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Property

21 June 2004 Angelo Coppola

The local residential property market is currently experiencing a boom period.

Wayne McCurrie, CEO of Momentum MultiManagers, says that the last time this occurred was in the early 1990's, which was followed by a protracted poor property market until 1998.

It is very important for all current and potentialinvestors to understand that the property market was very cheap in 1998/1999 and whatever decision is made now about property, the current boom is already well established.

This latest boom has seen the yield on property decline by 50% (ie property is twice as "expensive") as what it was in 1998/1999. Without any other additional data or comments, this should give rise to some caution by investors.

As an overall commentary, the success of any investment decision is primarily based on the valuation of the asset (or investment) when purchased.

While this sounds simplistic, it is very difficult to achieve in practice.

What normally happens is that investors believe a trend (is rising or falling prices) only well after it is established.

For example you hear statements like "I know it is expensive but look at all the good news" or conversely "I know it is cheap, but look at all the bad news".

Investors must understand that as a basic rule of thumb, if all the news you hear about an asset is good, the price probably takes this into account already (ie it is expensive).

At present the local residential property market is expensive, after a number of years of good returns. This does not mean that prices are going to fall materially, or that investors will be destroyed.

What this means is that on average over say a 3-5 years period, investors will be disappointed with their investment, not necessarily because the property market itself was terrible, but because they purchased at a high level.

Physical property developments are well above the normal level. For example the value of residential building plans passed as a percentage of household income has increased by 50% since 1998, and is approaching the levels that prevailed in the last boom period.

What all of this means is that plenty of supply is coming onto the market, which will become evident in the rental market.

The current level of property market prices and building activity is clearly supported by low interest rates. In fact property appears "reasonably" valued in relation to current interest rate levels.

However this situation will charge in the next cycle of interest rate increases, possibly starting later this year / easily next year. Current overall economic conditions are supportive of high property prices and will most likely remain supportive for a while yet.

However an increase in interest rates will dampen the property market, and will especially affect the investors who have borrowed 100% of the property value in order to rent out and get capital appreciation.

They could be squeezed. Of course certain individual properties will perform well, same as some shares rise in a falling equity market.

But in general interest rate increases will negatively affect the property market as a unit, especially if property is already well into a bull market run.

It is true that property does has never fallen in value over the medium period, but investors expect a reasonable return, while speculators rely thereon to stay solvent. The possibility of a reasonable return from this level is muted in the property market.

As a final summary the easy moneyhas already been made. From now on it becomes more difficult.

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