The REA Group Limited (ASX: REA) share price has been hit hard during 2022. At the time of writing the ASX share is down by 35%.
It's rare for a leading business to fall that much over 12 months. The higher interest rates (and inflation) seem to be really affecting some parts of the market.
REA Group is a business that operates property sites like realestate.com.au.
For REA Group, it's a tricky situation. Not only do higher interest rates (theoretically) hurt the company's valuation, but it's also hurting house prices – the thing that people are advertising on the platform. Why do interest rates matter so much for ASX shares and property? Warren Buffett once explained:
The value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100% sensitive to interest rates because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in over a period of time, and the higher interest rates are the less that present value is going to be.
So every business by its nature… its intrinsic valuation is 100% sensitive to interest rates.
Image source: Getty Images
What's going on with the property market?
House prices are falling amid the significantly higher interest rate. According to Corelogic, Sydney house prices have fallen more than 10% from their peak, though were still 10.3% above the pre-COVID level at the end of November 2022.
Melbourne prices are only 2.8% above where they were at the onset of COVID. Melbourne house prices could reach pre-COVID levels by March next year.
Corelogic said that most of the other capital cities and broad 'rest-of-state regions' are still showing dwelling values at least 25% above March 2020 levels.
REA Group earns most of its revenue thanks to two different factors – how much it can charge for property listings and how many listings there are.
Falling property prices may give the company less room to implement strong price increases.
Domain Holdings Australia Ltd (ASX: DHG) shares were recently crunched after it told the market that conditions were "deteriorating". There was a 16% decline in listings in October and a 22% decline in November. The ASX share then said:
Inner city Sydney and Melbourne continue to experience particular weakness, with November listings down 38% and 32% respectively. December is experiencing an earlier than usual seasonal decline as agents and vendors defer listings into the 2023 calendar year.
This trend contrasts with December 2021 when listings activity was unusually long, extending into late December. As a result, December month to date listings are down around 51% in Sydney and 37% in Melbourne.
Is the REA Group share price a buy?
It seems quite likely that REA Group is also seeing a sizeable drop in listings, which puts pressure on earnings.
However, it's possible that there could be a bit of a rebound in listing volumes next year if the higher interest rates encourage some property owners to sell.
The REA Group share price was higher than the current level for most of FY21 and FY22.
But, the ASX share could go lower than today if investors become more bearish about its earnings.
According to Commsec, the REA Group share price is valued at 36 times FY23's estimated earnings. But, it is priced at 31 times FY24's estimated earnings.
I think the business has a very strong market position, with promising investments in property sites in India, Southeast Asia and the US. But, we should pay most attention to the main profit generator of the business, which is uncertain.
It'd be even better valued if the shares were closer to $100, so I'd be happy to be patient, but I think the company can do well over the long term.
