A housing rebuild, without the boom features

The residential property market is recovering … but don’t expect a boom this time.

Summary: Low interest rates and a recovery in yields are helping to revive Australia’s residential real estate market. But, in terms of capital gains, don’t expect a property boom. Conditions are patchy, with some markets such as Victoria facing oversupply.
Key take-out: While some believe Australian property prices are overvalued, on an average house price to income ratio we sit around the middle of the pack.
Key beneficiaries: General investors. Category: Growth.

When it comes to property, it seems the world – at least in Australia – is divided into two warring camps.

There are the shrill cries of impending doom from academic economists, convinced that we are on the cusp of disaster. They believe the Australian property market is one enormous bubble set to burst and will take the banking system down with it.

Then there are the property spruikers for whom it is always boom time, even when the market is heading south.

Not surprisingly, neither is correct. Residential property prices certainly are on the upswing, kicking higher after two years of declines and, from a national viewpoint, 2013 is promising some strong gains. But the rises are uneven across state lines and the housing category, And, unlike previous recoveries, this will fall well short of a boom.

Despite a strong lift in housing affordability, and with surveys indicating that potential buyers view the current market as an ideal time to enter, first home buyers are almost completely absent following the withdrawal of federal and state government incentives.

The macroeconomic picture is also more complex than in previous recovery phases, where real estate prices have bounced by 10 to 20%. While more affordable – largely due to 18 months of interest rate cuts – Australian residential housing certainly isn’t cheap from a global perspective.

That places the Reserve Bank in a difficult position. While clearly determined to maintain an easing interest rate bias to aid a recovery in the non-resources sector of the economy, it is likely to tolerate only moderate and steady increases in residential housing prices.

To achieve both goals – firing up the domestic economy without overheating the property market – will require some innovative policy, possibly through prudential controls, with the help of the Australian Prudential Regulation Authority, on banks.

This has broad implications for property investors. Such controls – like more stringent loan to valuation ratios – could limit capital gains. But existing property owners, particularly those who are geared, are likely to benefit from continued lower interest rates.

Earlier this week, UBS economists Scott Haslem and George Tharenou published one of the most insightful papers on the Australian property market in the past few years. With their permission, Eureka Report has used this, in conjunction with studies from RP Data and other sources, to compile this investment outlook on property’s State of the Nation.

The interest rate effect

After 18 months and 175 basis points of rate cuts, residential mortgage rates are now at their lowest point in 50 years.

That has lifted affordability to its highest level in a decade, improved rental yields to up to 5% in some categories, caused a resurgence in property prices and lifted residential building approvals, with a shift towards medium density.

For calendar 2013, UBS predicts a 7% rise in real estate prices that should moderate to around 3% growth in 2014.

While the doomsters delight in pointing out that Australian real estate is overvalued, and one of the few developed nations to not have suffered a major fall, on an average house price to income ratio we sit around the middle of the pack.

Certainly, we are far more expensive than the US and Japan – following near catastrophic falls – but cheaper than the Netherlands, Denmark and New Zealand, level-pegging with Canada, and only slightly higher than the UK.

Nationally, residential real estate prices, while well off the trough of a year ago, are still well below 2010 levels.

Rental yields

Rental yields are on the rise. With vacancy rates nationally at around just 2%, yields have risen to almost their highest levels in a decade.

The average national yield on a two-bedroom apartment is now just short of 5%, up from 4.25% in 2007. Given their elevated levels, growth in yields has begun to moderate sharply.

The picture is even more enticing when borrowing costs are taken into account. Net yields are approaching their highest level in almost 30 years. and look particularly attractive when compared with other assets such as equities and term deposits.

State v state

Residential real estate may be in recovery, but the gains are far from even. Victoria clearly is the weak link in the chain at the moment while NSW, and particularly Sydney, shows signs of the strongest gains.

Victoria’s main problem relates to oversupply. It has shown the strongest trend in approvals since 2008 and is still above the other states. But much of this was related to government incentives, particularly for new homes, which now have expired.

Recent Reserve Bank studies have raised the spectre of oversupply in Melbourne, particularly for inner city apartments, following previously strong growth in the supply of detached houses in the outer suburbs.

The UBS analysis points to Sydney as the strongest area for growth both in price and for new development. After lagging significantly for several years, Sydney now has the strongest growth in dwelling approvals and is the city with the greatest undersupply.

Property research from RP Data reinforces this argument, with annual price rises for Sydney property at 3.1% compared with 1.2% in Melbourne.

UBS argues that Perth once again is trending higher after a trough in 2011 although its study highlights the looming risk that a slowdown in resource investment may have on the market. Brisbane, meanwhile, is slowly recovering from its depressed levels.

With its tourism industry hit hard by the strength of the Australian dollar, Brisbane property values (which include the Gold Coast) have been in a slump and with building approvals just above multi-decade lows.

RP Data studies have shown that large numbers of property investors have lost money in Queensland real estate in recent years, selling for well below purchase price. And the group’s most recent statistics on vendor discounting and the time it takes to sell a property are illuminating.

Crystal ball

Residential real estate prices are particularly sensitive to interest rates and normally are quick to respond to lower rates.

From a peak in October 2010, house prices fell 7%, in one of most sustained housing price falls in the nation’s history.

UBS, which had forecast price growth of between 3 and 6% for 2013, this week upgraded its forecast to 7% growth nationally. While it believes price growth will moderate to 3% next year, a continued strong Australian dollar will force the RBA to maintain rates at or near record lows, thereby improving the chance of stronger than expected appreciation in 2014.

Price growth, however, will be tempered by continued relatively high household indebtedness and an RBA that will “lean against” strong growth in real estate values, either by threatening to raise rates or employing other tools to dampen speculative investment.


Australian residential real estate is looking like a sound investment, with some of the best yields on offer in history. But, in terms of capital gains, this recovery will not mirror the booms of previous periods.

Not only will the recovery be steadier and more moderate than previous periods, it will also be more erratic. Perth has led the way, but Sydney has an undersupply. Melbourne is facing an oversupply while Brisbane, labouring under the yoke of a depressed tourist industry, is still in recovery mode.

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