Today’s newsletter from my local property agent reads “House No.5 sold for $250,000 above reserve: more houses wanted for an almost guaranteed quick sale!”.

Meanwhile in the papers, a 3rd release of the Darling Square development consisting of 391 inner Sydney apartments, sold out in just under 4 hours.

For the time-poor casual observer of the real estate market, you’d be drawn in by the headlines thinking that the property market is going gangbusters.

But then you turn on the evening news and Westpac bank reports that the property market outlook is less than positive given weakening house finance applications led by the absence of investor activity. The news then goes on to say that property auction rates across the nation are dropping.

What exactly is going on you ask?

With so much contradicting information sloshing around the place, it’s far too easy for people to get confused on what is property fact vs fiction. To alleviate some of the confusion, I’m going fact-hunting to find out exactly what is going on in the property market.

I’m not going to speculate on the direction of the market, nor am I going to give you crystal-ball type answers. What I will do is help provide a list of questions that every property investor needs to ask given the relevant property fact.
Hopefully this will lead to better property decisions for you and your family.

So to start, why does it matter that the Australian property market continues to grow strongly?

For many Australians their home remains the largest single asset in their portfolio. When property prices go up, so does the perceived wealth of a household (ie positive wealth effect). The resultant increase in the “feel rich” factor makes people spend money at the shops, which is ultimately good for businesses. Employment will rise, the household wealth effect increases, leading to more household expenditures. The cycle continues which results in a strong economy.

So in essence house prices are going up is a good thing, and you’d hope for it to continue forever.

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To put into context just how well the Australian property market has been doing for the past 20 years, have a look at this colourful chart of average Australian house price (blue line) below.

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If you bought a property in 1996 for the price of $180,000, your property would be worth $750,000 now 20 years later; a superb return of 316% (or 7.4% per annum). As observed on the blue line graph above, property prices have been on an upward trend since 1996 and are still showing no signs of stopping; a fact that has probably contributed to market optimism of some that thinks property prices would keep on rising forever.

If you are in that camp, then the question to ask is will property prices really keep on going up? To answer this question, I present to you more questions to help you on your journey.

Is there evidence of interest rate manipulation that artificially raises property prices?

On the chart above, you will have noticed that an interest rate cut (indicated by the shaded grey bars) precedes every rise in average property prices. What is not shown on the chart however is the fact that when interest rates were raised in financial years 2008 and 2011, average property prices consequently dropped.

That is, property prices and interest rates seem to have an inverse relationship and act opposite to each other. When interest rates rise, property values fall – and vice versa.

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So when we look to the RBA for answers on the direction of future interest rates, they have indicated their reluctance in cutting rates further, preferring instead to adopt a wait-and-see approach on the economy’s performance for the rest of the year. What that says is that interest rates will likely stay flat, maybe drop a little further before rising again when the economy improves.

The reality is that no one really knows what’s going to happen to the economy. In the face of such uncertainty about the economy and interest rates, and with the knowledge that property prices and interest rates have an inverse relationship, the question that you need to ask is which way you think interest rates will go in the future? Would you gamble against the RBA and hope for interest rates to keep on falling? Or would you decide to reduce your debt risks for fear of rising interest rates?

Can you really afford the debt you take on?

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We live in a debt-ridden society. Low interest rates offer better loan serviceability levels to debt-holders, who become more attractive to the banks, who in turn generate more profits by lending more money to the market.

We, the consumers, love debt because it allows us to buy things now.

The above graph shows how much debt the average household has taken on over the last 30 years, with debt now making up more than 175% of a normal household’s disposable income. That’s very alarming because it shows that low interest rates have encouraged property lovers into buying property on the misconstrued belief that they can afford huge debts.

But unfortunately in reality, they really can’t.

A simple example to make my point; a $500,000 debt at current rates of 1.75% costs $8,750 per annum in interest. That very same debt loaned at 5% costs $25,000 per annum – a 185% increase in annual interest payments!

A lot of property lovers out there base their buying on the expectations that interest rates are expected to stay lower for longer. But what if they don’t? There is nothing that is certain in the world of finance, and therefore the question you need to ask is whether your household budget is strong enough to sustain elevated household debts? Could you continue to comfortably support your current lifestyle if rates were to go up by 5%?

If the answer is no, then it’s time to sit down to rework your debt obligations.

The lack of wages growth for the ordinary Australian

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If you are an employee and have recently experienced difficulty in trying to negotiate a pay rise, seek comfort in the fact that you are not alone. The Reserve Bank of Australia recently reported that average wages across the country only grew +2.3% last year, and just +3.3% over the last 18 years. While immensely depressing, it gets worst when compared to the rate of growth in house prices over the same period of +7.4% – a full 4.1% differential gap!

If Australians are paying for houses that are growing at 7.4% vs earning a wage that is only growing at 3.3%, then it doesn’t take a maths genius to figure out why the country is constantly complaining about housing affordability. The fact is Australians are just not earning enough wages to keep up with property prices!

But despite the affordability crisis, plenty of Australians still want to own their piece of home sweet home.

If you are one of them sitting on the sidelines waiting for “the right time to enter the property market” – whether it be for property prices to drop or for your wage to increase – the questions you need to be asking yourself is whether the “right time” would ever come? Would property prices keep on rising and cause you to further lag behind in affordability? Should you abandon your dreams and rent? Or should you buy now at elevated prices just to get onto the property ladder?

Where are the buying catalysts?

As you may have read on the papers, Chinese buyers were one of the main reasons leading to the meteoric rise in property prices over the last few years, especially in Victoria and NSW. The Foreign Investment Review Board (FIRB) reports that the Chinese was by far the biggest foreign buyer of residential and commercial property in Australia, spending $24.3 billion in 2014-15 – more than triple the United States and six times the outlay from Singapore. Now that’s some serious coin!

Things seem to have changed in 2016 however.

Three of Australia’s largest banks – ANZ, CBA, Westpac – have recently announced the discovery of hundreds of home loans approved on the merits of fraudulent Chinese income documents. In light of this, new rules to stop lending money to foreigners with foreign-sourced income has been put in place to stop further damage, and severely limiting local funding options for Chinese buyers. The Chinese government are also doing their bit to decrease Chinese buying in Australia as well; new rules announced in 2016 limits its citizens to only USD$50,000 a year in foreign currency purchases.

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These new policies have no doubt impacted on Chinese buying activity. Australia’s #1 property portal www.realestate.com.au has begun to see decreasing online visitation numbers from China this year. And just for fun, I attended a house-for-sale inspection over the weekend and noticed the lack of black-haired individuals at the property; a clear contrast to last year where the property would have been buzzing with Chinese buyers.

So with Chinese buyers starting to disappear in today’s property market, one would expect property prices to cool off somewhat due to reduced buying demand. If you were a potential buyer in the current property market, the question you need to ask is whether to believe that the Chinese are indeed leaving the Australian property market which would likely lead to falls in property prices? Or is this just a bad patch which would recover in due time?

Increased housing supply just as buyers are disappearing

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For those who have just recently bought an apartment hoping to cash in on the property boom, look away now!
It seems that the market is flooded with apartments at the moment with the RBA reporting record number of building approvals in higher-density housing.

You just have to walk down Elizabeth street in Melbourne to see the scale and speed of said high-density housing being built within 3kms of each other – I counted 6 blocks of at least 300 hundred apartments each all under construction at the moment.

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Research firm Macroplan Dimasi estimates that approximately 44,784 apartments will be completed across Sydney, Melbourne and Brisbane in 2016, with that figure rising to 52,920 in 2017.

The bad news then is that the influx of these apartments will come on at the same time as Chinese buyers (remember I talked about them leaving the Australian property market in the previous point?) are leaving, likely affecting property prices as demand becomes absent.

Given the expectation of an apartment oversupply being met with dwindling Chinese buyers, the questions you need to be asking are
1) if you were an apartment owner: should you sell your apartment now before new supply comes on?
2) if you were a potential apartment owner : would other property options (townhouses or bungalows) be better options given capital values of apartments would likely be affected when new supply comes on?

More questions than answers

I know I’ve given you more questions than answers, which might not be what you seek, but sometimes it’s really the journey of discovery that matters rather than the end destination. Questions, rather than answers, guide us towards our goals which may be ever changing as our individual circumstances evolve.

The information given here is not a definitive list of questions that every property investor needs to ask; you very likely have a lot more to ask. If you do, please share it in the comments below!

Your wealth building journey starts with asking the right questions; I hope I have provided some to get that process started.

Good luck!

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Jason is the author of www.jasonjots.com, a personal finance blog on what it really means to build long term wealth. Having been professionally involved in Finance for over 10 years, stories shared on his blog touch on lessons learned from being a Melbourne Uni alumnus, Chartered Accountant, fund manager, investor, and husband/father.

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