What determines house prices Part 1

© Other Media articles — www.propertyplanning.com.au.
Reproduced with permission.

If investors and home buyers understand the factors that determine residential property prices, it puts them in a better position to capitalise on opportunities that may not be obvious to the majority of the market.

If you can get into the market before prices start to go up and get out before they come down, you maximise your profits and minimise (or hopefully eliminate) your losses.

The forces that influence the prices of our houses are the same that influence the prices of cars, TVs and groceries – demand and supply.

The price of an item is dependent on the demand for that item and how much of it is for sale. For example, imagine two types of property; a seafront house and a small apartment in the CBD. Demand for property on the sea front is high but there is only a limited supply of properties with absolute sea frontage. High demand, low supply, the price goes up.

On the other hand, demand for apartments is not as high as demand for houses on the sea front. In addition to this, there is a large supply of apartments in the city. Low demand for apartments, high supply, the price goes down. The price of apartments will start to go up when demand increases and/or supply dries up as no more apartments are being built.

In this article, we look at the two major influences for the demand of property. In the next instalment, we will discuss the remainder of the demand influences. Finally we will outline the factors that influence the supply of property.

Demand

It is owner-occupiers and investors of property that provide the demand for property. Understanding what influences their buying behaviour can give you an insight into when property prices will increase and decrease.

Some of the major factors that influence demand are interest rates, economy, demographics, government, finance, rents and returns on alternative investments, prospects of capital growth.

Interest rates
Historically, interest rates are one of the biggest influences on our buying behaviour. In other words, the movement of interest rates up or down has been one of the biggest determinants of demand.

When interest rates go up, people are less likely to buy as it costs more in mortgage repayments to purchase property. When interest rates go down, people are more likely to buy one or more properties as mortgage repayments drop.

I mentioned the word ‘historically’ because up until 2007, this was the case. In late 2007/early 2008, interest rates were rising but amazingly so were prices as demand for property didn’t wane. Similarly, interest rates have dropped approximately 400 basis points (4 per cent) from March 2008 but property prices have actually fallen slightly as demand has waned significantly, as evidenced by the relatively low numbers of property sold in the past 12 months.

These two recent anomalies can be explained.

Late 2007/early 2008 was the peak of the last “mini-boom” and it takes more than just a couple of interest rate rises to dampen consumer confidence in a boom.

However, the last interest rise in the first week of March 2008 (which was the fourth increase in seven months) did the trick. Since this last rate rise in March 2008, property prices have struggled.

The period March 2008 to now has seen the Reserve Bank of Australia (RBA) drop the cash rate by 4.25 per cent. However, due to the large drop in business and consumer confidence which has been brought on by the Global Financial Crisis (GFC), the falls in interest rates have not had as big a positive influence on property buyers’ behaviour as has the negative impact of the GFC. Once the negative effects of the GFC start to diminish demand for property and prices will start to rise.

Economy

If we were to provide a report card on the world economies and allocate grades, the rest of the world would receive a D+ and Australia would score a C-. The major economies of the world are performing at a below-average level but there are some signs of improvement. Australia, on the other hand, is at a ‘pass’ standard, but only just.

At the moment, it is the uncertainty of employment that is the biggest economic influence on property purchases and is also the largest single influence on the property market. This is having a larger impact than the very low interest rates we are currently experiencing.

Other economic factors that have a large impact on property include the level of wages and disposable income. If our wages are increasing, we are more likely to buy, thus creating more demand and increasing property prices. If disposable income increases, either due to wage increases or tax cuts, this also makes us more inclined to buy property, especially investment and/or holiday homes.

One of the key indicators that demand for property will increase again is when unemployment peaks then starts to drop again. This is at least a year away. Keep your eye on unemployment figures, especially when respected economic and property forecasters start to talk about “unemployment nearing its peak”.

In the next article in this series, we look at demographics, government, finance, rents and returns on alternative investments, prospects of capital growth and their effects on demand for property.

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