Is it a bubble? How high can it go and will it crash?

This is the big question about the Sydney property market that everyone is asking but few want to answer. Are house prices in a bubble?

In late 2012, we were told that housing affordability was poor and property was essentially over valued. House prices then shot up 30% over the next 18 months. Has this latest growth taken the market from fair value to being over valued? Or was the market actually under valued in 2012 and is now simply trading around fair value?

The current strength of the market has caught many respected analysts and forecasters by surprise. The bulls in the market may be winning now, but that is not to say that the bears in the market have it completely wrong either.

To make the right decision when trading in this property market, it is crucial to be aware of some fundamental principles which will play a role in determining the market’s fortunes. These principles will also guide you in determining and identifying any unsustainable price bubble.

Interest rates – Let’s cut to the chase. As interest rates have continued to go down, Sydney house prices have gone up by an almost uncanny ‘similar’ amount. May’s rate cut suggests they won’t be going up anytime soon.

For example, at the beginning of 2012, average interest rates for home loans were around 7.5%. But in May 2015, home loan interest rates have fallen to 5.0%. This is a 33% drop which translates into a drop of 33% in home loan repayments.

However, this extra money has been diverted from the bank to the vendor in the form of higher house prices, because Sydney house prices have increased by more than 30% over that same time period.

If rates keep going down, provided other fundamentals remain in tact, you could expect more house price growth. Each rate cut seems to stimulate the property market further – not that this is the RBA’s intention or desire.

If Sydney was to experience a market correction, RBA boss Glenn Stevens wouldn’t have much sympathy. He has been fairly clear in expressing his concern at the current level of Sydney house prices.

Investors – Sell in boom, buy in gloom they say. Well it’s now a boom and there is no doubt about that. The major problem facing property investors now sitting on huge paper gains is, what to do with the money if they did sell? Selling and buying in the same market gives them no gain at all.

Currently there is no sign of a mass investor sell down in the market as it stands. Therefore housing stock is likely to remain very tight, which creates strength in itself. Incoming investors now need to tread very carefully. The price surge has seen entry prices sky rocket as rents have stagnated and/or declined. The net yield for incoming investors to the Sydney market is only around 2%.

Australian dollar – As the AUD goes lower, the Sydney housing market becomes cheaper for expats and international investors. As one segment of buyers pull back from the market, another enters. Whilst a 2% net return may not appeal to most investors, Sydney house prices have hardly risen to an expat living in the US or the UK once currency movements are factored in.

Markets within markets – Be careful about simplistic commentary relating to National markets. Commentary such as ‘Australian house prices’ or ‘NSW home sales’ may not tell the true story. London house prices are not a true reflection of prices in broader England.

Just as New York prices don’t reflect prices in the broader US market. Sydney may now have decoupled itself from the rest of the country in similar fashion. Unlike previous booms, the price growth has not swept up the Eastern seaboard to Brisbane. Even Melbourne has lagged behind Sydney, experiencing only about half the growth Sydney has.

To demonstrate the markets within markets theory, certain price points in Sydney are looking overly strong whilst others are still showing relative value. The sub $1.25 million market is much stronger than say the $2.5 million plus market. The value on offer is unrelated in these two price brackets, even though they are within the same geographical market.

Government intervention – Based on Australian’s enthusiasm for property (and negative gearing), the market could react badly to any policy change in the property sector. Since Superannuation funds have been able to take on debt, a lot of that money has poured into property, contributing to the buoyant environment. Small changes in policy can have a rapid impact on the property market, both positively and negatively.

Take the First Home Owners Grant during the GFC as an example. A small incentive set the market alight during a financial crisis.

Unemployment – the National unemployment rate is tipped to rise but the NSW economy is powering along. Unemployment concerns don’t seem to be hanging over the Sydney market like they are in other capital cities.

If there was one segment of ‘Australian house prices’ that was in a definite bubble, it was the mining towns. As the mining boom winds up, house prices in mining towns have been hit severely. Lots of investors who bought property in boom mining towns are now suffering with overpriced real estate that they can’t sell.

So yes, there was a bubble that has now crashed in Australian housing, but it was in country mining towns and not in metropolitan Sydney.

Sydney never goes backwards – In every boom, a mentality seems to emerge that some people term ‘ignorant confidence’. A common trap in a boom is to think that prices will never go down, but they always do – eventually. Even in Sydney you may ask? Yes, of course!

Don’t get caught peddling or believing some of those baseless ‘real estate facts’ which are bandied around.

Claims such as, Sydney house prices never go down – they just level out. Or, property doubles every 7 years. This type of thinking can set you up for a total misread of the market.

As amazing as it seems, prices will probably continue to rise for some time yet. This is good for those in the market and not so good for those trying to get in.

Like a good thriller movie or book, we are going to have to wait for the end to see how this market plays out. The reality is that no one can predict the finish with any great certainty or confidence.

Picking the peak of the market is a guessing game, even for the experts.

The boom will finish when it finishes.

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