What is happening in the Australian Residential Property Market?

It’s hard to ignore the headlines, which tell you that something is rotten in the Australian residential market.

There would hardly be a property investor who is unaware by now that house prices have fallen, in Sydney and Melbourne, down 6.1% in Sydney in September, on the year before, and by 3.4% in Melbourne.

This means that house prices fell by their fastest rate in six years.

This is measured as part of property consultant Corelogic’s national home value index, which shows that on a national basis, home values were down 2.7% in September, since peaking 12 months ago.

From such figures come the headlines of home-price “downturn,” “decline” and “correction.”

There are several points worth making about the numbers.

First, while it certainly helps the industry to have a national index, for general comparison purposes, it is only an index; and the residential property market does not lend itself easily to being indexed. Residential property is not a homogeneous market, with each property having idiosyncratic attributes, with a great deal of subjectivity involved in assessing it, and different market factors depending on location. There is no uniform Australian residential property: there are, in effect, hundreds of small ones around the country.

 

The decline in the national index hardly worries Hobart homeowners, who see that their city’s housing stock shows a 9.3% rise in value over the year to September; or Canberra homeowners, who see a 2% appreciation. Brisbane and Adelaide home values also edged ahead over the year.

Sydney and Melbourne account for about 60% of the national value of housing, and the weak conditions in these cities is dragging down the overall national housing market performance.

Corelogic says the housing downturn is becoming more broadly based, with dwelling values tracking lower across five of the eight capital cities in September – although regional Western Australia is the only ‘rest of state’ region to record a fall in house values over the past twelve months. But regional markets, where housing values have generally been more resilient to falls than in the capital cities, now appear to be facing more challenging conditions.

We believe there are several factors at play, some new, that help to explain some of the pressures coming to bear on house prices, which all property investors should understand.

But even before that, we believe that investors should take a moment to look at the headlines and the numbers from a different angle: house price falls are usually presented in the media from the perspective of home owners and potential vendors, for whom price falls are unwelcome. However, for prospective buyers, price downturns bring a change in affordability that is very welcome – especially after many long years of rising markets.

As judicious residential property investors – who are only prepared to ‘play’ by very strict rules – we have noticed that we are now able to participate in sectors of the market that we have avoided for many years; for example, inner-city terrace houses. There is value emerging in some of those niches, where value has not been present for quite some time. That is an aspect of the current market that we, as investors prepared to buy, find anything but gloomy.

Let’s take a deeper look at some of the factors at play.

 

First: the banks.

 

Bank lending has tightened dramatically in the wake of the Royal Commission, and we expect it to be wound back further, in the lead-up to, and following, the release of the Royal Commission’s final report in February. Tighter credit policy has definitely driven the slowdown, particularly the reduction in investment activity. It is becoming harder to get a loan, more segments of the market place are being restricted from credit, and the loan-to-value (LVR) ratios are dropping to protect the banks.

No longer are the banks waving through loans in order to hit lending targets – they are now actually looking at applicants’ household and lifestyle expenditure and generally, trying to be much more responsible in the wake of the Royal Commission. Unexplained glitches in credit history, lying by omission about spending, and debt in other areas (for example, credit cards) are suddenly potential deal-breakers.

Investors in particular have been targeted. People with interest-only loans – who clearly felt that they could sell their properties for a gain – are now being made to refinance on a principal-and-interest (P&I) basis: with a further 1.5% of principal being added to the loan rate, the investment proposition becomes a different one to what it was several years ago. When net rental yields are in the range of 1%–2%, how will investors respond to what are changed capital-gain expectations?

Property lending is also drying up for self-managed superannuation funds (SMSFs). The Australian Securities & Investments Commission (ASIC) was known to be concerned by this; the Opposition has said that if it wins the next election, it will ban borrowing by SMSFs as part of its housing affordability package; but the fall-out from the Royal Commission appears to be doing these parties’ jobs for them. As of now, none of the big five lenders will lend to new SMSF clients. There could be a source of property turnover on the back of this.

Foreign buyers – particularly Chinese buyers – who were a feature of the property boom have largely left the scene, as tighter capital controls by Chinese authorities have crimped their ability to buy in Australia. The “vacancy tax” introduced in Victoria in 2018 – in which a vacant residential land tax applies to homes in inner and middle Melbourne that were vacant for more than six months in the preceding calendar year – is also biting, and inducing some investors to sell.

 

In summary, we’re finding that there are fewer buyers in the market, and those that remain cannot afford to borrow as much.

Buyers that are prepared to buy are at last seeing some good opportunities.

Melbourne, for example, has been a seller’s market for six years – but the pendulum has swung in favour of buyers.

If you are a discerning, serious buyer, you can approach auctions feeling confident that you’re not going to be rapidly bid-up past your limits: in fact, at present, you may be the only serious buyer. You may be able to strike advantageous deals off-market, as vendors are decreasingly keen on committing to expensive marketing campaigns, in the risk that the property is passed-in. As a serious, disciplined buyer, we are seeing more properties coming into our ‘sweet spot,’ where we can make the numbers work in our favour.

Like any traded market, residential property moves in cycles. This one has moved temporarily in favour of serious buyers. Longer-term, Australia still has a growing population, rising life expectancy and physical restrictions on supply in already heavily developed capital cities – all of which support the demand side.

Our investors achieved return rates of about 10.5% in the 2017-18 financial year. With the market now favouring buyers, there is the opportunity to do even better than that over the medium term.

 

 

Jock Bing | Director

         

Portfolio Management Services Pty Ltd

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