poseidon crash. People were paying hundreds of dollars a share for mining companies that were never going to make any money.

Sure this time round some shares were a little overpriced. But in general our financial fundamentals are strong and our economy is sound. Share prices were not in a “speculative bubble” this time round, like they were in previous share crashes.

It is important to remember that our markets and particularly the share markets are driven by fear and greed. Currently the investors are exiting the market in fear of what “may” happen in America.

Investors have lost confidence in the future.

Of course there is another group of speculative investors who are exiting the markets because they borrowed against their shares and have to either sell these shares or pay for margin calls now that the value of their portfolio has dropped dramatically.

Another difference is that this time round Australia’s economy is more insulated from the United States economy. But as the USA economy does slow down it will affect our main trading partners China and Japan. This in turn may decrease the demand for some of our resource and products.

What will happen to interest rates?

The Reserve Bank has a difficult path of reining in inflation (which is still rising) and at the same time sustaining our economic growth. It does this by controlling interest rates.

There will almost certainly be one or two further interest rate increases in the coming months to bring inflation back into the RBA’s 2 to 3 per cent target range.

At the beginning of this year most economists suggested that next interest rate rise was going to occur in February. This prediction has now been down graded and maybe the next rise will occur in March

While there is a case for tightening interest rates, considering our inflation rate has jumped again in the December quarter, there is also a strong case for doing nothing at present as there has been a major downshift in global “prospects”.

Another interesting factor to watch with regard to interest rates is that the banks recently made some commercial decisions and increased interest rates claiming their costs of borrowing in overseas funds increased. Now that interest rates have dropped in America (the US Fed had lowered its interest rates by three quarters of a point from 4.25% to 3.5%) it will be interesting to see if these same banks now lower their interest rates.

What does all this mean for the property market?

It is important to remember that house prices are not as volatile as the share prices.

The property market is the only investment market where the majority of players are not investors. This means that as a home owner or a property investor, we are underpinned by the fact that 70% of properties are owned by owner/occupiers. And they don’t sell their houses just because share prices are falling or because of the problems overseas.

Having said that, it is likely that for a short time demand for homes and investments will drop. People just don’t like making important buying decisions at times of uncertainty.

The properties that outperformed over the last year or so were premium properties - homes in our more exclusive suburbs. Many of these increased in value by 30 -40% last year. These sales are closely linked to the state of our economy and to business sentiment and it is likely that high end sales will suffer this year.

All this means that if you have “money in the bank” or your line of credit ready to draw down on, the property markets will provide opportunities not seen in the last decade.

As a home owner or property investor you should be in the market for the long term - property is a long term play and Australia’s economic and property market fundamentals are still sound. This means that any slow downs in the property market will offer great opportunities for those with a long term view to buy their new home or investment property.

The fundamentals that will push our property markets forward have not changed from the beginning of the year. Let’s look at them briefly:

1. Supply and Demand –

There is still strong demand for properties from our growing population, our increasing immigration and our demographic changes. Yet there is a severe undersupply of dwellings around Australia. The ANZ Bank predicts that by 2010 we will have an undersupply of 200,000 dwellings.

Currently the cost of construction is too high to allow new development to take place and this has created a marked undersupply of dwellings.

To bring a new medium density development out of the ground today costs 25% to 30% more than the market will pay. New development will not take place until the market values move up to close to this level. Of course the fact that new apartments will cost more in the future means that the prices of existing houses and apartments will also increase.

2. Rising rents –

Rents are rising due to our very low vacancy rates. This means yields are rising for investors. This will draw new players back to property and will underpin our property markets.

3. Our economy-

Our Australian economy is basically sound and will continue to remain so, which will underpin our property markets.

In summary:

We have not seen the end of the crash – there are always aftershocks as new information surfaces. Once the fall out is over investors will put their money into the property market as they will see it as safer and less volatile than the share market.

This means that our property markets will continue to perform well in the long term.

In the meantime we won’t see a continuation of the mini boom conditions that occurred in many east coast capitals last year. And this is good for our markets – growth rates of over 20%, as was seen in many affluent suburbs last year, is unsustainable.

As a property investor or home owner take a long term view and remember the big picture. Australia’s fundamentals are sound and the price of well located property has doubled every 7-10 years since 1920.

Give it a few years and the stock market crash of 2008 will be a distant memory.

About the Author:

Michael Yardney is Director of Metropole – Property Investment Strategists, and a leading property commentator and publisher of Property Investment Update. Subscribe for free at www.PropertyUpdate.com.au

He is also author of How to Grow a Multi Million Dollar Property - in your spare time and co author of All You Need to Know About Buying and Selling Your Home

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