Is residential property a worthwhile investment?

We're all familiar with the property mantra Location Location Location. It's a catch-phrase reputedly coined back in the mid 1920's which has stood the test of time and is today the universal truism amongst property experts who espouse the virtues, that is to say, the long term capital growth, that buying residential property in desirable and sought after locations brings.

I don't think anyone would disagree that location is one of the most important factors to consider when choosing where to buy. However, there is another equally important factor and that is choosing when to buy – in other words, Timing, Timing, Timing. This refers to knowing when to enter the market, when to get out of the market and equally importantly, when to stay away from the market. So where are we with timing right now? Well, I think the market is suggesting, at least for the time being, that property investors would be better off sitting tight and waiting for things to pick up.

Current market performance

The reason for staying out is because the residential property market has not, according to data compiled by Residex, performed well over the recent past. In fact, as the table below shows, every capital city other than Sydney has experienced negative house price growth over the past twelve months. And the picture isn't that much better for units either, where only the ACT and Sydney saw positive growth. (More from Peter Boehm: How To Find A Property Bargain)

What is really concerning is that Residex's research indicates almost anyone who bought property a year ago has lost money, with some pretty big annual falls in Perth, Darwin and Brisbane.

However, it's not all doom and gloom, with property prices over the past ten years showing double digit growth, other than in Sydney where house and unit price growth is around half that of other major capital cities. Put another way, the data indicates that someone who bought a property ten years ago has seen the value of that property increase by around 160%. And that's an excellent, if not a remarkable result, given the economic turmoil that has occurred during the last decade. The analysis also supports what we all know, and that is that property is a long term investment, subject to cycles during which prices move down as well as up.

Why are property prices falling?

What's behind the current weakness in Australian property prices? I think there are two opposing forces. On the positive side we have low unemployment, low interest rates, a strong commodities sector, a growing population and a desire by most Australians, young and old, to be home owners or property investors. These factors help push property prices up, especially when there is a lack of housing stock to satisfy demand. (More from Peter Boehm: Twenty Home Loan Myths: Part One)

On the negative side however, we have severe home affordability problems, a weak global economy, the spectre of interest rate rises, political uncertainty, a two speed economy resulting in an increasing unwillingness of borrowers to leverage-up because they're worried about their jobs and taking on too much debt and the current downward direction of house prices. I believe the negatives currently outweigh the positives and as a result buyers are holding back (auction clearance rates and the lengthening out of average days on market for sales by private treaty). And that is why prices are dropping.

The future direction of property prices

No one can predict with certainty where property prices will end up in the medium term, especially given the high level of uncertainty surrounding the local and global economies. But in the short term, that is, over next year or so, it would appear prices will remain flat at best, with the likelihood they have further to fall. In fact, some even believe we are experiencing a housing bubble that is likely to burst, and are predicting property prices could drop by as much as 40%. (More from Peter Boehm: Beware Of Property Bargains)

I doubt this will be the case. Although there is still a bit to overcome before we see prices heading north again, the chances of a full blown property crash appears highly unlikely. For this to happen, a number of extreme and severely adverse events would have to occur, and I don't think these events will happen. These include;

• A big jump in the cost of home loan finance
• A big reduction in the availability of home loan finance
• A big jump in broad based unemployment
• A big slowdown in economic activity and demand for our resources from China
• A big increase in housing construction resulting in oversupply.

So while I don't expect the property market to crash as some of the more pessimistic pundits predict, I do expect prices to soften for the remainder of 2011 and perhaps into the early part of 2012, and then to be flat for most of next year.

What to do

This is not a particularly enticing outlook for property investors, especially given the high entry costs and the fact that most will be negatively geared. And don't forget, even if prices remain flat this is not a good outcome as it means that in real terms (i.e. after taking inflation into account), the capital value of property investment is actually going backwards.

The key in property investment (and pretty much any investment for that matter) is to know where in the cycle you are buying so you can judge whether you're getting a good price and whether prices have further to fall. Getting the combination of location and timing right is therefore vitally important, as well as an understanding that not all property types and locations move in the same direction or in the same way. For instance, while prices may be coming down in most areas, there will be others where the opposite is happening. The trick, or rather the skill, is to find these properties and these locations. (More from Peter Boehm: Home Ownership Halved)

On balance then, while I believe property prices will recover, I also believe we have a little further to go before we hit the bottom of the cycle and for this reason it's probably a good idea to wait a little longer before investing - at least until there is more certainty that prices are on the way up. Furthermore when the time comes to invest, it may be wise to lower growth expectations to something round 4% plus inflation and use this figure to determine whether you'll get the returns needed to make investing in property worthwhile.

Do you think residential property is a worthwhile investment? Do you expect prices to fall further? If you have bought during the past year, how has your investment performed?

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Peter Boehm's first book, The Great Australian Dream: A Guide to Buying Your First Home, is available online and at all good bookstores. It discusses the numerous challenges Australians face in entering the property market as owner occupiers and investors and provides straightforward advice, hints and tips on getting past them.