Some property analysts claim the property cycle changes every 7 to 10 years. The AMP Capital’s chief economist, Shane Oliver, explores this view and explains what causes property cycles to change over time.
The seven year property cycle
Q: Shane, what is meant by the seven year property cycle? What are the different phases?
A: The “seven year property cycle” is often referred to by property market commentators and refers to the swing in house prices through the phases of boom, bust, bottoming and recovery. But it’s rarely seven years. In fact, average Australian capital city prices have had multiple cycles over the last 15 years with booms around 2003, 2007, 2010 and just recently.
The cycle is better seen in terms of the rate of property growth, as not all downturns or bust phases have price declines, but rather just a slowing. The cycle can also vary from city to city, with only Sydney and Melbourne being in boom phases recently, and also within cities.
Q: What factors influence this?
A: The main factor driving the property cycle is the cycle in interest rates, with periods of rate cuts eventually driving upswings in the property cycle and vice versa for rate hikes. Around this, the supply of and demand for property also has an impact, along with job security and unemployment.
Q: What is the rule of 72? Is this accurate in predicting how long it takes for a property or area to double in value?
A: It’s a short cut to understand how compounding works. It’s actually quite useful because it all depends on the growth rate or interest rate (which in the case of compounding is the same thing). Because it depends on the growth rate, it allows for the impact of a shift from a higher growth world to a lower growth world.
For example, when inflation and growth in wages was higher in the 1980s, property prices averaged growth of around 11.5% pa, which meant they would double in value roughly every 6.3 years.
But now in a world of lower inflation and wages growth, property price growth over the last decade has slowed down to an average of just 6% pa, which means they are doubling in value roughly every 12 years. So it’s a mental arithmetic shortcut for investors to use: 6 X 12 = 72 (hence, the ‘72 rule’).
Q: Do you believe that if people haven’t been through a full property cycle then they can’t really know real estate markets?
A: No. People can understand how real estate markets work by doing their homework. They need to look at past property cycles to gain an understanding of how the cycle works and how it interacts with interest rates and other variables. Unfortunately, as with other investment markets, people tend to get lured by property at the worst point in the cycle, after it has already had a strong gain and is more expensive.
Q: Where are we currently sitting in the cycle in Australia and how much does this vary by state, city or suburb?
A: Perth and Darwin are going through a bust after the mining boom. Canberra, Hobart and Adelaide are in a soft patch, which could turn into a gradual recovery. Brisbane is in a recovery phase. Sydney has been in the midst of a boom and Melbourne too, but both have started to slow lately. The range by state, city and suburb is immense with price gains averaging around 18% year-on-year in Sydney to price falls of around -4.5% year-on-year in Darwin.
Q: And finally, what’s the general outlook in your opinion for the Australian property market over the next 3-5 years, and longer?
A: It will vary from city to city, but I’d expect modest average gains over the year ahead, followed by modest average price falls around 2017. This will occur because the RBA will eventually raise interest rates and increased supply will start to really hit the market.
Overall, price gains are likely to be constrained and over the medium term, given that house price-to-income ratios and debt levels are very high and given we have just seen a period of very strong gains in our two biggest cities, Sydney and Melbourne.
