When Booms Bust…

When Booms Bust…

Melbourne is well known as the real estate auction capital of Australia – and possibly the world. Year to date, over $4 Billion homes have been sold via auction (compared to $2.9 Billion for the same time last year,) a number which would include properties sold ‘prior to’ and via a ‘passed in’ negotiation, all of which count towards the weekly clearance rate. 

In the current atmosphere in which sentiment has improved, larger percentages are gaining enough competition to sell ‘under the hammer’ and this has certainly been so from an anecdotal perspective. 

The auction process obviously thrives in an atmosphere where confidence predominates and most selling agents are well educated in the means of manipulation to inspire buyers to openly state their interest in front of a crowd of individuals on a Saturday morning. 

If a couple of bidders are brave enough to commence the battle, others have their initial attraction to the property demonstrably ‘fed’ by the competition and join in – conversely, if no-one openly states an interest, the reverse can be the case, leaving potential buyers wondering ‘what’s wrong with the home?’

Each scenario – played out in the public arena – causes a roll on effect across the market either boosting sentiment, or delaying the onset thereof; however, once confidence does take hold, the ‘act now or miss out’ frenzy is perpetuated, laying down the foundation for a typical boom bust cycle.

Auctions are marketed as a transparent way to sell real estate; however aside from the openness of the public event itself, the pre-sale process is anything but transparent.

 Like a good retail sale, the key for the three week campaign preceding the auction is to get buyers through the home initially which in Melbourne, results in agents encouraging the vendor to withhold their reserve price to enable a “conservative” estimate of value – as either a verbal or published quote range – to glean as much buyer enquiry as possible.

In my own experience, I have seen these ‘conservative’ estimates as low as the nominal value the current vendor paid some six or so years ago – with a ‘+’ thrown in for good measure.

The idea is ‘sold’ to the vendor via explanation of the “buyer pyramid” – it works a little like step quoting – get the lower priced bidders to build momentum during the auction to fuel those bidding with ‘deeper pockets’ to step in at the end.

In reality – real expectation is often a good percentage above the quoted range with excuses such as “the vendor’s reserve can change” used to waylay future complaints.

Without the lower budget bidders, auctions can pull up short without the usual mania that has in our boom eras of growth, significantly contributed in pushing prices to unsustainable levels.

In a market where auctions predominate, the price multiplier effect buoyed on through the physiological stimulant this method of selling promotes, results in prices gaining much stronger traction that would be possible in most private sale campaigns – something that has been well documented in various scientific studies.

Although other states have a larger percentage of private sales, the auction system, when used, is just as opaque. In Brisbane for example, it’s apparently ‘the law’ to dodge any responsibility to give an accurate indication of vendor expectation – with an act that reportedly ‘limits’ what real estate agents are ‘allowed’ to disclose. 

As if deliberately designed to confuse buyers – selling agents are ‘unable’ to indicate a likely selling range, any hint of a reserve, or an opinion of value. 

I can see this methodology eking its way into Victoria if ever we get to the stage of national licensing, with many agents already using their own liberal interpretations of current published ‘guidelines’  – and whilst I’m sympathetic to the task an agent undertakes when selling a property, I hold the opinion that vendors – who foot the advertising bill – should take a greater responsibility and ensure published price ranges are updated to accurately reflect the range in which they are willing to negotiate.

I’ve commented previously that the “boom years” of capital growth in Australia’s property market – and in principle the inner and middle ring metropolitan areas of Melbourne (which sits at the top of the ‘boom’ chart see here) – have not been lead by population growth as such, rather speculation, ease of credit, and a general expectation from investors (as well as home buyers), that prices will continue to rise.

This is evident from the amount of investor owned stock in the inner and middle ring city suburbs.  These areas contain a larger percentage of units and townhouses for which well over 50 per cent, and in some states over 70 per cent, is rented and owned typically by ‘mum and dad’ baby boomers buoyed on by the policy of negative gearing. 

As mentioned previously, the success of negative gearing relies on speculation of capital increases, ensuring supply and vacancy rates sit at a lower percentage than would be the case if we instead concentrated on strategies to increase the supply of affordable ‘quality’ accommodation – (a subject I’ve explored at length before) – and a policy which goes some way in encouraging the ‘head to head’ investor battles I witness weekly, which significantly inflate the value second hand stock on the suburban streets of Melbourne.

And it’s not all that easy to directly align other market variables such as the unemployment rate, wage growth, or even rising rental prices which many assume in theory, will push a greater number of first home buyers onto the ‘ladder’ – with large movements in property prices.  When there’s a rush to invest, it’s more to do with the gold rush spread of optimism that seems to spread like some infectious disease.  

It certainly wasn’t the above general market indicators that inspired four bidders (all investors) at an auction I attended last Saturday for an un-renovated house quoted at ‘$700,000 +’ sell $100,000 above the reserve, which due to the rapid pace of bidding, wasn’t announced on the market until $850,000 – albeit, I suspect had the bidding not been quite as frenetic, the reserve would have been ‘called’ at a lower level.

It was evident from the body language portrayed that the remaining two bidders had pushed far past their limit – based on comparable data, the house itself would have struggled to pass a valuation at the purchase price – yet for future sellers in the surrounding streets, the amount paid will set a new ‘benchmark’ and overall vendor expectation will rise – so too for buyers, who will see it as a comparable sale for a similar property of choice and raise budgets accordingly.

The prices achieved in heated auction markets are unsustainable in the long run, and yet the one thing all bidders have in common when caught up in the momentum of an auction, irrationally stretching their budgets – is a speculative ‘hope’ that at some future date, the next generation will be prepared to pay ‘more’ for the home than they did – enabling them to gain a profit over and above both outlay and inflation.   

All are assumptions which work whilst the majority hold the same view and fail dismally when the ‘bubble’ of positive perceptions pops under the pressure of the opposing view – which is never completely absent.

The boom and bust cycle is evoked by the market dynamics of consumer sentiment, as those feeling ‘good’ borrow the ‘most’ possible to purchase with ‘positive’ thoughts in mind about rising prices, whilst the opposite reaction predominates when people avoid buying under the general perception that prices are going to keep falling – is something we were all witness to following the ‘peak’ of 2010 during which transaction levels were back to numbers not evidenced since the late 1990s despite other relatively good market indicators (low unemployment and the comforting ‘myth’ of a surplus – not to mention falling interest rates etc.) 

For this reason, the real estate industry as a whole makes strenuous endeavours to maintain the perception that prices always rise – or if prices are falling, it’s simply part of the ‘market cycle’ until they start on their upward profit making curve once again.

And they are not the only industry to do so. A vast amount of personal debt is tied up in the property market – not to mention the many retail offshoots that also benefit from rising property prices. Should there ever be a significant downturn – the economy would inevitably suffer as a result.

Therefore, if price rises in our major capital city markets have been primarily inflated through speculative investment, the positive mantra must be maintained to and at the expense of future generations who are going to find it increasingly hard to purchase.

I’ve listened to many an angry agent throw their hands up in pure exasperation at articles produced in the real estate section of The AGE (as one example,) openly remonstrating how any downbeat ‘vibes’ are directly responsible for declines in property prices. Funnily enough, they never complain when the reverse is the case.

And in the USA, where negative equity has affected the larger proportion of home owners, it’s been clearly demonstrated that even occupiers who are employed and own outright, and should arguably be unaffected by a loss in the capital value of their property, resist investing in the general upkeep of their home when values are dropping, spending around $200 less on maintenance and improvements per quarter – favouring instead to buy only those items they can ‘take with them’ such as cars and furniture.

The concept that housing is the ‘best investment’ a person can make has been promoted widely throughout the developed world. In the years of boom growth, during which values rose in excess of 200 per cent, the total amount of money banks ‘lent’ into existence through the gradual easing of restrictions surrounding the mortgage lending market, was the core driver of increasing values, aptly benefitted those who entered at the start of the lending boom, above those who are now tapping into the bank of ‘mum and dad’ or relying on joint ownership, grants, and a low interest rate environment to push their foot through the door.

The recovery we’re currently seeing is largely lead by the investment sector – with an equal perception that values will maintain their upward trajectory. Albeit, to do so, requires a new generation of bidders to buy into the same speculative mantra – more debt requiring more activity just to maintain the amount of money we have in circulation. Without it, we lose our jobs and our ability to service this growing supply of credit.  

Whilst I’m a great advocate for home ownership – particularly for those establishing a family – and recognise the need for investment in the property sector with a long term mindset as part of a diversified portfolio – it’s clear we need to pour a far greater proportion of recourses into structuring a plan for effective development, infrastructure being the key.  

Albeit, with an historically reducing pool of first home buyers, an increasing proportion of ‘interest only’ investors, and an aging population which will provoke the big Australia advocates to hail ‘populate or perish’ – a bit like a doctor telling his patients they will never die, the real estate industry will maintain the myth that prices always rise.

  Catherine Cashmore

 

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