Investor Update – Winter 2013

Overview – A year of mixed influences

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To Australians accustomed to ongoing economic growth and appreciating assets, 2013 is turning into a year of uncertainty.

Whether it is political, economic performance, business, investment or employment, it is hard to escape an overhanging hesitancy reflecting the feeling that something is not quite right.

There is an unprecedented mix of cross current influences on the value of assets.

It is also the first time that generations aged under 40 have experienced tight conditions in their working lives.

It has been a year of unusual focus on politics. Business is reluctant to commit to new investment while there is so little surety about political trends and what, for several months, has been a policy vacuum.

Federal debt continues to grow as public spending increases impact. State governments are running record levels of debt. This impinges on their capacity to provide infrastructure needed to support productivity gains.

Federal elections create uncertainty, slow many sectors of business activity and defer decision making. The election simply cannot come quickly enough for business, investors, consumers and potential home buyers.

Economic sluggishness has caused monetary authorities here and abroad to run interest rates to their lowest levels since the 1960s.

There probably is more downside in rates short term. But, if governments globally decide to address their strategies of stimulus to support excess spending, rates can turn and rise quite sharply, albeit to nothing like the levels of the 1980s. Low interest rates and a soft market for all forms of property should entice investors to assess the potential in carefully chosen – and certainly not across the board – residential assets. In some locations it could be one of the more opportune times of the past 40 years.

A falling currency could add uncertainty to the capacity of banks to fully pass on interest rates reductions. On the other hand, weaker currency superimposed on the Foreign Investment Review Board’s easing of offshore investment limitations should lift Asian interest in Australian residential property.

The big picture of economic performance remains clouded. There is little or no reduction in public sector debt in North America and Europe. China continues to attempt to rein in excesses of bank lending of recent years and adjust to the lower level of demand from customer nations.

China’s growth will remain the most important external influence on the business and investment pulse of Australia. China’s GDP growth is projected to slow short term to around 7 per cent – which still markedly outperforms the western world.

International share markets which often are a bellwether of future economic performance, have been strong this year, particularly in the USA. Economic growth there may be modest but, at least it is occurring.

Australians have been amongst the prudent populations in their approach as consumers to the stressful financial times of recent years. There has been a flight to conservatism with bank deposits soaring to unprecedented levels and no rush into irresponsible borrowing despite the 50 year low in interest rates. Indeed quite the opposite. Australians on an individual basis seem content to sit through the economic crisis.

Signs of the muted confidence are reflected in flat consumer demand – and industrial and commercial property values. Business capital expenditure and property investment remains sluggish.

There is a lot of short time being worked in 2013 as well as the headline publicity given to businesses which are closing their Australian operations. There will be more such news in the months ahead.  Unemployment numbers are likely to increase.  Large scale closures have significant flow on effects to suppliers, many of which are small or medium sized businesses. Their closures, staff reductions and shortened work hours may not feature on the nightly television news but are a significant factor to the caution of business and consumers that flows over into the mixed trends of the property market.

The impact on housing and land and investment  

It has been a winter of hesitancy in the housing sector of Australian with softness in rentals in some areas, a shortage of housing stock for much of the time and caution the overriding approach of buyers.

New residential construction remains near an historic low. It seems an odd time for states to slashing support for construction of new housing. Housing starts have been sluggish.

The largest support scheme for new housing in recent years was the first home owners grant of the Australian government.

The Howard government introduced this scheme of support for first home buyers in 2000 to temper the impact of the Goods and Services Tax on the housing sector.

State governments, which administer the scheme, have tampered with the grant over the last 12 months and materially reduced its application. Effectively the scheme provided for a one-off grant of up to $7000 for first home buyers both for newly constructed dwellings and until late 2012, for purchase of an existing dwelling. Since October last year most states have limited the grant to those constructing a new home or buying a new house. About 80 per cent of first home purchases had hitherto been of existing houses. The change has had material impact with falling sales of new homes which are usually in outer or new suburbs. Young people simply do not want to reside in outer urban areas which they see as too far from the action.

There are sound reasons to encourage investment and home ownership at present. Banks are willing to lend at historically low rates although cautious on lending ratios given the softer employment outlook. Vacancy rates on rental properties have tightened a little.

Renters and mortgagees are concerned about servicing debt out of wages that are under downward pressure with increasing numbers on short time. Unemployed anecdotally appear to be taking

4 – 6 months to find fresh acceptance.

 

SYDNEY – below replacement cost

Property markets are quite disparate at the moment reflecting the uncertainty. There is little activity in Sydney to address the long-standing stock deficiency in housing.

BIS Shrapnel has estimated the underlying shortage of stock in Sydney at more than a full year’s requirement for additional housing and 1.25 times the estimated number of dwellings commenced there in 2012-13. Rental levels have increased recently.

The shortage of stock is starting to impact. Housing prices rose by up to 5 per cent through winter. That partly reflects the Reserve Bank’s May reduction of its benchmark rate to 2.75 per cent. Beyond the knee jerk response, the impact of moves in rates typically emerges two or three months later.

Residential property in Sydney is still changing hands at well below replacement cost.

Yields of around 4.5% now available from investing in Sydney residential property are more competitive than for many years.

Sydney remains the outstanding city of opportunity for residential property investors. It offers excellent prospects of above average capital appreciation over the next two years. The relationship housing values in the two major cities in Australia has fluctuated consistently in recent decades. Melbourne has enjoyed strong growth since 2009 and opportunity existed for arbitraging investments between there and Sydney. That no longer exists.

Sydney historically appreciates at a rapid rate as exemplified in the aftermath glow of its Olympics when average housing prices rose 50 per cent within three years.

After several years neglect signs are that the NSW State Government will start investing in infrastructure to tackle the city’s notorious service problems. It can be anticipated that an array of new funding mechanisms for infrastructure will be deployed in coming years.  This may well involve superannuation money.

Confidence for near to the city residential activity is heightened by the prospective impact of the Barangaroo project and second casino and, the return to inner suburban developments by Meriton Group, the leader in large scale residential units.

 

 

 

BRISBANE – yield and growth

We have started buying properties in Brisbane for clients after spending lengthy time in the past two years researching the housing scene in this rapidly growing city. With prices much under those in southern state capitals, Brisbane housing should provide high yield and capital appreciation over the next five years.

Brisbane historically has been under investors’ radar. Southern investors aplenty acquired assets in the Gold Coast and Sunshine Coast holiday areas. These are heavily influenced by economic vagaries  and, consequently, have provided mixed returns.

Brisbane’s population is now 2.15 million and rising at a high two per cent a year. This compares with the national population growth rate of 1.4 per cent.

Brisbane’s market has been in a lull in recent months. However, the new Newman government is bringing its inherited excessive deficit under control creating opportunity to free funds for enhanced infrastructure. The city was markedly impacted by the “once in a century” floods in the 2011 and 2012 summers. Much of this damage has been repaired or replaced.

The rental market in Brisbane is tight with a near record low vacancy estimated at 1.5-1.7 per cent.  Housing rentals in Brisbane close to the city generate yields of 4.9% to 5.1%.

Rental increases in Brisbane, until this year, have been rising typically at about 2.5 per cent a year since 2007. However, in recent months this has widened to five per cent a year reflecting the tightness of the market.

Average prices of houses fell in both 2011 and 2012 and over the five years to 2012 grew at only 3.4 per cent per annum compound which was below Melbourne or Sydney. The average house sold in Brisbane in 2012 was 17.5 per cent under Melbourne.

The real attraction of Brisbane is the supply of good, reasonably cheap housing within 3 kilometres of the GPO. Areas like New Farm, despite substantial redevelopment in the past eight years, still offer significant opportunity as lifestyle there becomes akin to that in close to the city Melbourne.  Brisbane’s vibrant arts and entertainment precinct and its inner city suburbs on weekends bear not the slightest resemblance to the empty, sleepy city that existed for so many years.

Investors are looking at established suburbs such as Ascot (the highest median house price in the city at around $1.2 million), Hendra, Paddington, West End (on the southern banks of the river opposite the CBD), and traditional housing rental suburbs of Hamilton and Toowong. The upwards movement over the past nine months has been slow, but real.

Paddington, even closer to the city than the favoured investment suburb of the same name in Sydney, has a distinctive character with renovated workers cottages and city views. Houses here typically sell at $600,000 – $800,000 and yield up to 4.75 per cent per annum. Well located traditional Queensland houses yield a little more and generally cost less than Paddington.

 

 

MELBOURNE – off  two strong years

Melbourne’s residential market is flat after two exceptional years of capital appreciation which brought values up to those existing in Sydney.

There is no shortage of new stock in Melbourne in contrast to Sydney and Brisbane. The number of dwellings that commenced construction in 2012-13 was greater than anticipated annual demand and will add to the stock surplus that exists in the city.

This surplus partly reflects completions of a large number of city apartment blocks presold on an off the plan base. There is a high level of settlement of these units many of which were bought in anticipation of tenants. There has consequently been a rise in vacancy rates for tenanted units. This will be absorbed in time with a slowdown inevitable, although construction levels for units are still above those in 2012.

 

There are indications of renewed buying by Asian investors in inner Melbourne.  Further falls in the $A would add to Asian interest. Yields in Melbourne on investment properties remain below those in the other two eastern state capitals. After the appreciation of recent years, yields are typically in the 3.8% to 4% range.

Melbourne generally might underperform Sydney and Brisbane in the next few years. However, there are, as ever, specific opportunities to acquire well valued investments. Melbourne is an example of the impetus that investment in infrastructure can give to housing..

We believe above average returns will come from investments in areas as disparate as Footscray, Frankston and Geelong. Access to good transport and employment opportunities is a common link. To these areas should be added the ever-growing investment by business near Eastlink and the new Mornington Freeway.  The loosening up of Frankston as a residential area and consequent broadening of its attraction beyond a location for employment to a gentrified beachside suburb is a by product of the freeway and the enhanced access.

 

Geelong is an excellently located city with good infrastructure and education amenity. It has encountered setbacks over the years but remains prosperous. The impending closure of the Ford engine works will hurt but the Federal Government’s siting of Disability Care Australia’s head office there alone will create 500 jobs – almost exactly the same number who will leave Ford in 2016.

 

Random thoughts on investing

Some surety in government out of the election would start to restore confidence currently lacking and build on the underlying investment opportunity in residential property created by a 50 year low in interest rates and property values below replacement cost.

+We believe – as we have for over 40 years – that a core fundamental of investing in housing is that more people want to live close to the city than there is space available. Scarcity has investment value.

+It is a philosophy well known to the farming community. Over the years farmers have sustained rewarding returns by holding close to CBD residential properties in Melbourne and Sydney. These are still our favoured areas for long term opportunity for conservative investors – especially Sydney.

Somewhat paradoxically some in farming might be an exception to the tightness of the times with further benefits emerging from a falling dollar.

 

+Retired baby boomers were a driving force in residential property investment in recent years but some may now face changing circumstances. Low interest rates and an uneasy share market with dividends under pressure can impact on income.

+The new parliament will see changes in avenues for financing infrastructure including include a mechanism to tap some of the superannuation assets sloshing around as cash.

+Self managed superannuation funds are increasingly investing in property. As mentioned before it is important that these investors tread warily, and particularly in relation to documentation, to ensure correct and maximum tax benefits. We urge guidance from top legal counsel by those seeking exposure in superannuation fund ownership of property assets. Legislation on this issue is changing almost weekly.

+We also urge caution by those joining private syndicates to own and lease commercial buildings. Often these investors are approaching or in retirement and want to be in property. It is important to understand the business, its structure and the quality of lessees.

+Industrial properties also require greater vigilance by owners. Many properties that once housed plant, equipment and fittings are now solely for quick time storage of imported consumer goods. ENDS

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