There's no such thing as "Too hot"

Topics: Too hot, Overheated, Property investment, Capital growth, Cause of capital growth, Supply and demand
Author: Jeremy Sheppard
Date: 27 July 2015

How many times have you heard the following clichés used to describe a property market?

  • "Too hot"
  • "Overheated"

There's no such thing - depending on how you interpret these "temperature" metaphors. I'll explain why, but first we need to...

Define terms

What defines a market as hot? Is it:

  • a) Prices have recently risen faster than the long term national average
  • b) Buyers are paying too much
  • c) Demand currently exceeds supply
  • d) The daytime air temperature is above 30 degrees

Is a hot market one with high recent growth?

In order to witness price change, time must pass. Since property is a slow moving beast, looking at changes from one month to the next is like the kids asking, "Are we there yet?" every five minutes on a long road trip.

You'd need to examine the change in prices for at least the last 6 months to confidently say there has been strong price growth. And seriously, how much can prices legitimately rise in just 6 months. I'm not talking about medians which can jump 30% in one month and drop again the next.

To claim a market is hot by examining recent price growth, you're really saying that demand was exceeding supply which led to significant price rise.

What you're really saying is that the market has been hot. It might not be hot now though. After all, nothing subdues demand like sky-high prices.

Is a hot market one where buyers pay too much?

I've heard one property "educator" refer to an overheated market as one in which...

      "Buyers are paying too much"

That definition triggers another question: how much is "too" much?

Most would argue paying anything above fair market value is paying "too much". But fair market value is based on recent comparable sales. So if nobody pays "too" much, prices never rise!

If the definition of "overheated" is buying in a market in which prices are rising, I'll take that ahead of buying into a market where prices are falling.

Some of these "experts" are only just smart enough to know how to breathe (and promote themselves well). I hope they're not "educating" investors to buy in cold markets.

Demand cannot exceed supply by "too much". If it did, we'd have a concept called, "too much capital growth" or "too much profit". Investors might earn "too much money" leading to "too much wealth" and "too much financial independence and security".

When supply and demand are balanced, prices are generally flat. That may be good for Goldie-locks, but it's not good for property investors. We want the extreme end, where demand exceeds supply.

Is a hot market one in which demand exceeds supply?

Whenever I use the word "hot" to describe a property market, I'm always thinking of demand exceeding supply. That imbalance can force prices up; it can move stock quickly; it makes buyers competitive; auctions hectic; open inspections busy. That to me is a "hot" market - one in which demand exceeds supply.

Supply and demand

The law of supply and demand states that when demand exceeds supply, prices rise. Is there a point when demand can exceed supply by "too" much? What happens in this case? Does the law of supply and demand suddenly invert like a collapsed star. Are Newtonian physics inapplicable now we're in some bizarre quantum state?

No. There's no such thing. It's complete bunkum.

The greater the degree by which demand exceeds supply, the greater the pressure there is on prices to rise. It's as simple as that. You want to invest in "hot" markets, "overheated" ones, not cold ones or even lukewarm ones.

The ratio of demand to supply

To gauge the potential for future capital growth, we need to know the demand to supply ratio (DSR) right now. Many people think that if demand exceeds supply, this is a hot market and therefore one to avoid, as if they were too late.

Wrong. You want to avoid cold markets. That's when you're too late. Head towards the light, the heat, where demand exceeds supply. Cold markets are capital growth wastelands.

I hear statements every month concerning the DSR along the lines of...

     "Jeremy, the DSR is already too high"

There is no such thing as "too" high.

Success isn't easy

When I was first learning about real estate I went to many seminars and read many books. Many of the promoters of courses and books would say that anyone can achieve financial success in real estate. But I've come to believe that is a bit misleading.

Successful property investing is hard work. Anyone who says it's easy is either gifted or got lucky.

If you shy away from hard work, success is not for you. Aim for mediocre and you'll probably get it.

I understand that it is hard to buy into a high DSR market. It is hard to be successful. So what choice do you have? Take the easy option and buy in cold markets?

Suck it in and summon the best you've got in you. Put on your determined face and get out there with all those less-informed buyers. Invest in markets where you have to pay top dollar to get top props.

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