Is There Still Profit In N.S.W. Property?

There’s still money

investmentThere’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

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 […]

About 

Jhai is an award win­ning Inter­net Mar­ket­ing Real Estate Agent for Eld­ers Toongab­bie and Kings Langley. After run­ning his own inter­net mar­ket­ing busi­ness he has now set his own sites for the real estate industry. He observed that 90% of real estate agents did not know how to mar­ket them­selves online. Jhai is now fixed on one goal. To teach real estate agents that they can mar­ket online so much bet­ter than they cur­rently are.

Since then he has been con­sist­ently quoted in the Sydney Morn­ing Her­ald and Real Estate Busi­ness online. He is a reg­u­lar guest blog­ger on TheHomePage.com.au, shar­ing his expert­ise of mar­ket­ing aspects for the Real Estate Industry. His biggest pas­sions are his wife, mar­tial arts, dogs and most of all property.

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