value of vacant land in a falling market

great reply. If I can add to it, simplified basic math on why land falls harder when prices stall;

Consider a development site that can have 5 townhouses built on it. Each townhouse costs say $300k in build costs and sells for $550k. At a ~10% margin, this means the land component of each development is worth around $200k, giving a total value of $1m for the undeveloped land.

Now suppose there is a correction in house prices, and a completed townhouse falls by ~10% now selling for $500k instead of $550k. In order for developers to make the same profit, the price of the development needs to fall from $500k to 450k. Build costs are largely fixed, so that means the land component has to fall to $150k. The un-developed block is now worth $750k.

So a 10% fall in the house price caused a 25% fall in the development site. This is because build costs do not change, so 100% of the price fall of each apartment is absorbed by the land cost alone. Its an inverse of boom conditions, where people flock to development sites for the potential to double-down profits as price rises of one unit multiplies by the development potential of their land.

In general falls hit hardest what ever is the most oversupplied, and typically that is new build as supply of anything else can only increase by market sentiment for the product decreasing (whereas new build actually adds new stock). As for your house, a single dwelling, you're pretty safe from the development multiplier but exposed to the new build over-supply.

The problem with new land estates is that in a crash, people stop buying which means the companies that release the land loose a lot of customers. they then market new special estates and releases that undercut the existing market in order to win over established home buyers. In WA from around 2012 this is what the Alkimos estate did to neighbouring Jindalee. A sea-side block in jindalee sold for around $400k+, but then overnight you could pick up a H&L package a few km up the road for not much more. Jindalee prices today are no different to what they were in 2007 (and that isn't the same for all of Perth. Many un-oversupplied properties are up 30% since then)

 

That's very interesting, gives an extra layer as to why new development especially fringe estates fell so sharply. Ireland didn't go too nuts on apartments, it was the new fringe development that really went silly, though of course Australia's had plenty of this too. The effects can definitely knock on to other areas too, especially with the trend of apartment blocks and townhouses appearing in many established suburbs. Instead of strong competition to buy, strong competition to sell can create its own feedback effect. So my "buy in good suburbs" assumption, while it worked well for Ireland, might not necessarily work as well for some parts of Aussie cities. It all depends on what the competition is in a suburb.

 

The other thing to consider is an economic recession. We haven't had a proper one hit that was prolonged for past 2.5 decades. The in itself can contribute to negative feedback loop as well as massive deleveraging.

 

Ireland makes for an incredibly interesting case study in property. At its peak in 2009, there was an estimated 100,000 excess dwellings and a vacancy rate over 15% for a national population of 4.5m people. The fact that people still wanted to invest and banks would still lend shows the extent of hype and how little regulation was in place. in a similar vein but lesser extent, the US had a vacancy rate around 10% before the crash in 2008.

Australia doesn't have the same extreme levels of development, in that our development levels are quite tightly correlated to population growth (generally hovering around 1 new dwelling per 2-2.5 new people). The problem is the delay between approving and completing new dwellings, vs. the instantaneous change in population growth, and WA is about the best case study we have for this. In WA 2013/14, there were around 80,000 new people in the state (annualized) and only ~36,000 dwellings approved. this would actually have been an underbuild, but by 2015 when all of those approvals had reached turnkey completion, population growth had fallen to 30,000 people so it was a massive overbuild of 2x requirements. With Sydney on track to complete 70,000+ dwellings in coming years, anything under its recent peak population growth of around 110,000 will constitute an overbuild. If that 110,000 falls to 70,000, then much like perth, it will be 1 dwelling per new person and ~2x requirements to maintain its price point. So a potential scenario for the Sydney market is more or less a replication of what has happened in Perth over the last 3 years.

 

With the 15% vacancy rate though, much of this seemed to come out of nowhere. For most areas, especially around Dublin 4, Dublin 2 etc vacancy rates actually fell quite a bit right before the crash. During the peak of the selling frenzy, a lot of properties weren't counted as vacant because they were simply selling too quickly.

People genuinely thought these properties were going to be filled, and as the rate of investment was very rapid a lot of buy to let owners were leaving places empty then flipping them, sometimes in less than a year. Because people bought them immediately, they were never 'vacant'. I think Australia's vacancy rate will spike sharply when price growth stalls. A study a couple of years back strongly indicated Melbourne had up to a 20% vacancy rate in IPs even though the official rate is much lower. The manic phase of bubbles also tends to mask default rates because when people get into trouble they can just sell quickly.

A lot of Ireland's massive oversupply also became apparent only as investors started selling. I won't be surprised to find Australia has a huge oversupply we're not yet seeing. When you look at the high rate of investment ownership in dwellings like apartments, that's a lot of stock that people do own right now, but could certainly sell off in a pinch, which would worsen oversupply.

We're building about 230,000 homes a year, and according to BIS Shrapnel we only need 150,000-165,000 based on demand which includes that unusually strong demand from investors. If half of our new buyer market is investors (which it is, it's been hovering around 50% for 5 years and even hit 60% at one point) then our "bust market" need is probably much lower than BIS Shrapnel's range, possibly even half of the range. A lot of these inexperienced investors will stop buying if the market does correct. So we might only need as few as say 100,000 homes annually, especially with falling population growth, low numbers of first home buyers able to get finance, and if our number of investors in the market falls back as well to near its historic rate which was closer to 15-30%, we could see our annual needs drop very sharply and very quickly. I think unfortunately there are a lot of unknowns and a lot depends on what those large numbers of recent, inexperienced investors will do, and how many are actually leaving homes vacant.

People in Ireland were honestly shocked by all the oversupply. No one paid any attention to it or really knew it's extent till after the crash had begun. I don't know if Ireland's a good direct comparison, we're certainly a much larger market here, but still...

 

Tulips, art, wines, commodities, stocks, bonds, property, its all the same old story.

There is definitely no undersupply of homes to live in, otherwise there would be many living on the streets or crowding out caravan sites and vacancy rate would be zero or near zero. there is only an undersupply for investors growing their portfolios or parking some of their assets in property. When investors rush to sell in a bear market, you'd suddenly get an oversupply.

 

We are a bit sad with the whole process. We are 32 and 35 couple. Looks like we will have to wait for 5 to 8 years to be in a situation when house prices will likely be lower than now (10%-20%-30% who knows) and by that time we'll have more savings. Its a bit sad to imagine we'll have to wait that long to buy our dream house and keep. when we started planning, we visited many display homes weekends after weekend, already planned the perfect floor plan, landscape, orientation, placement of windows/door, even the color and layout of kitchen cupboard/pendant lights, furniture layout etc, spent nights on the build budget, read 100 blogs on homeone forum.its because we initially deposited 0.25% on a OTP land just next to Schofields station in February. after 2 months of contract review (extreme delay from vendors side), my lawyer found out that the 10% deposit of the land needs to be released to the developer (who is new in the field). to we pulled out and started to look for more a perfect registered vacant land. Then I realised why prices are dropping and blocks are not sold since February! something is wrong!! its a bit heartbreaking as we had our dreams and hopes up. trying to suck it up and forget about building house for few yrs

 

Dream bigger. Spend those hours learning to invest instead, and you can do better than a new build 45km out?

 

All that work is not for nothing. At least you are fully prepared to build and have not lost your pants.

Australia is a big place, perhaps you could go to a smaller coastal city or to another state capital city like Perth/Darwin where land is so much cheaper and nearer to the city. The land cost in sydney may buy you a house with big piece of land elsewhere. Who knows there might even be lithium or some other precious metal under your land that will set you up for life.