Is affordability improving?

PORTFOLIO POINT: Prices, incomes and mortgage rates are working in favour of home buyers, but investors should not assume it will last.

Affordability in our city property markets has been a major economic and social issue for several years. Some of the policies intended to help with affordability, such as first-home buyer grants, have undoubtedly added to the problem. But there are signs that it has improved markedly in recent months.

Addressing affordability is a complex challenge because it is a function of a host of factors: supply (both in terms of quantity and property type); demand (particularly with respect to how it matches or mismatches supply); population growth and demographics; property prices; household income; and borrowing costs, to name the most important.

At the moment, a number of these factors – property prices, household income and borrowing costs – are working together in favour of the prospective home buyer or investor, which is a rare occurrence in recent times.

The high-water mark of the Australian property market was about May 2010. Since then, prices in our capital cities have fallen between 5% and 10%, depending on which data source you consult. Concurrently, average median incomes have also grown strongly. According to the ABS, full-time private sector weekly earnings grew by 6% between May 2010 and August 2011. If growth continues on trend, cumulative two-year wages growth is likely to approach 9% by May 2012 (watch for the ABS November 2011 data on Thursday).

On the interest rate front, the mortgage interest rate on outstanding loans is now lower than it was in May 2010, according to RBA data. Notwithstanding last week’s positive unemployment news, I suspect ongoing concern about the situation in Greece will see a further cut in coming months.

My reading of improved affordability is confirmed by other sources. The HIA-Commonwealth Bank Housing Affordability Index improved 5.2% in the year to September 2011. Andrew Harvey, senior economist at HIA, says: “Affordability looks to now be trending in the right direction and, with interest rate cuts in November and December, we will hopefully see this trend continue.”

Rismark managing director Ben Skilbeck agrees, and says affordability is better now than at any point since 2003. “Housing affordability in Australia has experienced a striking improvement in recent times. Rismark’s research shows that disposable incomes per household have risen about 15% further than Australian dwelling values since the end of 2003. This helps account for the decline in Rismark’s national dwelling price-to-income ratio, which is as low as it has been since 2003.”

Anecdotally, there appear to be many more first-home buyers in the marketplace now than in 2011, judging from recent attendances at open-for-inspections and auctions. We’ll need to see how the autumn market progresses to determine whether this is a genuine trend, but if it is, it’s a good sign '” the return of first-home buyers is usually the result of improved affordability.

Can this welcome period of affordability be sustained? In the short term, yes, as I suspect we won’t see much capital growth in 2012 (see my outlook in Good property stands firm) so in real terms, affordability could keep improving over the year.

However, there will come a point where the improved affordability will be a signal to enough potential home buyers and investors to enter the market. Tim Lawless, director of research at RP Data, suspects that the improvement in prices could come sooner rather than later, especially if rates are cut. “If financial market pricing for substantial additional RBA rate cuts proves accurate, we could see a stronger-than-expected bounce-back in housing conditions.”

The February pause in rate cutting that surprised many pundits may end up being a blessing for investors, as it provided time for them to consider their strategies before the lift in prices occurs – including what and where to buy and their financial capacity and borrowing requirements – and avoided further stimulus to the market.

However, despite this good news, relying on low interest rates and growing real incomes to boost affordability in the long term may prove transient and unrealistic. History shows that low interest rates invariably lead to higher property prices in the long run – which of course eventually damages affordability – and we certainly cannot rely on above-trend wages growth indefinitely.

Ultimately, to address affordability requires major structural adjustments – ones that governments have failed to apply in the past. At the moment, too much of the new housing stock is simply the wrong sort in the wrong place. Developers are still building unnecessarily expensive and poorly designed five-bedroom McMansions in our fringe suburbs and cookie-cutter apartments in our CBDs.

These are properties that look enticing on paper or when brand new but have little merit when it comes to investment and future resale. They are in locations compromised in terms of amenities and/or transport.

Instead, developers should be incentivised or mandated to offer more two- and three-bedroom houses and one- and two-bedroom apartments built on infill and reassigned sites in our inner and middle suburbs that meet contemporary needs and tastes. At the same time, governments must improve the public transport links to our existing outer suburbs, in order to make them more appealing to home buyers.

Without these more radical measures, demand in our inner and middle suburbs will continue to outstrip supply and sustained affordability will be impossible to achieve. It may be that 2012 is the year of affordability, but given the level of dysfunction in government at the moment, investors should work on the assumption that it won’t last.

Property Q&A

This week:

• What are Ipswich’s prospects?
• We’re moving home on the Mornington Peninsula.
• Should I sell in inner Perth?
• Is the NRAS good for investors?

Ipswich

What are your thoughts on investing in a good suburb close to Ipswich? My early research indicates that the population has been growing steadily and is projected to grow substantially over the next few years. Prices seem to have run up significantly until 2008 and have stabilised around those levels.

Ipswich is a great example of what might seem like a good investment on paper, but in reality is a high-risk proposition. On the plus side, Ipswich, a fast-growing town 40 kilometres west of Brisbane, is an example of one of those locations that is expanding to accommodate Queensland’s high migration rate, and this is likely to continue for many years.

Unfortunately, while demand is growing quickly, so is the supply of housing in the region. Many new estates have been built in the past decade, and with plentiful land in the area and more generally west of Brisbane, there are few constraints on more housing being built. This lack of scarcity in supply will be a dead weight on future capital growth.

Further, the demographics and economy of Ipswich do not support the case for investment there. Ipswich has a population of just 170,000 and a narrow economic base: mining, defence and agriculture are key industries. And due to its relative affordability (the median house price is about $150,000 lower than Brisbane), incomes tend to be lower so there isn’t the earning power to propel the economy or the property market upwards.

Ipswich’s affordability is no doubt a good thing for home buyers. But investors interested in Queensland should stick within 10 kilometres or so from Brisbane’s CBD, where economic activity is most diverse and demand for property is most intense.

Peninsula move

We are contemplating a move from an acreage property at Red Hill on the Mornington Peninsula to nearby residential Mt Eliza and are interested in your thoughts on the impact of the soon to be completed Peninsula Link freeway on both areas. Because we are in the fortunate position of not having to sell before buying, and our belief that Red Hill will benefit more than Mt Eliza, we are inclined to buy mid to late 2012 and sell in 2013. Our buying price will be significantly less than our selling price.

The Peninsula Link is a 27 kilometre freeway currently under construction from Carrum Downs to Mt Martha on Melbourne’s Mornington Peninsula. It will connect three major freeways in the area and the project’s website claims it will reduce the peak period journey time between Mt Martha and Carrum Downs from 57 minutes to 17 minutes.

History shows that the development of major transport infrastructure does have a positive benefit on property prices around the route (as long as you’re not too close), and it is reasonable to expect an uplift for both Red Hill – a noted holiday location that contains rural and beach access – and Mount Eliza – a pleasant waterfront suburb that is increasingly a commuter hub for residents who work in Melbourne.

I agree with your approach. The greater inherent value of the Red Hill property compared to what you plan to buy means were you to buy before you sell and not sell until after the freeway completion in 2013, greater capital growth uplift is likely. In the meantime, as you are “trading down”, find and buy the best property you can, preferably in the area of Mount Eliza beachside of the Nepean Highway.

Perth

I’m 60 and own two good investment properties in inner Perth, worth about $1 million in total. The properties are positively geared as there are only small outstanding mortgages on each, and they deliver enough income to allow me to work just three days a week. I’d like to release about $200,000 in equity to finance renovating our home, a world trip and living expenses over next few years. Should I sell one or more of the properties?

Essentially, you have two choices. Either you sell one of your properties to release the equity or you set up a line of credit on one of the properties. Tax is an important consideration here. Were you to borrow additional funds, it is likely that the tax office would not deem them to be tax deductible as the purpose of the loan is not for investment. Please seek advice from an accountant regarding your specific circumstances and on the tax treatment in particular.

In light of the tax issue, your requirement for income and your stage of life, it may be time to sell one of the properties, ideally the one with the lowest ongoing investment merit. Consider obtaining some professional advice around the value of each property, their relative long-term growth potential, and which one might need more maintenance in coming years.

NRAS

Is it time for you to look more kindly on the National Rental Affordability Scheme? While 60% of NRAS properties are duds, there are some real gems with good rental yields and capital growth prospects.

The NRAS is a scheme, introduced in 2008, to address the issue of insufficient affordable rental properties. In essence, property investors who enter the scheme are compensated to the tune of about $10,000 a year by the government for leasing out properties at 20% below the current prevailing market rate to people of moderate or low incomes for a period of 10 years. The government subsidy has been calibrated so that it more than compensates the investor for holding the rent 20% below the prevailing rate.

Note that the NRAS is a wholesale investor scheme; that is, you or I can’t apply to provide one or two properties directly to it. Rather, developers or not-for-profit entities will apply to build many NRAS properties and they then market the properties on to individual investors.

As a consequence of these parameters, NRAS properties tend to be situated on new estates in more compromised parts of Australia where land values are low. The investor is of course restricted to a prescribed type of potential tenant. Should the investor wish to sell the property, the new owner must be willing to comply with the NRAS obligations.

The NRAS scheme only looks good if you are comparing NRAS properties to similar properties outside the scheme. With the government subsidy or incentive and the leasing competitive edge over nearby properties that a below-market rent delivers, the NRAS property looks good.

But, ultimately, you end up with an investment with compromised capital growth prospects due to the poor locations and type of property and the restrictions on who you can rent or sell the property to.

So the NRAS is not just another product of strategy. It is a scheme where the rules almost inevitably result in investors buying a sub-standard asset. The NRAS is an admirable idea, but should be avoided if you wish to maximise your returns from property investment.

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