ASX newbie

By Michael Yardney

A global credit crunch; US sub-prime crisis; US economy heading for recession; stock markets down; interest rate hikes; housing affordability plummets to an all time low; unprecedented rental supply shortage; lenders tightening their belts.

The incessant media hype surrounding our property markets on a daily basis has been overwhelming to say the least. I know from conducting my recent round of public seminars, that many investors and would-be investors are feeling very uncertain as to what it all means and where our property markets are heading.

There is little doubt that scare tactics are being used by the media to sell stories.
The question is – how do you sift through all of the information to work out what’s really going on? Will our property markets provide us with a feast of excellent opportunities in 2008 or are we heading into a sustained period of low growth and investment famine.

To answer this question, let’s consider the current underlying market fundamentals in more detail;

Supply and demand

Figures from Residex show that all capital cities enjoyed an increase in median values for the year to March 2008. The top performers were Melbourne, Brisbane and Adelaide, with median values rising by 20.03%, 21.15% and 19.38% respectively during this period.

So what has kept our housing market travelling well despite the various goings on overseas and here at home?

Quite simply…supply and demand.

Whilst new dwelling commencements have decreased substantially and remained stagnant for a prolonged period due to escalating construction costs and a lack of skilled labour, our population continues to grow exponentially.

This is particularly true for Melbourne, where the population is expected to boom by as much as 25% in the next 12 years to reach over 4 million by 2020. Melbourne will experience a significant housing shortage in the coming years.

Data suggests that Australia’s building industry can only support the development of around 140,000 new dwellings per annum, whilst demand is in the region of 170,000 accommodation units per annum.

The simple fact of the matter is we do not have enough accommodation for our expanding population.

Because of this chronic housing shortage, I can’t see how property values can decrease substantially or even remain flat for a prolonged period.

Whilst some forecasters are warning of significant drops in housing prices to come, others are more optimistically suggesting that things will continue to escalate over the next 2 to 3 years before slowing down to a moderate and sustainable rate of growth.

The bottom line is, as many potential owner occupiers and investors run for cover in the wake of all the negative press property has been receiving, for those of us who know better, there will be some excellent opportunities. Buying in a slower market is all about buying right. In areas where there is restricted supply and continuing strong demand….in other words where there is no more available land to develop such as along select parts of the coast and throughout inner city markets, where the majority of people want to live…property will always perform strongly over the long term.

In fact the latest ANZ Australian Property Outlook says that house prices and rents will continue to skyrocket on the back of a record shortage of dwellings.
“By 2010 we project a record housing shortage of nearly 200,000 homes, which risks becoming an intractable imbalance as renters and first home buyers become collateral damage in the reserve Bank’s ongoing war on inflation.”

Rental market

The flow on effect from the housing shortage that looks set to continue well into the next decade is that the rental market is experiencing the lowest vacancy rates ever recorded.

The national vacancy rate has dropped to below 1.5% according to data from the Real Estate Institute of Australia and this is evident at every rental open house you go to on weekends. Prospective tenants queue for blocks and battle fiercely to literally “get their foot in the door” of anything that hits the market in some areas.
This overwhelming demand coupled with a severe shortage of stock has inevitably caused rental prices to soar. “Double digit rental growth has occurred over the last year in many of our capital cities,” according to Pamela Yardney, director of property management at Metropole Property Investment Strategists.

“With a shortage of rental properties and no relief in sight, investors can expect an extended period of strong rental growth. At least another 3 years” she said.
Recently released figures from Australian Property Monitors indicated that the largest increase in median asking rent for houses occurred in Melbourne, rising by 17% in the last 12 months. In other states they reported the following: Sydney 11%, Brisbane 10%, Adelaide 4%, Canberra 8%, Perth 14% and Darwin 11%.

”I must caution investors that not all rentals have risen to the same extent and while their is an abundance of tenants, they are still very price sensitive. Therefore when putting up their asking rents, landlords should remember that if they ask too much they can still experience extended vacancy periods” explained Pamela.

Economics

Although there has been much conjecture over the uncertainty surrounding the US economy and how it will impact on us, many economists believe we can weather the storm.

The ANZ Property Outlook says, “Australia’s prospects are much more closely linked with Asia where the growth outlook remains positive. Over the year to September, the Australian economy grew by a robust 4.3% buoyed by strong growth in household spending and solid gains in business investment.”

With unemployment at an all time low and further income tax cuts promised by our new government, consumer confidence remains high despite rising interest rates and cost of living.

It seems Australians are embracing a glass half full mentality despite the bad press the US economy has received here at home. This is perhaps due to the fact that we feel more independent than we have ever done as a nation…we are able to stand on our own two feet and sustain our own economy without relying on our “big brother”.

There is no doubt that those in “mortgage belt” areas are having a tough time of it at present, with the proverbial belt tightening as households already mortgaged to the hilt struggle to make up extra on their monthly repayments. But overall, as the ANZ Outlook states, “in aggregate, rising debt servicing costs have been more than offset by solid income gains.”

In short, people can still afford to spend, and that’s always good news for our property markets.

Interest rates

Of course the double edged sword when it comes to a robust economy is the inevitable inflationary pressure that causes interest rates to climb. Some forecasters are predicting a continuing upward trend for our interest rates throughout 2008, just maybe not at the breakneck speeds we have recently experienced.

Many investors who are old enough to recall the 1980’s property pinch of 18% plus interest rates are cringing at the thought of returning to these conditions. But this is not a likely scenario according to most finance experts.

In fact our interest rates are still relatively low and even if the RBA feels inclined to raise them by a further 0.25% to 0.50% over the coming months, they will remain within 2% of the lowest they have been for the past 40 years.

Investors who know how to manage their portfolio and the financial obligations that goes with it, should be able to ride out any further interest rate hikes. The key is to plan properly, treat your investment endeavours as a business and never over-extend yourself.

Borrowing to buy good properties is not a worry. Not being able to repay your loans is! So ensure you have factored in further potential interest rate rises and have a sufficient buffer to be able to handle them. Look forward to the best scenario, but be prepared for the worst. Then you can sleep comfortably at night.

Affordability

Of course rising interest rates will impact that sector of the market that is already bearing a financial burden.

Would-be first home buyers are being forced to remain in an ever tightening rental market. Caught between a rock and a hard place, they are unable to get into the property market as they cannot afford to meet escalating mortgage repayments. And saving for a deposit is virtually impossible as they pay climbing rents to keep a roof over their heads.

This is good news for investors of course, as it will mean the pressure on rental prices will continue to build to all time highs. And this means that yields which have been lagging behind rapidly moving property values for some time, will finally start to catch up and look better.

So what does it all mean for investors?
The good news for investors who are wondering if they should jump the property ship, is that housing continues to provide strong and stable returns. Data from the ANZ Property Outlook reveals it remains the safest asset class of choice.

In raw terms, since 1984 residential property has delivered a compound annual total return of 13.4%, slightly below that of equities at 13.8%, yet far beyond commercial property (10.4%) and bonds (9.4%).

The bonus is that along with such solid returns, there is a consistency to housing that can’t be found in more volatile asset classes such as commercial property and equities. Quite simply there is really nothing else out there that is “as safe as houses”!

When we consider all of the above fundamentals and how they’re currently combining to impact on property, we can see that now is actually a perfect time to consider starting an investment portfolio or building on an existing one.

In summary, the facts are as follows;

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We have a strong economy that’s holding up well given the current climate of global uncertainty.
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Interest rates might be climbing, but they are still at some of the lowest levels we’ve seen for the past forty years. And quite frankly, they are yet to exceed the rate of capital growth delivered by the right property in the right location. Therefore, good capital gains can potentially offset current interest rates.
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The building industry cannot keep up with the high levels of housing demand we currently have and this is only going to become more apparent as our population continues to escalate – this means Opportunity with a capital “O” for investors as property that has some degree of scarcity (either due to location, architectural style or both), will continue to grow in value.
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Due to interest rate hikes, the supply/demand and affordability crises, rental prices will continue to escalate. With many locked out of the buyer’s market and a shortage of available rental stock, rents are set to soar over the coming years. This means stronger yields for investors, which along with capital gains will present a further opportunity to offset any further interest rate rises.
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The sub-prime crisis, interest rate uncertainty and low affordability will likely impact on buyer sentiment. This means that it will be a “buyer’s market”, with more people forced to sell and less people willing and/or able to buy. Seasoned investors recognise that this combination equals great prospects for buying at or below market value.

Of course I’m not completely blinkered in my assessment of our current market. There is no doubt that residential property won’t escape completely unscathed from the growing uncertainty that many are feeling.

Whilst I do not expect that we will see the large gains we experienced in many of our capital cities for the previous few years, the fact of the matter is that it is very rare for property markets to crash.

Any slow down should not be viewed as some type of doomsday omen.

Rather it is a natural phenomena within the recurring cycle that property markets move in. There are always ups and downs, peaks and troughs. And within Australian property markets, these cycles are continually at different points and moving at different speeds, depending largely on that supply and demand equation.

At the lower end of the market, where there is more supply than demand there is already anecdotal evidence of a slowdown.

That being said, I do not invest in these types of areas. My investment strategy is to always buy in high growth, high demand areas (inner city) that have historically provided excellent returns (of 10% plus), and endured the cyclical peaks and troughs.

Chief equities economist with CommSec, Craig James suggests that residential property prices will continue to grow by 10% to 15% in most capital cities this year. On the flipside, he predicts share prices will only move by 3%.

I always find that when others are too afraid to make a move, I gain the most benefit from doing the exact opposite and jumping in with courage and conviction…to the right property at the right price.

So where are the best opportunities for 2008? Let’s take a closer look at how each state has performed to date and in which direction the capital city markets look to be heading for the remainder of the year…

State summary

New South Wales
Pino Tedesco, director of Metropole PropertyInvestment Strategists Sydney office, says, “The best way to sum up Sydney is that affluent areas are experiencing strong growth, with much of the remaining market experiencing zero or in some cases negative growth. Sydney has regained its mantle as the country’s busiest capital city property market.”

After ambling along at a snail’s pace for the last couple of years or so, Sydney’s property market seems to be gathering momentum in those traditional, “tried and true” inner city locations.

Pino notes, “There were 94,500 house and unit sales across Sydney in 2007 narrowly bettering Melbourne’s 93,000 sales. Sydney is still improving, but broad growth of 7.2% hides a delineated market.”

Pino says the two speed market consists of the faster paced “autobahn”; the eastern suburbs, inner west and lower north shore; with the west and south west being the slower bus lane.

“There has been no or little growth but mainly price falls in the west since 2003, but Inner Sydney is up by 18.2% and the eastern suburbs by 15.7% over the last 12 months.”

Pamela Yardney says good news for investors is that long awaited rental growth is now occurring; “Yields have increased by approximately 10% over the past 12 months. Sydney’s rental vacancy was 0.9% at the end of October 2007, the lowest it has been in 20 years.”

Tedesco says the areas to watch in 2008 are the Eastern Suburbs - home of Bondi Beach; the Lower North Shore - the more affordable little sister to the East, which houses North Sydney CBD just north of the Harbour Bridge and the famous and sought after suburb of Mosman; as well as the Inner West, which is even more affordable and has great proximity to local transport and the city and airport.”
He adds, “The areas we hit the pavement on daily have units for sale from $450,000 to $700,000, making Sydney seem quite affordable considering its past stigma of being expensive in comparison to other states. Now it looks more like a bargain!”

Despite offering what appears to be some comparative bargains, the experts say that Sydney remains the most unaffordable city in the country for 2008. And this could translate to a drop in buyer sentiment if interest rate rises continue.
The good news for investors is that new home construction is falling well short of demand and it is predicted that there will be a rapid and critical supply shortage for some time to come. This will mean continuing increases in house prices and rents for the city.

Victoria

Melbourne property remains a solid option into 2008. The ANZ Property Outlook reported in January that the Victorian housing market is booming, “with prices, sales volumes and clearance rates all up significantly on 2006.”

As with NSW, Victoria’s building industry is struggling to keep up with escalating demand. Jack Henderson, director of Metropole Property Investment Strategists’ Melbourne Buyers Agency says, “Current market conditions are definitely a little unsettled. Increasing interest rates have made it harder for younger people to purchase their dream home, and the mix of properties available for purchase and number of purchasers are in a state of flux each week, with records broken and some major disappointments.

“With new construction approvals continuing to drop away, the tight supply we are witnessing at present will only become more dire into the future. A robust local economy is enticing increasing numbers of immigrants to the capital (both interstate and overseas) and bolstering consumer confidence in the local housing market. Our city’s population is increasing dramatically, greater than any time in memory. Invariably, this will see housing prices and rents continue to climb, especially in areas where demand is strongest; that is in those endearingly popular niche markets close to the CBD.”

According to the Real Estate Institute of Victoria, the median price of a Melbourne home has doubled over the past seven and a half years. Jack advises, “In my opinion, investors should stick to traditionally sought after areas within a 10 to 20 kilometre radius of the CBD for the best opportunities for long term capital gains. Now is not the time to seek out “hotspots” or bargain buys, no matter how tempting.”

He adds, “The fact that demand continues to build and prices continue to climb in tried and true inner city areas should provide investors with enough evidence that even when times get a little tough these suburbs will endure.”

Pamela Yardney says of the rental market, “Melbourne’s vacancy rate has just dropped to its lowest ever point, at just under 1%. There are people literally cueing to get in the door at open for inspections, as supply of vacant stock has all but dried up. We are definitely experiencing a rental drought here at the moment and it doesn’t look like it will get any better throughout 2008.”

Pamela says, “Average yields remain relatively low compared to some other states, as rents could not keep pace with rapidly escalating housing prices. However with more and more tenants looking for increasingly elusive accommodation, this is slowly turning around.”

Overall, the prospects for investors in Melbourne’s housing market are favourable throughout 2008 and 2009 in terms of both continuing solid capital growth and recovering rental yields.

Queensland

South East Queensland is experiencing similar population growth to Melbourne at present. With restricted land supply and a thriving local economy we should continue to see the housing market here continue to perform well in the short to medium term.

Queensland is enjoying the fruits of a commodity boom, with extremely low unemployment and increasing household income buoying consumer confidence and spending. These economic “good times”, which are providing extra disposable household income, along with a glut of private and public infrastructure works occurring throughout the region, should see the Brisbane property market continue to thrive into 2008.

George Kafantaris, director of Metropole Property Investment Strategists Brisbane office says, “The Brisbane property market has experienced the same jitters as all property markets across the country. Buyers have been faced with many questions and uncertainties from so many contradictory comments in the press.

“That being said, the entry level for purchases in the inner 10km ring is still increasing. So what does this all mean for investors and what trends are we seeing emerge?

“On thing we have noticed is that there are fewer buyers, but the quality of buyer is better, more decisive and ready to act, and they are not as nervous as one might expect.”

He continues, “The supply in the 10km ring around Brisbane itself is still very tight and demand is still very strong. On the flipside, there is more supply in the mortgage belt, but we do not encourage our clients to buy in this more volatile market anyway. Simply because in any downturn, these areas are always the hardest hit.”

George says that auction clearance rates have decreased, however properties which are passed in on the day are still selling soon after, when the buyer can have some conditions attached such as valuations.” He says, “We have noticed that upper end properties with a price tag of $1.5m plus, have reached a plateau and the number of active buyers in this market appears to be less.

“The demand for small development sites (up to 6 to 8 townhouses), is as strong as ever, with many of these properties selling cash unconditional. One of the main reasons for the continual demand for such sites is the introduction of the Small Unit Developments (SUD) which means you can now, with Council Approval, build the townhouses and have them individually titled, ie no body corporate.”

Pamela Yardney says, “Rents are starting to soar in Brisbane now. Good news for investors is that house rents in Queensland’s capital rose by more than 10% over the year to March 2008 according to data from Landsbury’s research. This upward trend, along with continuing supply constraints, will see Brisbane investors enjoying increasing yields into the future.”

Western Australia

It would seem most analysts are predicting a far more subdued 2008 for Perth’s property market. Although the ANZ Property Outlook says that the, “Western Australian economy remains the strongest in the country,” it also suggests that the, “housing market has temporarily come off the boil.”

Alison Johnstone, managing director of Choice Home Loans says, “Following the end of the property boom here in Perth, property prices have fallen in the outer suburbs by 10% to 20% on average from their peak and stabilised at best in the inner suburbs.

“There are more properties on the market in any given area and their duration on the market has increased. The exception at this stage being the very top end which seems to have shown some immunity to this trend.” ANZ predicts that the robust economic market in Perth will maintain stability within the property market throughout the remainder of the year, thus avoiding any major decline in property values.

Toward the end of 2007, house prices increased by just 2.8% according to ANZ data, in the wake of a 50% increase the previous year, and median house prices doubling between 2003 and 2007!

The breakneck speed at which Perth’s housing market was travelling, off the back of a major resource boom, was unsustainable and would have priced the vast majority out of the market entirely.

Now, Alison says, “Some excellent opportunities are beginning to appear across the board and some investors are now re-entering the market. Yields are higher, developers have dropped prices, builders will now negotiate and you can find some great deals on existing properties.

“The stabilising of interest rates, should that occur, along with continuous migration and near full employment, fuelled by a strong resource sector, should give confidence in the medium to long term demand for property in Perth.”

As far as the rental market goes Pamela Yardney notes, “Despite the vacancy rate rising to 2.5% late last year, Perth’s rental market remains tight. A lack of available dwellings continues to place upward pressure on rents, which some are predicting will rise by as much as 10% plus over 2008. This is good news for investors seeking greater rental yields, but very bad news for tenants who have already endured increases of as much as 35% over 2007.”

South Australia

As one of the outstanding performers in terms of median value growth to March 2008, some industry commentators are actually suggesting that Adelaide will be a bit of a property dark horse this year, potentially outperforming expectations.
South Australia is gaining more than 13,000 new residents per annum from overseas migration and the capital is still relatively affordable in comparison to other major cities.

Add to this the fact that it is sitting on the verge of a potential major resources boom and this looks to be an up and coming state. Even investors from Perth are starting to take notice and move their money into the area as prices at home become more unaffordable.

One drawback for Adelaide property in terms of long term investment potential is that it has recently bore the brunt of a sluggish local economy. There is also a greater supply of developable land here than in Melbourne and Brisbane at the moment.

Until demand further outstrips supply, it is not likely that we will continue to see the type of high end growth witnessed last year. I still expect healthy increases, but of a less robust nature.

Pamela Yardney reports, “Good news for Adelaide investors is that the city has the lowest recorded vacancy rate of any capital city, currently at 1.1%. This is expected to drop even further over 2008 and 2009 and the continuing rental shortage should see rents increase substantially into the future. In fact advertised rents increased by a massive 22% last year.”

Northern Territory

The Darwin property market is well placed amongst Australia’s capital cities due largely to the continuing commodities boom. Its strong and diverse economy, driven predominantly by the resource sector, has created a climate of prosperity and high rates of employment. Job growth has also fostered an interest from interstate and overseas migrants, with annual population growth up by 2% since 2005.

As with many other states, the Northern Territory is experiencing a tightening supply, with significant growth in demand for housing stock. As a result, Darwin’s property market has prospered over the last couple of years, “with growth exceeding that of other capital cities for some time,” according to the ANZ Property Outlook.

The ANZ predicts that although Darwin’s median house prices have doubled in the past five years and created affordability issues, “ongoing economic growth and a limited capacity to significantly add to the housing stock will see the market remain tight for the foreseeable future.”

Pamela Yardney says, “Rental yields in Darwin are the highest out of every capital city, sitting at a very reasonable 5.17% in February this year according to figures from Residex. Of course investors should remember that Darwin’s housing demand remains seasonal to some extent, with workers following seasonal demand in terms of industries such as tourism.”

ACT

Canberra’s property market was buzzing along nicely in the lead up to last year’s Federal Election, with a buoyant economy and solid population growth. In fact median house prices are now sitting at $462,000, only $7,000 shy of Melbourne’s median.

Although the city’s economy seems to have cooled significantly this year, employment levels remain high and disposable incomes are growing. Canberra remains the most affordable property market in the country. It’s not that real estate here is cheaper, rather it is the fact that residents enjoy higher disposable incomes than their counterparts in other major cities.

The ANZ Property Outlook reports that, “Repayments on the average mortgage are only 24.9% of disposable income in Canberra, much lower than the national average of 36.9%.”

Pamela Yardney says the rental market in Canberra is producing some of the highest yields for investors across the nation. “Apartments and units particularly are producing significant yields, higher than any other city at over 5.5%. This is most likely due to the fact that the city attracts many transient public sector workers looking for smaller, low maintenance accommodation options throughout the year.

“Vacancy rates are already sitting below 2% and with demand expected to remain strong into 2008, we will probably see vacancies drop further and yields creep up a little bit more,” says Pamela.

Tasmania

After enduring a sluggish economy for some time, Tasmania finally seems to be on the path to recovery. Employment growth has been promising and people seem confident enough to put their money into property, with housing finance approvals increasing late last year contrary to the majority of capital cities that saw approvals drop (apart from Sydney).

Hobart’s median house values took a small dive in the February 2008 quarter however, falling by -2.5%, the highest recorded decline of any capital city. This could be a reflection of the fact that demand has not yet outstripped supply in the state, as has occurred elsewhere across the country.

Pamela Yardney says, “Whilst vacancy rates remain at a historically low 2% or thereabouts, there has been little fluctuation in this figure over the past year or so. Yields are reasonable, but this is probably more to do with the fact that median values have not increased as substantially as they have in the mainland major cities. Evidently demand is not outweighing supply at present, as rental prices have remained stagnant for the year to February 2008.”

Michael Yardney is Director of Metropole – Property Investment Strategists, and a leading property commentator and publisher of Property Investment Update. He is also author of How to Grow a Multi Million Dollar Property - in your spare time and co author of All You Need to Know About Buying and Selling Your Home.

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