There’s still money to be made out of property if you are careful and hard-headed.
It has been the wealth strategy of a generation. Buy a home. Look after it, improve it, upgrade it. And if cash flow allows, gear up to your eyeballs to buy more property for other people to live in. For the baby boomers and for many from generations X and Y, it has been an easy path to success.
But the prospect of lower rates of capital growth and possibly even falls, if the doomsayers are right and the global economy takes another big turn for the worse, has changed the outlook for property investment.
Home owners and investors will need to be smarter about property. Solid rental yields, buying the right property at the right price and less dependence on gearing will be the key to making money. The days of certain returns made by gearing up and hitching a ride on the market boom are gone. At least for now.
THE OUTLOOK FOR PROPERTY
In November, The Economist magazine said Australian housing prices were still 38 per cent overvalued when compared with incomes and a hefty 53 per cent when compared with rents. Household debt levels in Australia exceeded those in the US at the peak of the boom, which makes us highly vulnerable to falling prices if the worst case of a second crisis – worse than that of 2008-09 – happens.
In December, ratings agency Moody’s said Australian house prices were unsustainable and last month a leading US real estate analyst, Jordan Wirsz, predicted Australian house prices could fall by as much as 60 per cent.
Last week, the Demographia International Housing Affordability Survey found Australia was one of the least affordable countries in which to buy a home. The median house price in capital cities was 6.7 times the median annual household income – with only Hong Kong being more expensive. Sydney was the least affordable city in Australia, with a median house price 9.2 times the average annual household income.
Many commentators say prices might be fully valued, or overvalued, but a crash is not the only way the market can correct itself. The head of property and financial system research at ANZ, Paul Braddick, says talk of a big crash assumes a doomsday scenario for the economy. While not impossible, he says it’s unlikely.
”Our base case is that the labour market will remain soft for the next six months but will start to pick up again in 2012-13,” he says. ”It won’t be a boom in any sense but [the economy] should bottom and start to pick up again.
”But there are risks and that does overlay sentiment. There’s a fear of the unknown and if Europe does implode, how will that affect us? As we saw in 2008 at the height of the global financial crisis, if overseas conditions get worrying enough, the Reserve Bank will react. In 2008-09, it lowered interest rates and boosted the housing market, though that was also helped by the new first-home owner boost and changes to the foreign investment rules, which are less likely to reappear this time.”
Given that, Braddick says the most likely scenario is that house prices will fall further in the next six to 12 months but once they have found a floor, prices should start to rise in line with household incomes. He says that means longer-term growth of about 4 per cent to 5 per cent a year on average, though there will be cycles around that.
The chief economist at AMP Capital Investors, Dr Shane Oliver, says historically, prices get ”stuck in a range” for five to 10 years after they have been pushed to extremes. He says research on house prices since 1920 shows they have risen about 3 per cent a year after inflation in the longer term.
He says in the 1990s, prices were below that long-term trend (see graph below) but they took off in the early 2000s and are now about 25 per cent above the trend line. Though not predicting a US-style collapse, Oliver says it is hard to see prices growing at the rate they were because affordability is so poor and people are more reluctant to take on debt.
Australian Property Monitors (APM) is predicting national growth this year of 3 per cent to 5 per cent (see table above).
It says Brisbane, Perth and Darwin have the potential for higher growth while Melbourne, Adelaide and Hobart are likely to underperform.
POTENTIAL STUMBLING BLOCKS
The managing director of SQM Research, Louis Christopher, says buyers need to ask what would trigger a major selloff in housing and assess the likelihood of those events happening. One strong trigger (thanks to high levels of household debt) would be a return of rising interest rates. ”All it took was the cash rate to get to 4.75 per cent to cause problems in this country,” he says.
He says buyers also need to watch for signs of the banks reducing loan-to-valuation ratios. He says house prices in most big British cities fell by about 20 per cent when British lenders suddenly cut lending ratios from 100 per cent or more to 80 per cent.
”Think about it,” he says. ”If you had a $50,000 deposit and someone was willing to lend 95 per cent, you could borrow up to $950,000. But if they would only lend 80 per cent, you could borrow $200,000 and your maximum purchasing power would be cut from $1 million to $250,000. You can see the havoc that would cause in the market.”
Why would banks cut their loan ratios? Like most things, it comes back to Europe. At worst, if Europe unravelled, we would be likely to see significant bank defaults that would limit the ability of other banks to raise finance outside their own countries. Australian banks have already raised the threat of another credit squeeze.
Other risks include unemployment rising to levels in which forced sales become a problem (Christopher says SQM Research’s modelling suggests problems would occur if unemployment broke through 7 per cent) and banks lifting interest rates independently of the Reserve Bank’s changes.
Oliver says the most vulnerable are heavily geared buyers, because they are most exposed to negative equity and forced sales. RP Data recently found slightly less than 5 per cent of Australian houses were worth less than their purchase price. Queensland had the highest levels of negative equity while Victorian households had the strongest equity positions. In Melbourne, 1.9 per cent of houses were worth less than their purchase price. However, the figures did not take into account debt, especially mortgage redraws.
The research director at RP Data, Tim Lawless, says coastal lifestyle markets are also vulnerable to a downturn and have already suffered from a downturn in tourism and sea-change migrants, as well as weak demand from second-home buyers. He says many of these lifestyle markets experienced dramatic appreciation before the GFC.
He says markets that had a big run-up in prices during the most recent growth periods are now also potentially more exposed to weaker conditions. ”The Melbourne market, for example, has seen home values appreciate by almost 50 per cent since the start of 2007,” he says. ”Rental yields in Melbourne are now the lowest of any capital city and new housing supply has been much more sufficient than [in] other cities.”
WHERE THE OPPORTUNITIES ARE
In this market, most analysts say the old strategies no longer guarantee success.
Buyers will need to do their sums and ensure they are buying well rather than simply picking the next ”hot suburbs” and riding the boom.
Success will also depend on having the flexibility to decide when to sell. That means buyers will need to keep borrowings at a manageable level so they are not forced to sell at the worst possible time.
Christopher says he is loath to tip particular areas, given that any recovery might not be long-lived. But he does favour the outer ring of Sydney, particularly the western and south-western suburbs.
”We see a big movement to more affordable housing,” he says. ”Rents there have already been rising by about 5 per cent a year, infrastructure has been improving and they have the potential to outperform over the next five years. We think 7 per cent growth there is possible.
”More average and above-average income earners are moving west because they don’t want to raise a family in a unit and it makes the mortgage more manageable.”
APM forecasts growth in Sydney this year will come mostly from middle- and lower-band suburbs, supported by high rents and an undersupply of housing. In his 2012 outlook, the senior research analyst at RP Data, Cameron Kusher, also predicted Sydney might perform better than in 2011. ”Home values across Sydney have increased at an average annual rate of just 4 per cent over the past 10 years,” he says. ”Although value growth has been limited, rents have increased by 5.4 per cent for houses and by 6.4 per cent for units in 2011. Estimated sales activity as at September 2011 was 6 per cent above the five-year average. Sydney’s market continues to be hampered by an undersupply of new housing at a time when demand remains strong.
”Although we don’t expect property values to increase at a rate above inflation, we anticipate Sydney will continue to be one of the better-performed markets, especially considering that when adjusted for inflation, values remain below their 2004 peaks.”
A property adviser at Lachlan Partners, Ana Bennett, says areas along the main Sydney transport corridors ”should do well”, given the undersupply of housing – ”areas that aren’t reliant on having two cars to get to work” – though she says Melbourne is a different prospect.
”The large volume of stock coming onto the market in Melbourne is a concern,” she says.
For investment, she favours ”the groovy, funky areas with a younger demographic”, such as South Yarra, Richmond and Middle Park.
”The other opportunity is the old house on the corner block in suburbs like Cheltenham where there is the potential for multi-residences down the track,” she says. ”Investors can rent them out for five years or so with a view to either selling the site or developing themselves. People are saying they’ll build one residence for themselves and sell the second for profit.”
Braddick says buyers should be aware that states are likely to perform differently. ”NSW has the advantage of being the most undersupplied market but it’s tricky to look at particular sectors.” He says if the construction and resources sectors continue to boom, this could support the upper end of the market, while soft conditions in retail and manufacturing could dampen the middle and lower parts of the market.
”But ultimately it will come back to the ‘atmospherics’ – the number of properties on the market, current sentiment and so on,” he says. ”Over the short term there could be significant increases or falls but on average the market is unlikely to achieve much.”
A GREATER FOCUS ON YIELD
To a large extent, buying a home is a lifestyle decision and you can afford to trade off slower capital growth against the desire for a place to call your own.
But if you’re considering putting your hard-earned money to work in investment property, you’ll need to be hard-headed.
Braddick says investors in the 2000s ”got away with non-focused property buying because most prices were going up.” But with capital gains likely to play less of a role, investors will need to focus on yield for more of their return.
”You need to look at the yields now and what they will be in the future,” Bennett says. ”The initial yields in the inner city may be lower but newer stock can balance that with depreciation allowances and if you get income growth, the yield will bounce back.”
Lawless says units have outperformed detached dwellings in terms of value growth in recent years.
”This is probably due to both improving demand related to price sensitivity [units are generally more affordable than houses] as well as the fact that units generally provide higher rental yields than houses. With more focus on urban renewal and higher densities around transport hubs and employment nodes, we would expect that well-located units will continue to be a popular choice for investors,” he says.
”Another tactic that is likely to remain popular among investors is buying within close proximity to the capital cities. The 10-kilometre to 15-kilometre ring should continue to provide reasonable housing demand with tight supply constraints. Public and private transport options are becoming even more important and these factors will be one of the primary drivers of long-term capital gain.”
Oliver says investors might also want to consider looking outside the residential box.
”You can argue that if you’re going to buy investment property, you’d be better off looking at commercial property where the yields are higher and there is less evidence of overvaluation,” he says. ”Listed property trusts have gone back to their roots after going through a more speculative period and are offering yields of 5.5 per cent to 6 per cent, unlisted property trusts and syndicates are an option [though you have to be careful], or you can invest directly in something like a shop, warehouse or strata office.”
The new rules to property success
When it comes to gearing, less is more. ”It’s not what you own but what you owe,” Shane Oliver, of AMP Capital Investors, says.
Think affordability. The more expensive your property, the smaller the list of potential buyers or renters.
Buy well. What’s the point of being in a weak market if you don’t get to dictate terms? ”You make money in property when you buy, not when you sell,” Ana Bennett, of Lachlan Partners, says.
Don’t count on making a quick buck. ”If you think you’re getting a bargain, you’re usually not,” Bennett says. She says property should be regarded as a long-term investment. ”Particularly for investors, you have to ask whether you can really afford it,” she says. ”There’s no point struggling and realising you have to sell in two to three years.”
If you’re investing, think income. In the absence of strong capital growth, investment returns will increasingly depend on a decent, and growing, rental yield.
Do your homework. While average returns might not look promising, the property market is highly segmented and demand for the right properties will remain strong. Look for properties that are in undersupply, not a dime a dozen. ”I would be wary of locations that have recently experienced a large surge in home values or where rental yields are lower than average,” RP Data’s Tim Lawless says. ”Areas where housing can easily become oversupplied should also be treated with some caution.”
Understand that property prices can be volatile – especially in the short term. Just because your house price isn’t quoted on the news each night doesn’t mean it can’t go up and down. ”If you put a large proportion of your money into a particular investment, it is a risky position, particularly if you’re also leveraged,” Michael Sherris, from the Australian School of Business, says. ”There may be half the volatility that you get with shares but people think there’s no volatility at all.”
Look for areas with strong population growth, strong demand and good infrastructure that is improving.
Think outside the box. Will it be possible to add value to the property in the future? If residential property doesn’t stack up, what about commercial?
Don’t expect history to repeat itself.
Story by Annette Sampson, source: www.domain.com.au