I continue to see signs of optimism in the property market.  After being freed from restrictions, with the virus apparently under control in this country, government stimulus paying a role and with some strength in the property market (albeit from a very low base) there is a feeling that everything will be back to normal – or better than normal – very soon.

I remain very cautious about the economy and the property market.  The Economist Magazine introduced the concept of the 90% economy.   This is the ide7a, based on experience in China, that whilst the economy will recover to a large extent, it will not recover to 100% for some time after restrictions are fully lifted – at least a year or two.

Instinctively this makes sense to me.  It appears that our international borders will remain closed for some time and social distancing measures will remain in place until a vaccine can be made widely available.  In this scenario, I can think of at least 10 areas that won’t immediately recover and that might each materially reduce economic output over the next 12 months:

Consumer Confidence – Whilst Consumer Confidence has started to bounce back, it is hard to see it recovering in full for a number of years.  This means reduced spending (especially on larger purchases) and higher savings rates going forward whether this is driven by residual fear of the virus or a more conservative approach to spending.  The reduction in the value of shares and other assets will also tend to reduce consumer spending – the so called wealth effect.

Construction – Whilst many builders have been remarkably unaffected by the pandemic as they are completing existing projects the incoming pipeline for many builders must be drying up.  In addition, the demand for retail and office space must be permanently reduced to some extent going forward with a resulting reduction in construction activity.

International Tourism – Tourism accounts for about 3% of our economy.  Domestic tourism is about 75% of this – and may increase as Australians are unable to travel abroad.  However, international tourism is at a standstill, international tourists tend to spend more per capita and it’s hard to see domestic tourists fully bridging the gap.

Retail – Retail as an industry was struggling prior to the pandemic.  Even with rental concessions and support, many more stores will not reopen and chains will reduce their store numbers.  We are seeing this already.

Unemployment – Reserve Bank forecasts suggest that unemployment will be around 2% higher for two years than was expected pre-pandemic.  That 2% means around 250,000 people whose income will be reduced to the level of unemployment or other benefits.

Investment – Investment typically represents around 24% of our economy.  Many businesses have been focussed on survival and preserving cash over the past few months.  It seems natural to expect that investment will be reduced as a result of cash shortages and subdued sales forecasts and there are suggestions that planned capital expenditure might have fallen 10% already – even noting that government infrastructure and many large mining projects will continue.

Social Distancing – Social distancing requirements are expected to continue for some time.  This will impose limits on many businesses that will restrict their turnover and profits.  Examples include pubs, clubs, restaurants, cinemas, gyms and large sporting events.

International Trade – Exports represent more than 20% of our economy.  With economic downturns around the world, there must be some negative impact on the volume and prices of our exports.  The direct and indirect impacts on paid international student numbers are not expected to be positive.

Immigration – Australia has received something like 200,000 net immigrants per annum over the past few years.  This will be reduced to a trickle for at least as long as our borders are closed.

Small and Medium Enterprises – SME’s are a key driver of employment.  Recessions tend to cause higher rates of SME insolvency and reduce the rate of new SME’s being formed.

The government is clearly seeking to ameliorate the worst of the effects with stimulus programs – the most recent being HomeBuilder.  Reduced interest rates, government spending programs and other actions will have an impact.  However, governments need to be judicious.  If HomeBuilder encourages building more homes but there is no demand for them the program may keep tradies employed in the short term but create a glut of homes that will cause medium and longer term problems.  Reducing interest rates sounds like a good idea – but if risk averse lenders and tight lending criteria mean you can’t get a loan the benefits will be reduced as lowering interest rates reduces the incomes of those who live off the interest on their investments.

Modern economies are complex mechanisms with all sorts of feedback loops, multiplier effects and dynamic interactions.  The net effect of the pandemic restrictions is simply unknowable – especially as there is no precedent for these restrictions.  Some areas and markets will be affected more than others and at different times.

The above effects will also diminish over time as restrictions continue to be relaxed, as a vaccine is hopefully introduced and behaviours return to ‘normal’.

On balance, I remain cautious about the economy and the property market over the next year or two.  I believe investors should prepare for turbulence by reducing excessive gearing, getting their affairs in good order and making sure that they are in a position to seize the opportunities that will surely emerge.

As always, I remain optimistic about the long term future of Australia.

Lewis O’Brien

Melbourne’s property lawyer of choice.