Melbourne property – the worst performing major city this cycle

Posted by Gavin Chau

Apart from Darwin, Melbourne has clearly been the worst-performing major capital city since this property cycle began in March 2019. A quick look at the house price growth of each capital city from then until now confirms this.

I won’t go too deeply into the reasons, but the pandemic lockdowns and the additional state taxes required to fund them have been the primary reasons for the underperformance. Does this mean we shouldn’t invest there? Looking back on these reasons will seem silly in the decades to come, and everyone will forget them except the craziest property research fanatics.

The first thing to look at when analyzing a market

Let’s have a look at how to begin thinking about property investing. In macro investing, the first thing to look at is the market’s long-term returns. If the market has performed well through various economic crises, wars, interest rates, and so on, we could reasonably assume that whatever fundamental factors have driven the market will continue to drive the market, and all of those signals would be included in the price action. This is one of the most robust and practical ways to zoom out and get the clarity required to make an investing decision. It hasn’t failed in the 140 years of data that I’ve studied. If you get the macro part right, it doesn’t matter what the micro is…. A rising tide will lift all boats. You cannot say the same about getting the micro part right – that’s simply fine-tuning.

How does Melbourne compare?

Very well. If we compare the datasets on the longest timeframes available, Melbourne houses are at least as good as the best markets in Australia (except for Sydney and Brisbane, where prices have run up considerably harder this cycle).

Interestingly, at this point in the cycle, the performance of Melbourne units is slightly better than that of houses. They have beaten the long-term performance of most housing markets, which is very unusual. A 7.7% annual return for units is simply exceptional.

The second thing to look at

The second thing to look at would be how the market is sitting compared to its calculated fair market value. We can determine this mathematically using something called an exponential regression analysis. While it sounds very complicated, it can really be thought of as a fancy way to create a line of best fit through all the data points. If the current prices are below the regression line, they are undervalued. Conversely, the current prices are overvalued if they are above the regression line.

Let’s have a look at where Melbourne is sitting.

The dotted lines on the chart above are the regression lines (or the line of best fit for the dataset). The ‘R²’ value on the equation is the first thing to look at. This is the ‘goodness of fit,’ which can be interpreted as the regression model explaining 97.49% of the variation in house prices and 93.7% of the variation in unit prices. Immediately, we can tell from this that the regression will indicate where prices will be heading with a reasonably high probability.

The second thing to notice is that prices for both houses and units are sitting well below the regression line, which means they are both very undervalued at this stage in the cycle and that they have a lot of room left for upward movement. This is the closest thing you’ll get to a time machine that would let you go back to the past to buy property cheaply. Prices will invariably shoot up (and past) the regression line before they peak this cycle and return to the line.

The interesting thing about investing is that two investors can hold opposing views about a market, and both are correct. The only difference is the timeframe. A day trader looking to sell for a quick profit may see a particular stock as expensive, whereas a long-term value investor looking to hold it forever will see the same thing as cheap.

One of the most overused quotes in investing is from the great Warren Buffet.

“Buy when there’s blood on the streets, even if the blood is your own”.

Buffet is a value investor, has an uncanny knack for finding undervalued investments, and perhaps has one of the best track records as a countercyclical investor. This means he sees value while the rest of the herd looks elsewhere. Incidentally, he sold half his Apple stock just before the market dumped recently. He is the only person in the top 20 richest people in the world who got there purely from investing and not from founding a company or being an heir to a wealthy empire.

I’d say he’s probably worth listening to.

Posted by Gavin Chau, on 27th Aug 2024