2008 Property Investment Essentials
At an initial glance across the various national media, we could be forgiven for gaining a fairly negative attitude to investment prospects for 2008.
"With the sub prime mess and a sluggish economy, the US looks tired. Internationally there are signs that this may rub off on other countries. Internationally the stockmarket is in turmoil. Australia's economy is overheating, with consequent interest rate rises likely. Locally, housing affordability is reaching a critical point. And the all perennial favourite Australian housing prices are out of context internationally".
Yet on closer scrutiny, there is a series of strong indicators, and irrefutable evidence for selective property investment today.
What are the key issues, where are the opportunities, and how can we best capitalise on the 2008 property market?
And with affordability being critical, how can we look to increasing investment yields and strong capital growth?
This short article strives to objectively address the relevant issues and provide a constructive pointer to sensible investment in 2008.
The current mark state of play
The headlines are relatively simple:
- US consumer sentiment is weakening, the economy is already soft, and the sub prime financial market fallout has world economists concerned about an inevitable US recession.
- Internationally stockmarkets have sharply reacted, on the premise that US based economic problems could flow on to the greater global economy.
- At home, the Australian economy show signs of overheating, with the consequence of rising interest rates.
With this relatively sombre background, Access Economics provided a welcome ray of light on 21 January Sunrise News 1. Regardless of current inflationary interest rate pressures, and a not unexpected sharemarket correction, their attitude to the Australian economy is very strong. They emphasise that we should not be overly concerned, "the Australian Economy is as strong as an ox (the sharemarket) will bounce back."
Their point being that the sharemarket is merely adjusting after a record growth phase, and that it is China's positive influence on Australia that is of consequence not America's current malady.
These points are strongly reiterated by NAB's Chief Economist Alan Olster in his article "Caution, don't follow the herd" in the National Press on 24 January 2008. He states "the US which is very much in the eye of the storm [as against] China, India, and associated resource related economies including Australia - which are still expanding strongly . domestic demand is likely to be increasing by about 5.5% there is little sign of any slowing in the Chinese economy to date that means commodity prices will remain firm it could well be that the Reserve Bank will be more reluctant to move rates".2
BIS Shrapnel, one of Australia's foremost economic and building market commentators, sees interest rates levelling off in 20083. We would image that with US interest rates falling in the face of a significant downward trend in consumer demand, and an already uncomfortably high Australian dollar, the Australian Reserve Bank's attitude to rising interest rates must increasingly be tempered. Prospectively good news for investors.
But what about the property market how is it currently positioned, and does it take its cue from international economic and stockmarket events? Or does it respond to a different set of stimuli?
Property's performance in an economic context
The most salient example of the property market's relativity to both global and local economic events was the period immediately following the October 1987 (10/87) international stockmarket crash.
Sydney and Melbourne property markets were catapulted into over 100% price growth within 2 years, an historical peak and the other major markets followed similarly4. For good reason bricks and mortar have historically been the trusted vehicle for consistent wealth creation over time. We all have an imperative to continue investing safely. In troubled times, property is seen as a safe haven, and invariably prospers.
In the case of 10/87, the greater the economic and sharemarket shakeout, the greater the subsequent direction of investment funds to direct property, for safety, and tangibility.
It is true that Australian housing prices are relatively higher than say the US market. This is principally an historic reflection of our comparative population densities, and the lack of choice of appropriate locations in Australia.
The USA supports 43 cities of 400,000+5 population, with most of these cities being within a 1 hour flight of a major (1 million+) population centre. This offers huge choice without lifestyle compromise. It effectively contains excessive price growth in any but the major cities a true free market.6
By comparison Australia has just 6 cities with population in excess of 400,0007. There is extremely limited choice.
To put this in context, just 20% of Americans (around 60 million) live in 43 cities, where as over 55% (around 11 million) Australians live in just 6 cities.
We have extremely limited choice, and this is not about to change. Our only example of Government sponsored decentralisation is Albury Wodonga with a total population of just 70,000 after decades of well intentioned government sponsorship.
Australians will continue to compete for accommodation in the few major population centres. Interstate migration may favour 1 or 2 cities, but there will always be the central 5-6 population hubs to the detriment of affordability.
If this means a gradual reduction in home ownership, a reduction in average dwelling size, or a greater trend to medium density living, so be it. This is and has been for centuries a fact of life in the larger American cities, and throughout Europe.
Real property is very different from the alternative "paper" investment vehicles, in that currently 98% + of all residential property is required to house the population. It is socially and economically, an essential asset class.
Property's primary price growth drivers are local, not national, and certainly not international. It is the relativity between local supply and demand, and affordability, that determines property price growth.
It is broadly recognised that right across Australia we have an acute shortage of rental accommodation. But the severity and unfortunate inevitability of worsening housing shortage may not be so well understood. National vacancy rates are the lowest in recent recorded history, and the situation is worsening. Apart from Hobart every single capital city in Australia has vacancy rates of less than 2%8 - historically unsustainable, and without precedent.
Rental Vacancy Chart
| National residential property vacancy rate | |||||||
| Sydney | Melbourne | Brisbane | Adelaide | Perth | Hobart | Canberra | Darwin |
| 1.4% | 1.2% | 1.7% | 0.9% | 0.8% | 2.3% | 1.5% | 1.2% |
| Note: Traditionally a market with 3% vacancy is assessed to be in balance. Less than 2% indicates a severe stock shortage. Less than 1.5% reflects a critical shortage. | |||||||
as at May 2007 Source: BIS Shrapnel Building Industry Prospects September 2007
Current construction levels are nationally consistently falling below the underlying demand, fuelling what must become an historical housing shortage.
But what of the spectre of rising interest rates compounding an already unsustainable level of ownership affordability? How will this impact on property price growth?
Affordability and the foundation to inevitable investment success
While any thinking person could only smile at the current assertions in the National Press that "Bundaberg shares the same severely unaffordable rates as New York"9, the reality is that we do have an affordability crisis on our hands in most Australian cities and the problem is not likely to go away easily, or imminently. The purchase of a home is increasingly beyond the reach of a growing market segment. But here is the catch. This is a dream position for the property investor.
A growing level of rental demand, with the capacity to pay higher rents.
Capital growth is the result of increasing demand whether it is from owner occupier or investor. Where there is a critical housing shortage, rents must rise, and where rental yields rise, investment competition is inevitable creating price growth.
Why can (and must) rents continue to rise?
It's very simple. Current rental yields nationally are around 3-5% p.a. (as a percentage of property value). So it is possible to rent a property annually for around 4% of its value (e.g. $18,000 p.a. on a $450,000 property or $360 per week.) But for any owner occupier to buy this same property requires around 10% p.a. of its value (interest + principal + outgoings), or $45,000 pa - $900 per week.
So for the sea of prospective home purchasers who are faced with the insurmountable cost of $900 per week and for those who prefer to rent than buy, the rental option is just $360 per week a 60% cash saving. The same logic applies across a broad range of price points.
It is these people who can readily afford the $360 per week, and subsequent rental price escalation, that guarantees our investment yields and subsequent capital growth.
In summary
- Property yields and price growth are related mainly to domestic supply and demand patterns and affordability.
- While affordability changes the nature of demand (owner occupier versus investment rental) it is population growth and household foundations that determine the volume of overall demand.
- Though affordability is increasingly thwarting home ownership, housing demand is continuing to grow strongly (via the increasing rental market).
- Construction levels are below, and are forecast to remain below the underlying level of demand.
- The current rental vacancy crisis is set to further deteriorate, inevitably leading to rent increases.
- A growing component of the market has the capacity to sustain this rent growth.
This combination of variables presents the investor with excellent short to medium term opportunities.
So where are the opportunities?
Though the top end of the market has enjoyed exceptional demand led price growth in recent times, the economic uncertainty and share market fallout may well depress this highly discretionary market in the near future. It is not necessary to move into, or up within this market at this time.
And while it would be equally simple to point to basic bread and butter property categories that should continue to enjoy strong demand and yield growth, it is no doubt prudent to examine the nature of demand, and likely short to mid term demand growth.
A brief look at Australia's current demographic statistics and trends reveals some interesting patterns:
- Increasing numbers of people not marrying
- Increasing age of first time motherhood
- Increasing single female, single person household
- Increasing childless, or 1 child couples
- CBD apartments averaging 1&2 person households
- Increasing 50+ years and 65+ years old segments
- Sea change and tree change
In uncertain times it is always sensible to look for safety in volume markets, accessible price points, popular locations, desireable designs, and affordability.
The largest growth sector
The biggest and most easily identifiable growth sector is the currently 50 years + and imminently 65 years + segments. In fact the ABS10 has forecast that "the proportion of citizens 65 years and older will nearly double by 2045, accounting for about a quarter of the population, or 7.3 million people".11
While there is a great range of financial diversity within this segment, they are likely to place higher priority on utility, and serviceability than in previous years.
Property types specifically relating to these sectors target relevant aspirational, financial lifestyle, and accommodation requirements.
Examples of a cross section of appropriate property types would include:
- Downsized but sophisticated 2&3 bedrooms CBD related apartments
- Financially sustainable but attractive lifestyle apartments is recognised sea change locations
- A spread of appropriate retirement specific living options
The key being to offer maximum dignity, security, community and lifestyle benefits within reasonable affordability and ongoing serviceability parameters.
An obvious growing volume sector
The single and partnered under 35's with no children. This is an active, CBD focussed, lifestyle oriented segment. They spend little time at home, often travel with work, and enjoy finer things. Security is a significant requirement, especially for these living alone, and working late.
Examples of a cross section of appropriate property types would include:
- Sophisticated 1 bedroom CBD related apartments offering contemporary design, lifestyle (both on site amenities and neighbourhood facilities) and security (for both the individual and their property).
- Suburban, village related 1&2 bedroom/ensuite apartments offering immediate neighbourhood centre lifestyle amenities and security.
The increasing alienated home ownership segment
Affordability in most Australian cities seems to hit a hurdle in the $400,000 price range. Generally this offers a reasonable 3 or 4 bedroom house, near new in an emerging outer suburb. Generally these properties achieve a 4% rental yield, or higher, in the order of $300-$400 per week rental.
In the current homeownership affordability crisis, rental properties of this description should continue to enjoy relatively high demand, good and growing rental yields, and longer term capital growth realised as affordability is re-established, and home ownership aspirants finally take a position.
A perennial favourite
Permanently rental guaranteed properties with no vacancy, and attractive yields. These are occasionally found in the private sector (defence housing, a variety of affordable retirement products, longer term resource based corporate leases etc.)
The key is to ensure that regardless of the security of income and yield, that the property matches traditional market demand in the area (price point, accommodation, weekly rental, design etc.)
It is pointless securing an income stream with a product that may have questionable longer term price growth the key purpose in investment.
Queensland appears to be the east coast state with the most attractive affordability, and consistent population growth. And most importantly it continues to offer investors good quality rental yields and short to medium term price growth prospects.
"Unprecedented infrastructure spending will drive substantial residential property price increases in key Brisbane suburbs this year, as analysts forecast 10% price growth across the board in the fastest growing capital city". 12
Victoria has enjoyed a recent market resurgence, but with currently heated prices "concerns that the top end of Melbourne's house market may have peaked 16 of the top 24 suburbs fell in the final 3 months of 2007"13. Other than perhaps older CBD fringe units, New South Wales continues to suffer from a severe affordability problem. South Australian prices have had a marked upward correction considering its ongoing lack of population growth, and Western Australia has hit a real stock and affordability problem in the short to medium term with negligible price growth.
2008 presents us with a more rational market with perhaps less emphasis on indulgence, and greater attention on utility and affordability. With such a critical, and worsening stock shortage and ongoing ownership affordability, a whole generation of partially and fully funded retirees, and a burgeoning single and two person household market, there is clear direction as to the safe medium term properties in which to invest.
Selective Property investment has not looked like such a sound proposition for decades. With vacancy rates critically low, yields strongly growing, and inadequate new construction to meeting growing demand, sound capital growth would appear to be historically inevitable.
The key lies in judicious selection.
References
1) Channel 7 Sunrise News 21 January 2008 Chris Richardson, Chief Economist for Access Economics
2) The Australia Finance Review, 24 January 2008
3) BIS Shrapnel "Building Industry Forecasts" September 2007
4) BIS, ABS, REDI (data previously published)
5) US Census Bureau 2005
6) Australian Bureau of Statistics 2001 Census data
7) Australian Bureau of Statistics 2001 Census data
8) Australian Bureau of Statistics 2001 Census data
9) Brisbane Courier Mail 21 January 2008
10) Australia Bureau of Statistics, Courier Mail 21 January 2008
11) The Courier Mail 21 January 2008
12) "State's billions to drive Brisbane prices" Australian Financial Review 29 January 2008.
13) "Portsea auction hints at fading growth" Australian Financial Review 29 January 2008
