RESIDENTIAL PROPERTY REVIEW: JULY 2011

From the desk of Compass Capital's Michael Shreeve

Recent Data on Residential Property

The charts and tables below overview recent published data on the residential property market. 

In summary, fundamentals remain solid, but sentiment is weak.  

The weak sentiment, on balance, is currently proving a stronger influence on property prices than the fundamentals - Sydney is the only capital city to show an increase in dwelling prices over the year to May (RPData Rismark).  However, medium-term prospects (which are based on fundamentals) remain positive - although each capital city and region has different prospects.  

Key recent news includes: 

• Dwelling price growth over the last five years has been the worst in recorded history - see table below from Residex, showing house price growth since 1901.  Residex feel that (over the medium term) capital growth will improve and be closer to 7% pa (of course, some regions will outperform and some will underperform - see more below). 

  
  

  This recent poor price performance, together with a strong economy and low unemployment, has improved housing affordability (measured across all regions) to its best levels since 2003 (RPData-Rismark)

• The poor sentiment, and difficulty for property developers to obtain funding, means that new dwelling supply remains low. The HIA released projections out to 2012/13 forecasting the lowest housing starts since the mid 1990s (excluding the two recessionary years for housing associated with the GST and the GFC). With population continuing to rise, rents are rising and projected to rise further - median gross rental yield for units is now 5% (RPData-Rismark) 

  
  

• The strongest capital city price growth is projected to be in Sydney and Brisbane (recent reports by both Residex and BIS Shrapnel) - some regional areas, such as Gladstone, are also expected to do well.  The table below shows that while NSW & Qld have 50% of Australia's population growth, they have only 36% of the nations dwelling approvals.  Further, approvals over the year to May are well below their long term average, by 23% for NSW and 30% for Qld. So the dwelling shortage is worsening in these states   

We feel that the combination of negative sentiment and strong fundamentals provides very good buying opportunities for selected projects in selected areas.  While we have access to quality property in most regions we, consistent with the major forecasters, are currently most strongly recommending property in Sydney (we have excellent property on the lower north shore and northern beaches), in Brisbane, and other areas of south east Queensland where prices have fallen by up to 40% in recent years and now provide very good buying in selected developments.   

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Dwelling prices continue, on average, to be generally flat or softening.  While the various market segments performed differently (see more below), the overall picture was a slight fall over the year to April, following quite strong growth during 2009 and 2010.

Capital growth has been slowing since the RBA started to increase interest rates in late 2009.  Since this period, not only have dwelling price increases slowed (and recently fallen a little in some areas) but:  - sales volumes have generally reduced, and        - vendor discounts have increased.

The general weakness was not evenly spread:  - Not across regions Results were mixed across capitals, with only Sydney showing growth over the year to May 2011.

- Not across types of dwelling   The falls were mainly in established houses, with (on average) units and project homes rising a little in value.

ABS data suggest:  established houses -0.2%   vs   project homes +2.8%

- And not across price segments   The falls were mainly in most expensive 20% of homes (down 5.4% over the year to April), with little change for the middle 60% (-0.9%) and the bottom 29% (-0.5%) - RPData:  17 June

With sentiment weak and price growth softening, the appetite to construct new homes has also been weak New dwelling starts continue to trend lower, indicating a continuing supply shortage.

Looking further forward, new dwelling approvals, while volatile from month to month, also continue to trend lower.   Difficulty in obtaining finance also constrained developers

Loan data for new home lending is consistent with low supply of new dwellings   Loans for new housing fell substantially over the three months to April, across all regions.

The supply shortage has been growing for some years.    Even though the cost of residential construction continues to rise, the amount spent on residential construction has not increased since 2003 (Source: HIA, ABS).

Meanwhile, population continues to grow While the amount spent on residential construction has not increased for almost a decade, population has been increasing quite strongly.  In May, the government released a report on "A Sustainable Population Strategy for Australia".  The Report failed to deliver a population target, noting that "Since the 1970s, all population inquiries sponsored by Australian governments have rejected the notion of a population target or national carrying capacity".

With low supply and rising population, rents have increased.

ABS: Rental component of the CPI +1.3% in March quarter REINSW - the rental vacancy rate for Sydney suburbs within a 10-kilometre radius of the CBD fell 0.2 per cent to only 0.9 per cent in April RPData: o Weekly rents +4.6% over the six months to March o House gross yields average 4.2% pa o Unit gross yields average 4.9% pa (over 5% in Darwin, Sydney, Canberra, Hobart and Brisbane) Commonwealth Budget:  skilled migration target has been revised upwards to 185k from 168k the year before.

Overall, this is not bad news for investors, who are generally better off when rents rise by more than prices fall (especially when they receive the rent but do not need to sell).

In March quarter: o Rents up 1.3% o Prices down 0.4% s.a.

Rising inflation caused some commentators to foreshadow interest rate rises.  But the RBA at its July Board meeting left interest rates on hold for the 7th meeting in a row. And a recent fall in GDP leaves most commentators suggesting that rates will remain where they are for some time.  However, GDP growth is expected to quickly recover driven by a resumption of exports halted by the Qld floods, and the associated reconstruction

Overall Assessment

Underlying fundamentals for residential property remain strong.  (Population continues to grow.  Australia's economic prospects are very good, with low unemployment and strong demand for our resources.  New dwelling supply remains weak which is adding to the under-supply of accommodation.)  This is leading to rising rents.  

However, prices are not just driven by fundamentals - they are also influenced, particularly in the short term, by sentiment.  Sentiment is generally weak, influenced by uncertain economic conditions in several overseas developed economies, poorly performing equities markets (both in Australia and overseas), consumer conservatism, prospects of higher interest rates (driven by Australia's strong economic performance), and associated negative press.

At the moment, negative sentiment is proving a more powerful force than positive fundamentals.  The weakness is being reflected most strongly in expensive property (which is usually more volatile, and more sensitive to sentiment and stock market performance) and also in tourism-related markets adversely affected by the high Australian dollar.

Sustained divergence between fundamentals and sentiment provide a reason to act.  When sentiment is strongly positive, and not based on sound fundamentals, prices will inevitably fall.  When sentiment is weak, but fundamentals are strong, prices inevitably rise.   

While the long term direction is predictable, sentiment is not, which is why prices rise further than is sensible, and why prices can fall further than is sensible. 

In the current market, there are good buying opportunities in areas where demand is very strong and supply is constrained.  While some areas should be avoided, certain areas are still showing good growth (for example, REIQ reports that Gladstone house prices rose by more than 5% in the March quarter).  And inner Sydney still has excess demand.

While we have quality property in most regions of Australia, some areas we can recommend at the moment are Gladstone (property under $400k appraised to rent for $450 per week - for more information on Gladstone, including $66bn of approved new projects expected to deliver up to 18k jobs in Gladstone, click here); and  Sydney's exclusive Neutral Bay (boutique off-plan development - block of only 12 apartments - priced from $497-$760k, and will yield over 5%) and Sydney's northern beaches (1 & 2 bed off-plan apartments all under $600k to benefit from the current NSW government stamp duty exemption).  

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