While property has traditionally been seen as the safest of all investment options, new analysis has emerged which challenges that belief.
In its monthly newsletter, investment management firm Auscap Asset Management has said that our reliance on past growth trends may be blinding us to certain risks that may adversely affect the property market in the future.
“Risks exist for every investment whether we acknowledge the risks or not. Risks that have not appeared for a long time can be ignored by investors or even assumed not to exist,” Tim Carleton and Matthew Parker, principals at Auscap, said.
The assumption that property inherently carries a low risk could be traced back to the fact that real estate has not experienced a broad decline since 1991, they said.
Carleton and Parker added that since there had not been a meaningful correction in the market for a while, this implies that the risk “might be quite high” since excesses in the system had been building up during that time.
With growth rates in house prices exceeding growth in household income, this shows that prospective residential returns will be lower going forward, they said.
“But many draw the opposite conclusion, that the historical growth rates are evidence that house prices should continue to grow at those rates in the future. The inference is that past returns tell us something about future returns. This extrapolation bias carries considerable risk.”
The pair said that the chances that residential property prices are elevated stems from a number of factors including low interest rates, high debt levels, solid employment levels and strong long-term historic growth.
“The preconditions for high property prices are in place. Prices have risen to reflect the favourable macroeconomic factors. But like a stock that is pricing in the continuance of favourable conditions, this most likely means that the downside risks associated with investing in property are elevated.”
According to Carleton and Parker, risks most likely to impact the residential property market include:
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- Significant effects from interest rate rises over the medium-term given the current low interest rate environment
- Unemployment rates which may increase from the current levels
- Natural headwinds for domestic economic growth that overcome any tailwinds
- High debt levels compared to historical household leverage ratios such that any deleveraging may negatively impact prices