Cause And Effect

“Please, ma cherie. I have told you. We are all victims of causality. I drank too much wine, and now I must take a piss. Cause and effect” - The Matrix Reloaded

Cause and effect... If only the world was that simple. 

The economic response to COVID-19 has come hard and fast. Equity markets have nosedived, interest rates have been slashed and governments across the globe have doled out trillions of dollars and euros to “soften the landing” for their respective economies.

Up until last month I hadn’t been watching a lot of financial news. After years of studying and working in financial markets, I just got bored of it. Over the last month however, I’ve had Bloomberg and Sky running non-stop. Admittedly, I like a little white-noise whilst working from home, but c’mon - prime ministers in intensive care, countries on lockdown, cruise ships stuck at sea - It’s like watching a post-apocalyptic action movie unfold, The Matrix maybe?

A friend of mine who breads race horses once told me the more you know the less you know. I think the same can be said about investing. There are days where the expected happens and there others where I just scratch my head. I guess that’s why they call it a social science.

So, what about the real estate market? Depending on who you talk to, you’ll get a different response, laden with biases. 

My view is we’re somewhere towards the middle of a major systemic shock and when a shock occurs, rationality goes out the window. 

Picture someone sneaking up behind you, just as you’re about to take a sip of coffee. What’s going to happen? The short answer is, nobody knows, however there are now a lot more possibilities, than just take or don’t take a sip; you could spill the coffee on yourself, you could spill the coffee on the person next to you, you could continue to take a sip unaffected, or indeed you could have no reaction at all. The only immutable truth is two extra possibilities have taken the chance of a positive outcome (taking an enjoyable sip of coffee) from 1 in 2 (50%) to 1 in 4 (25%).

So, as a bystander to COVID-19, what should you do? “Mean reversion” suggests that once the semblance of rationality returns, expectations of price should return to the mean. What this fails to account for however, is when there is a big enough shock, average expectations may change.

Consider the big ticket items below when making your assessment of where property prices will be after the dust settles.

Unemployment

This is the big one. Whilst the official numbers from the ABS aren’t in yet, Roy Morgan is estimating that the unemployment rate for March has jumped to 16.8% and the underemployment (part-time or shift work) has increased to 10.6%. To put that in perspective, that’s 3.92 million Australians that were either unemployed or underemployed in the 2nd half of March.

Not only will there be less buyers in the market, but pressure on the rental market is sure to be felt also. The value of an asset is usually a function of it’s earning potential. There are 2.6m investment properties in the country and many Australian renters struggling to pay the agreed amount. The government has put a moratorium on rent, which could see capital flows shift away from property as an asset class.

Result = downward pressure on price.

Stimulus

The RBA slashed interest rates to almost zero at an emergency meeting last month and the state(s) and federal government combined have delivered a whopping $216b in fiscal stimulus to prop up Australian workers and businesses. Acting quickly and decisively was a good move from the government. But keep in mind, we’ll have to pay back it all back at some point, meaning higher taxes down the track. We have to also consider the efficacy of the stimulus provided, who is it going to and how well can it be utilised to stimulate growth?

Result = upward pressure on price

Share market

Keep in mind that a lot of property investing comes from self managed superannuation. There are over 1.1 million SMSFs in Australia that have varying degrees of exposure to the share market. A reduction in these portfolio values will see less funds available for potential property investment

Result = downward pressure on price.

Social distancing measures

No open homes and no auctions have dramatically reduced competitive tension in the selling market. Open homes have been replaced by virtual and private inspections, where you just don’t get the same feeling of urgency as you do with an open home that’s full of potential underbidders.

Not having auctions have seen most listings change to private treaty, with either a guide or ‘For Sale’ sticker on the property. Compared to 2 months ago where everything in Sydney was being sold at auction above reserve, we’re now seeing a much more subdued buying environment, with offers being made well below price guides.

Result = downward pressure on property price.

Supply and demand

Whilst our infection numbers are doing well against the rest of the world, we’re still on high alert. A lot of businesses remain closed and selling restrictions still in place. 

In this instance the expectation is for both supply and demand to contract. A lot of sellers will take their properties off the market with the view to re-list after conditions improve. Buyers will also leave the market, due to financial circumstances or potentially their view of further price reductions.

Almost two months ago the clearance rate for auctions was tracking on average around 80-85% in NSW. The weekend of Feb 15, Realestate.com.au reported 307 auctions and 1,224 private sales. That’s 1,531 properties for sale. Fast forward to last weekend's result and 37 properties were sold via virtual auction and 792 private sales were closed. That's 829 sold in total, or a 32% decline since February.

Result = downward pressure on price

Verdict

If you were a buyer prior to COVID-19 and have stable income, there are some fantastic buying opportunities around. Buying opportunities are favouring those with an investment horizon of more than 18 months. Owner occupiers are better placed than investors looking at short or even long term letting, as travel bans are now in place and many tenants around the country are struggling with financial hardships.