How to invest in the changing Australian property market

It’s impossible to escape the cold hard fact that the Australian property market is undergoing major changes.

Thanks to the Australian Prudential Regulation Authority’s macro-prudential measures restricting lending to investors, and the banking royal commission making banks allergic to risk, the availability of credit has tightened — especially for investors — and our property markets have moved to the next phase of the property cycle.

The current paradigm is one of slumping prices in some locations and slower property price growth in others.

These changes have been great fodder for many clickbait headlines in the media, which have brought out the property pessimists saying: “I told you so”.

But don’t panic

The markets are behaving normally.

Periods of strong capital growth such as we experienced in some of our capital cities in the last few years are always followed by a period of flat growth, no growth or falling prices. That’s just how markets work, especially after phases of unsustainable strong growth as we experienced in the Melbourne and Sydney property markets.

But this time around our markets peaked in a low interest rate environment, so we won’t experience many mortgage defaults and businesses will still be able to borrow funds to grow and create jobs. This means we’re in for a soft landing as the supportive fundamentals of a strong economy, jobs growth and population growth will underpin our property markets.

Having personally invested in six properties I’ve learned to appreciate the opportunities this stage of the cycle presents; I also recognise that in times such as these many potential home buyers and property investors will sit on the sidelines waiting to be told the market has bottomed. Of course this actually creates opportunities for those with a long term horizon.

I also know that some investors who step into the market today will lose out as their investment mistakes won’t be covered up by a rising market. In other words correct asset selection will be more important than ever – property investors need to be more strategic and think long-term.

Yes, it’s still possible to invest successfully in this new environment …

Here’s how

The key to investing in a challenging market is to play it safe and not go out on a limb and risk your savings on the ‘next big thing’.

Smart investors stick to a time tested, proven strategy and only buy investment-grade assets. That is, properties which will be in continuous strong demand from a wide range of owner-occupiers, with excellent rental and resale potential that are located in areas less likely to be dragged down by the languishing market because of their demographics.

This means it’s best to avoid the top end of the market, where the most expensive homes are likely to suffer in a market downturn because tighter finance conditions and reduced cash flow will dry up discretionary spending and put downward pressure on top-end property prices.

The same is true for the lower end of the market.

The more affordable, working class suburbs will also struggle during this period, as they tend to be populated by young families with limited funds who max-out out their finances buying their home – and most likely max-out their credit cards furnishing it.

These also tend to be areas where wage growth is stagnant and locations where infrastructure spending and development is lagging desperately behind population growth, making opportunities for socio-economic mobility scarce.

So avoid these markets which have limited growth potential due to affordability and instead buy in areas where the residents’ disposable income is rising.

New, off the plan and high-rise apartments are an even more risky investment in this climate

The significant number of new apartments under construction and due to come onto the market over the next year or two, especially in the CBD’s of our major cities, means owners of these properties are likely to see significant falls in value and no rental growth for many years.

Add to that the expenses involved in owning this type of property – body corporate and strata fees in Melbourne or Sydney could top $10,000 per year – and you can see why buying an apartment off the plan isn’t a sound investment decision to make at present.

So where should investors buy?

Instead, look to gentrifying suburbs and more established inner and middle-ring suburbs where residents have higher disposable income; think Bentleigh in Melbourne, Randwick in Sydney or Stafford in Brisbane.

There will always be strong demand for good properties in these areas, with both rental returns and long-term capital growth virtually assured.

It’s also important not to despair about the changing market, but rather, to be savvy enough to recognise the new opportunities it presents.

Remember, property values only matter if you are buying, selling or refinancing a property

If you own a property and the market turns down, the value of your property really does not matter unless you’re try to sell or refinance your property.

So if you’re a long-term investor, there’s really fewer reasons to worry about the value of your property than most people seem to think, as long as you have the financial buffers in place to see you through the next year or two. And as potential buyers will be constrained by the changing face of lending, fewer people in the market to buy real estate will mean there are more tenants for your investment properties.

This is the time in the property cycle where rental returns catch up, having lagged behind property price growth for the last few years.

Immigration has an enormous role to play in the Australian property market. About 55% of our massive population growth is made up of migrants from overseas.

Melbourne has around 85,000 overseas arrivals a year, while in Sydney, overseas arrivals account for around three-quarters of the city’s annual population growth (90,000 people). Nearly all of these people start off as tenants who will need to rent for a number of years before they can buy their own properties – just another factor that will underpin our property markets.

There will always be opportunities in the property market for wise investors

It’s simply a matter of tailoring your strategy to meet the changing conditions.

Don’t be deterred by the current market conditions and don’t focus on trying to time the market – it only leads to disappointment. Instead, when your finances allow it, start hunting for your next investment.

This is still a good time to buy the type of property you’d be happy owning for the next 20 years, rather than hoping for an instant large return.

Instead, buy now when there is less competition, and buy well, with a sound, long-term plan.

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