Mastering supply and demand: part 2

The demand chain
When everyone is riding a bull market, we have a boom on our hand. This is apparent in Sydney right now.

It seems people will pay just about anything as demand increases with no ceiling. Everyone converging on the marketplace at once creates a frenzy of activity that leads to a price war. Real estate is a game of supply and demand, but it is best to keep your head.

In September, a 65 square metre, one-bedroom apartment in Kirribilli sold for $1.2 million. That’s a staggering $20,700 per square metre. There is no argument the location is amazing, but the previous owners are the real winners in this purchase.

So why would someone pay this price? Where does the upward pressure to pay this kind of money come from?

Case study of demand chain
Before we answer that, let us explore why some booms fail. A few years back I was asked to comment on Moranbah. At the time many experts suggested it was the best growth market around, and there was no doubt it grew. In 2011 I described that market as “crack cocaine” to property investors, which caused a stir. Many experts wrote to me explaining their point of view and suggested I was wrong.

Basic properties were over a million dollars and renting for up to $3,000 per week at the time. Today, you can buy a home there for as little as $190,000. Buyers in 2011 lost money, as that boom had begun some six years before. They bought too late in the value chain.

The only real group that was buying in that township were investors. So who was missing? First home owners and upgraders were not interested, downsizers were not relocating to the area, overseas investors were not clamouring to buy into the market and institutional investors and super funds were wary.

When market forces changed, the investors imploded. Unable to find a market to sell to among other investment groups, prices dropped significantly – up to 75 per cent in some cases! Now opportunistic investors can probably nab a bargain as the supply chain begins again. But it’s a boom-and-bust market because it lacks key buyer groups.

As for the market in Sydney, there is no doubt there will be a price correction in the future. There always is. Will the bottom fall out of the market like Moranbah? No, because there are too many demand groups. Each group has its own challenges and opportunities but, because the risk exposure is spread, we won’t see a train wreck.

Don’t get me wrong – prices will drop, possibly up to 10 per cent. However, right now I believe more gains may occur first.

Demand chain groups
These types of buyers make up the marketplace:

* First home buyers
* Upgraders
* Downsizers and retirees
* Investors
* Aged care
* Overseas investors
* Institutions and super funds as well as SMSFs

What investors need to gauge is which groups are shopping when they are buying. Generally, not all groups will be shopping at once. When half the groups stagnate, then the market has an even pace and is just plodding along. Demand may be considered moderate or low.

Conversely, when all groups are shopping aggressively at once, we have a property boom.

I like to review markets to see who is shopping and give them a score out of five. I don’t consider aged care because it is a specialised area with rules as to who can live and buy within that sector.

So let us rate Sydney with one being weak and five being very active:
* First home buyers: 5
* Upgraders: 5
* Downsizers: 5
* Investors: 5
* Overseas investors FIRB: 5
* Institutions and super funds: 5

I recently did a focus group in Hobart and asked locals and realtors to rank activity. As you can see, demand appears a lot less exciting:
* First home buyers: 4
* Upgraders: 1
* Downsizers. retirees: 3.5
* Investors: 1
* Overseas investors FIRB: 1
* Institutions and super funds: 1

There is not enough horsepower right now in Hobart to spur on a property boom. Activity is moderate at best.

The demand chain for buyers usually begins with one group, then spreads or dies off. It could be argued that Sydney’s boom began with first home owners back in 2010, followed by downsizers and overseas investors in 2012. Then upgraders went auction-mad and institutional money cashed in on the boom.

However it started, the demand from groups in Sydney has led to a massive boom. It is now up to us to watch which group will opt out first. Will the rush among first home owners die off as substantial planning changes reduce minimum lot sizes? Or will upgraders slow down first because the amount of money they are required to leverage has become too high?

The demand chain, made up of the various buying groups, is an important gauge for investors. People who make up a market and their consumer habits are as important as the property itself.

Combine knowledge of demand levels with the supply chain and you will formulate a great way to find value and the elusive value chain.

Don't miss my third and final blog in this series, where I will explain how you can implement the value chain in today's market to buy well and provide a case study of an investor who mastered supply and demand to create wealth. 

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