Close to the tipping point?

PORTFOLIO POINT: The property market is likely to remain subdued due to current volatile conditions, but buying conditions are definitely right for astute investors.

In two speeches over the last fortnight, Glenn Stevens has told us that in coming years we can’t expect property prices to appreciate at the rate they did between 1995 and 2007. He sees average capital growth moderating from around 6% per annum in real terms during that period to around 3% per annum in real terms going forward.

His theory is based on the premise that much of the growth between 1995 and 2007 was built on households increasing indebtedness from 70% of income in 1995 to about 150% in 2007, after which households have had to be more cautious.

I agree that the 12 years or so to 2007 was an extraordinary time for property price growth. Indeed, whilst residential property assets as a whole may have averaged 6% capital growth in real terms overall, high-quality investment grade property did a great deal better. It was not unusual for good, well-located property in our capital cities to triple in value in that time frame. This well exceeded my benchmark that quality residential property doubles in value every seven to 10 years.

Furthermore, the residential property sector received an unexpected further boost during the GFC as a result of increased government largess to first home buyers. This aggressive pump priming by the then Rudd Government in effect brought forward in time a significant amount of the natural capital growth we would otherwise be experiencing now, even though this period was one of overall reduced investor confidence.

The resulting fall in values over the last 18 months to two years therefore shouldn’t be that surprising. The property market needed to take a breather after the irresponsible engineering of the market via huge grants and stamp duty concessions. And despite the nation emerging from the GFC largely unscathed with a healthy domestic economy, Australian investors are understandably more cautious in light of volatile international economic conditions that may well persist for several years.

Subdued growth
So where do these observations lead us? I agree with Stevens that future price growth is likely to be more restrained for the next few years. Yet I am a little more optimistic about the prospective rate of growth than Stevens, but only when it comes to investment-grade property. Due to Australia’s long-term outlook I still believe high-quality assets can double in value within the long-term benchmark of seven to 10 years – but in this cycle that doubling will be closer to 10 years than seven.

Why am I relatively confident that this is a cyclical phenomenon? Notwithstanding domestic consumer caution born of economic uncertainty abroad, there is a confluence of factors at home which, in my view, will eventually lead to a tipping point in terms of property market sentiment. This, in turn, will support future albeit more moderate capital growth.

We have low interest rates, low inflation and low unemployment. And with 18 months to two years of weakening property prices and steady growth in rents, rental yields are rising, which is narrowing the difference between servicing a mortgage and paying rent. This is typically a cue for renters and prospective investors to enter the market, although in this cycle the impetus to do so may take longer than usual to filter through to investors.

I also suspect that in a time when the other major asset class – equities – is also experiencing high volatility and downward pressure on capital growth and yields, increasing numbers of investors are likely to preference property over equities because of property’s relatively superior resilience, performance and lower price volatility. As well as the asset class’s relatively stable hedge against volatile equity markets, we may also see a shift away from fixed interest assets given falling interest rates, low earnings and the tax liability for these assets.

Further, we need to put the current market weakness into context. Present conditions are not exactly unprecedented. For instance, most recently there was very little capital growth in property during the period 1990 to 1996 when the Australian economy was either in or just coming out of recession. Arguably, domestic conditions were worse then than they are today.

Tipping point
Unfortunately, whilst we know which factors and fundamentals will support an eventual return to capital growth, in the current nervous environment we can’t know when the tipping point will occur. The market may well tread water for up to a year or two before we reach it. We saw this in the early to mid 1990s. On the other hand, it could reach that tipping point sooner and unexpectedly. Note that history shows that the longer and harder a market is held down, the greater and stronger the rebound when conditions improve.

In this time of uncertainty, investors need to focus on what they can control rather than what they can’t. So whilst you can’t control the existing fundamentals and the international or domestic economic context, or the moment when the market turns up, you can ensure you make the most of market transparency, improved affordability and choice of assets.

Just as a rising tide lifts all boats, even compromised or second rate assets experience some capital growth when markets are strong. In a market with overall slower growth, these types of properties will trap many investors attracted by their high percentage yields and lower-than-average entry prices, only to suffer capital losses. Investors should never lose sight of the main game – residential property must be viewed as a growth asset rather than an income asset, especially during softer times like these.

Investors should also be more cautious about financing and be disciplined about paying down debt. It is only through controlling equity – either through acquiring assets that perform above the market average or repaying debt – that investors can secure financial independence.

We are living in unusual times. Never have Australians placed more weight on global conditions than local conditions, and never again will we be able to be ostriches when it comes to the impact of global conditions on domestic asset classes. Ultimately, however, compelling domestic fundamentals will reassert themselves. Today, the much improved affordability is an opportunity, and those who are brave enough to venture forth will ultimately benefit from that foresight and judicious asset selection.

Property Q&A

This week:

• The FIFO effect on Perth and Brisbane.
• Understanding stratum titles
• Will the NSW first home owners grant boost the market?
• Are our capital cities overvalued?

Perth, Brisbane and the mining boom
You’re sceptical about the merits of investing in mining towns. What about opting for larger cities that are relatively close to the mines such as Perth and Brisbane? Do they benefit from fly-in, fly-out (FIFO) workers basing themselves there?

Yes, but perhaps not as much as they used to. With modern transport and work flexibility (e.g. two weeks on, two weeks off) many mining staff find they can live anywhere within five or six hours flight. Indeed, some even live in Bali.

At the margin, cities like Brisbane and Perth probably do benefit the most of all our capital cities, but I’m not convinced that this additional demand may be significant or stable enough to boost growth and income over an extended period. And, of course, the fickleness of the mining sector means the FIFO effect may disappear as quickly as it arose. Ultimately, it is safest over the long run to purchase in a location where demand is multi-faceted and persistent – that it relies more on the permanent population than the transient one – rather than speculate on where FIFO workers will base themselves.

Are stratum title properties a safe investment?
I’m looking at an apartment in Melbourne that has a stratum title. How does a stratum title differ from a strata title, and should I avoid it?

The 1960s saw an evolution of property ownership and introduced us to the terms 'stratum’ and 'strata’ title. Before the advent of stratum titling property owners were like shareholders. Many blocks of units were owned on one title and share parcels were allocated to individual owners of flats. This company share structure made it difficult for investors with modest purchasing power to enter the residential property market.

The introduction of stratum titling in the early 1960s allowed blocks to be subdivided for individual ownership, paving the way for investors to become the registered proprietors of their own flats and hold a certificate of title. Holders of stratum title properties own shares in a service company, as well as their title. Like company share flats, many stratum flats are located in the inner city and bayside suburbs of Melbourne.

From 1967, properties were subdivided according to the Strata Titles Act. Owners would receive a title to a unit along with a car parking title – if available – and would become a member of a body corporate.

Generally speaking, I’m comfortable with investing in stratum title. Occasionally lenders are a little hesitant about stratum title as the mortgage can take second place behind service company debts should the owner default, but this does not appear to be a common issue.

Make sure you get your solicitor to check the title and decipher the company rules and entitlement. And definitely make sure you have a legal entitlement to a car park. Remember, flats without off-street parking are a no-go.

The NSW first home owners grant
Do you expect the new first home owners grant in NSW to boost the market there? As an investor, should I buy now?

Oh groan, here we go again! State governments seeking to fill their coffers with stamp duty funds by artificially engineering the property market upwards. On this occasion, the New South Wales Grant will increase from $7000 to $15,000 on October 1, then drop to $10,000 from 2014.

All other things being equal, one would expect this grant to encourage first-time home buyers to delay their entry into the market until October, leading to a drop in prices now and a strong bounce back in Spring. If one thinks this will eventuate, then investors may wish to buy before October.

However, it may be that first home buyers are becoming a little bit savvier about the illusory benefit of the grant, and its impact may be less than yesteryear. Best to buy when you can afford to as either an investor or occupier, rather than try to time a market entry around an arbitrary stimulus. What you buy is infinitely more important than when you buy.

A costly place to live
According to Mercer’s cost of living survey of expats, our major capital cities are more expensive than London and New York. Is that not an alarm that Australian property is overvalued?

The Mercer survey takes in much more than the cost of property. Living in our cities may be expensive, but our property prices – even for prime real estate – are nowhere near the levels of top northern hemisphere capitals like London or New York.

This is a subjective index which should not be taking as gospel unless you are an employee of a transnational corporation who is being relocated around the world and require a salary adjustment to compensate for cost of living variations across rent, groceries, restaurants and education amongst other factors.

Given the robust nature of our economy, this is an encouraging measure of our market’s resilience in the face of global adversity, not (another!) portent of doom.

Monique Sasson Wakelin is a director of Wakelin Property Advisory, an independent firm specialising in acquiring residential property for investors. Monique can be found on Twitter: @WakelinProperty.

Note: We make every attempt to provide answers to readers’ questions, however, answers are of a general nature only. Subscribers should seek independent professional advice for more in-depth information that is specific to their situation.

Do you have a question for Monique? Send an email to monique@eurekareport.com.au