PORTFOLIO POINT: Eureka Report's property expert Monique Wakelin discusses the key issues facing Australian residential investors.
Despite the overwhelming bias among Eureka Report’s contributors towards shares, our property expert Monique Wakelin has served her followers well over the last five years, consistently recommending selected residential property.
Through the GFC and many other challenges, residential investments have paid off; in fact they have, on average, delivered outperformance. Consider the investment returns for different asset classes for Australian investors in the 10 years to December 31, 2011: international shares (-3.5%), cash 5.4%, Australian shares 6.1%, bonds 6.3% and residential property'¦8.6%.
But the key question for Monique, her many followers and everyone from builders to mortgage brokers, is whether Australian residential property – among the dearest in the world – can possibly match the returns of the past or indeed the potential of shares, bonds or cash in the years ahead.
I was fascinated to find Monique as confident as ever about the local property market, though as you will see in the interview below, her enthusiasm has narrowed to highly selective zones of our national market. – Eureka Report managing editor James Kirby
For a long time, investors have expected Australian residential property to double in value every seven years or so. Can you reasonably expect that sort of return in the next decade?
I think my estimate has always been doubling in value every 7-10 years, and I always build in that buffer, because you have to take into account particular points in a property cycle, which is very much what we have experienced in the last couple of years, where property growth is going to be on hiatus because of external conditions predominantly. So as long as people build in the buffer, and they get their asset selection right, and these are the two big riders; I can’t see any reason why that benchmark won’t still hold.
So where do you think we are in the cycle at the moment? We know building approvals are still falling, we know house prices, certainly in the last year, have fallen '¦
Yes, between 5-10% across the nation.
Maybe 20% plus in the Gold Coast and the Sunshine Coast'¦
In some places much more, yes.
Where do you think we are in the property cycle now?
I think, like the economy, we’re in a multi-speed property market, and that really covers the gamut of all types of real property, whether it be residential, industrial, commercial. At present, Sydney is leading the cycle. That market was held down for quite some time, particularly as it felt the effects from the GFC more acutely than other states and other cities, but because it was held down '¦ property tends to behave a little bit like a pressure cooker; the longer and harder a market is held down, the greater the rebound will be when conditions improve, and we’re seeing this very much in Sydney at the moment.
In the national market, do you think prices have bottomed or are they still falling?
I think they have bottomed, except for very particular areas that may be, for example, just dependent on the fortunes of one particular industry. Those markets are always more vulnerable to economic and commercial ups and downs, particularly on a global scale. As I said, I think Sydney is probably leading the cycle, Melbourne is certainly at the beginning of a new cycle, and I quite like to think of property cycles as a little bit like a clock face. So if you were to think that 12 o’clock is the top of the cycle and the market, to use Peter Costello’s term, is “going gangbusters”, and 6 o’clock is the depths of despair and we’re all slashing our wrists, I would suggest that probably Sydney might be coming off the bottom at about 9 o’clock. Melbourne is probably at around about 7:30-8 o’clock. The rest of the capital cities tend to bump along a little bit, and they’re less predictable in terms of cycles, mainly because they are smaller. I think Adelaide tends to be fairly consistent and fairly predictable, and Brisbane has taken a bit of a hammering because of the floods.
You mention Brisbane: it’s supposed to be a resources-driven region, but its house prices fell harder than in any other state.
Yes, I think we have the anomaly of the floods, all the damage and the insurance claims, and I think that that is, what I call, the “Act of God” clause. That was something that nobody could have predicted; no-one saw that coming. Adelaide hasn’t seen quite the same drop '¦ and yet it is actually quite dependent on the resources sector. We haven’t seen quite the same level of angst in the Adelaide market. So I think, excluding everything else, I would have to say that floods in Brisbane was the wild card.
In the Melbourne market, I expect the primary concern is the potential oversupply of apartments to the inner city.
I think the potential oversupply of inner city areas – and I say city, not inner suburban, because they are two very different markets – has been a concern for me for over a decade. When we first saw the very first Mirvac, Australand, Lend Lease developments back then, I expected that there was going to be this problem for decades to come and that is certainly what’s happened. Where you have large tracts of undercapitalised land, and I’m thinking particularly west of the city in the Docklands and further west than that, you are going to see the potential for that kind of oversupply. The interesting thing about that is that where people are screaming about a chronic lack of affordability up until very recently, the good news is that, whether it’s Melbourne, Sydney or wherever it might be, the price falls have actually improved affordability.
Can the prices in inner ring suburbs that you’re fond of – in Melbourne, say – be insulated from a price collapse in the city itself?
Yes, absolutely, because one of the things that people don’t understand is that the new high rise apartment market is not the same kind of market, because one sector, the high rise city market, is potentially infinite in its supply. There is theoretically no limit '¦ there are limits in terms of how much land there is available, but there is a good quantity of land available when you go around that particular arc, and theoretically there is no limit to how high you can go. So that is a market that is potentially infinite. However, the inner ring suburbs, both the supply of land and the restrictions as to what you can do with that land, creates a finite market in terms of the supply. So that is the difference.
And you think that is genuinely sufficient to insulate the inner ring suburbs?
Absolutely. Plus the kind of infrastructure that you have in the inner ring suburbs does not exist in that new high-rise sector. You’ve got abundant schools, abundant transport and very high levels of employment opportunity in the suburbs.
The strongest argument that house prices will be suppressed for years is the argument which says that the house price increases we have enjoyed for years were driven primarily by easy credit, and if credit is not easily available, then people can’t borrow to pay the prices they might have. It cools the whole sector for years. Everything says the banks are going to keep levels of credit suppressed, so how can we expect good returns?
I can understand why Steve Keen and others mount this argument, however he has only taken one factor – credit – into account. First of all, people simply cannot walk away from their loans here. People take that responsibility very, very seriously; that’s the first thing. The ease or the lack of ease of credit is a relative measure. Arguably, if the amount of available credit tightens up a little bit in Australia, I’ve got to tell you, I believe that’s actually a good thing, not a bad thing, because it does create a sense of greater restriction and responsibility. The third thing is that he has not taken into account the level of demand, underlying demand that exists in the prime property market in major capital cities in Australia. So if that was just a one-dimensional argument, and that was the only factor in play, I would say to Steve Keen, “Yes mate, you’re right”, but he’s not because there are many other factors in play that he has not taken into account.
Our readers would be well aware of your key principles [of faith] in property purchase, and correct me if I’m wrong, but it’s been purchase in cosmopolitan cities, in inner ring suburbs, in older blocks, near good facilities and public transport, with a car space, with reasonable views?
Yes, correct, yes.
Has anything happened of late to change these key principles for you?
No, no, if anything James, they are even more important than they used to be.
OK, well picking up on that, it was probably inconceivable a few years ago that developers would build blocks without car spaces, but now they do it successfully?
I think some of that depends on the location of the actual block. That does not change my view, because what you have to ask there is, is that inductive thinking or deductive thinking on the part of the developers? I would argue that it’s actually inductive thinking, the reasons being it is very, very expensive for a developer to create on-site, off-street car parking. To them, it’s effectively a bit of a waste of space, and in terms of the actual sale price of each individual apartment, the presence or absence of car parking does not actually add, in an initial sale, and this is heavily qualified; in an off-the-plan, brand new sale, it doesn’t actually add a great deal to the developer’s profit margin. So the developer has one agenda. That is, how can I create the greatest possible return on my investment, and how do I optimise the site? Car parking isn’t necessarily a terrific site optimisation strategy.
What do you think a car space adds to the average value of a unit?
If it’s a lock-up garage, it would add somewhere in the order of $50,000 to the resale value of an apartment; of a good, low-rise, scarce commodity like that. If it’s a car space, then it’s probably in the order of somewhere between $20,000-$30,000.
There seems to be a rush of apartment development on railway stations, right through Melbourne and Sydney. Is this something new, and will it affect the market in any way?
One of the reasons that developers are picking up these particular sites that are near railway stations is that they can be bought and, I use the word advisedly, relatively inexpensively, and they are not what would be considered by the intelligent market, if I can put it that way, as the really high-quality sites. The dirt, the noise, etcetera '¦
But it seems to me people are willing to live there, where they weren’t willing to live there 10 or 20 years ago.
I think this is partly a function of site availability and site affordability for developers, because, let’s face it, unless we’re going into the major capital cities, and there are tracts of land available like down at the Docklands, what you have available in the suburbs that are serviced by railway stations, in terms of sites, are very few and far between. So, it’s a question of slim pickings.
I take it then, you don’t recommend railway junction developments?
No, no, absolutely not. There might be one or two exceptions.
Are there any significant changes in the regional outlook for your views on property? Maybe these outlying towns that are becoming de facto suburbs, such as Wollongong, Bendigo, etc?
I think that the larger centres and the ones that you cited are good examples: Wollongong, Bendigo, Ballarat, Geelong, those kinds of what I would call major satellite towns, probably have a greater upside.
A greater upside than which?
Than some of the smaller ones; for example, the mining towns, for me, are very questionable. They’re like meteoroids; they will streak across the sky and create a spectacle, and a beautiful one, but the fall to earth will be rapid and a bit of a burn.
We might just finish on the financing side. What do DIY funds like to buy?
There is a pattern emerging. First of all, the incidence of investors going the DIY route is increasing. Typically, what they buy are assets somewhere between $300-$800,000, probably with a greater bias to something between $400-$600,000, mainly because that’s more affordable. They tend to buy apartments, partly as a function of that price category, but also as a function of perceived greater convenience; less 'mucking around’ and maintenance associated with good apartments rather than houses. I think that that is a terrific way to hold an asset. It is consistent with the medium to long-term strategy that characterises residential, or for that matter, commercial property as an investment vehicle, because obviously the super vehicle is a long-term strategy, and I think as long as the asset selection is right '¦obviously there are rules associated with what you can do to a property once it’s in a DIY fund; there are obviously all the arm’s length rules associated with it, and as long as people go in with their eyes open and they seek legal and tax and strategic accounting advice, I think it’s a fabulous way to go.
One last question: rental yields seem to have been stuck fast at 4-4.5% forever.
Is there any prospect that they will rise?
I don’t see that necessarily happening at a really high level in the foreseeable future. I recall very well, in 1996 and 1997, that we were getting rental returns of something in the order of 6%. I think those days are behind us for the foreseeable future, and that is primarily a function of very strong asset values, because when you express it in terms of a percentage, if the percentage is low, it means the capital value is high, and so you would need to see capital values fall very substantially or be stagnant for a very long time.
So you don’t think, even though there’s great rental demand, that yields will budge?
I think they will budge a little bit. I could see them maybe going up to '¦ if we use 4% as just the round number, I could see them going to 4.2-4.3%, but they’re not going to go to 5%.
* Property Q&A will return next week.
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.
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