Prepare for a property upturn

PORTFOLIO POINT: Investors looking to buy property at the bottom of the cycle need to get ready, as we’re likely to encounter a seller’s market later this year.

The property market is definitely picking up in Melbourne and Sydney. This is a nascent but palpable sign coming out of the first few weeks of the 2012 auction year. Let me tell you why and, more importantly, what you should do with that information.

First, let’s look at Melbourne, the auction capital, where the trend is most clear. As you can see from this table, since the weekend of Saturday 18 February, auction clearance rates and volumes have increased.

Melbourne auctions

Source: REIV

A market has to have pretty good momentum to absorb increasing stock and maintain or increase the clearance rate, meaning growth in buyer numbers is outstripping growth in properties for sale.

It would appear, from anecdotal evidence, that the clearance rate in inner suburban Melbourne is much higher than the data in the table above would suggest. A number of estate agents are selling all their listed auction property each weekend. For instance, Anna Perry of Hocking Stuart Armadale declared on Twitter late last month: “Well done team, 100% clearance rate so far in 2012.” Greg Hocking, director at Melbourne-based Greg Hocking Real Estate tells me that he sold four out of four listed properties in the weekend before last.

As I move around the inner suburban market, my experience in the last three weeks indicates that the percentage clearance rate may be in the range of 80-90% in Melbourne’s inner suburbs.

I asked Greg Hocking why he thought things had improved in 2012. “Because supply is quite tight and interest rates are trending downwards, even though we’re getting mixed messages,” he says. “There’s a little more pace among the group of buyers out there at the moment and more buyers are filtering into the market. A lot of fence sitters in the upper echelons of the market are starting to make their move as things firm up a bit.”

However, I think it is early days in the 2012 market recovery and there is still some scepticism about what the market is doing. Hocking agrees. “Many buyers need hard evidence as in 'sold’ stickers going up before they quicken the pace of their search,” he says. “But the belief is forming among buyers that the next move will be a firming of prices and if that occurs buyers won’t want to be on the back foot. We’ve noticed that some long-term buyers who have been in the marketplace for anything up to six months have just committed to a purchase in the last few weeks.”

Sydney auctions

Source: REINSW

Turning to Sydney, auction numbers and clearance rates are a little more mixed but anecdotal evidence suggests the trend is also up. Rich Harvey, managing director of Sydney-based PropertyBuyer, advises that the improvement has been gradual.

“The lacklustre activity over the holiday period continued at the end of January and into the first two weeks of February. However, recent weeks have seen buyers awaken from their slumber with numbers at open houses increasing significantly.”

Harvey stresses that while inspection numbers are up, this has not translated into an increased volume of sales at this point. “We are seeing up to 30 or 40 groups go through some open inspections for quality properties. Typically, this is only translating into one or two serious buyers.”

He says the lower end of the market is performing best. “In the sub-million dollar market, turnover has increased with buyers looking to upgrade and relocate. Our investor enquiries are also increasing as rental yields rise in line with Sydney’s chronic housing shortage,” he says.

Harvey warns that the Sydney market is price sensitive. “Prices are soft in the above $3 million prestige sector, but deals are still ticking over. The mid-sector market from $1 million up to $3 million is patchy but again we are seeing increased activity there.”

Harvey believes that further improvement in the Sydney market is likely. “I believe people are back to the point of making decisions rather than just sitting on the fence,” he says. “The next few weeks will be a telling signal for the Sydney market as the lead up to Easter traditionally brings in a good volume of sales in Sydney.”

So what should investors do with this information? Investors who are serious about buying near the bottom of a property cycle need to mobilise, in my opinion. Greg Hocking is just as adamant: “This is probably the phase of the market where people should be positioning themselves and their property plans,” he says. “The worst of the downside is behind us and prices are likely to firm up, so there shouldn’t be any hesitation for people to act now. They should get into position now because if the market does take off there is no point running down the platform and trying to get on the train when it is pulling out.”

Hocking’s train metaphor is an apt one. Like a steam train, property cycles have a tendency to gather momentum slowly and then speed up, in terms of competition for property and subsequently capital growth. Once the property market does pick up speed, it is harder for participants to plan their strategy as, in a matter of weeks, a budget may not deliver as much as it did a couple of months earlier.

Harvey agrees. “Now is a better time to trade as the market is slowly beginning to rise. As long as you buy and sell in the same market, you won’t get caught out with large price swings.”

Don’t get me wrong – we are not in a bull market by any stretch of the imagination. The dynamics are reasonably balanced between the buyer and the seller; neither has the upper hand at the moment. It is most likely that this situation will persist in Melbourne and Sydney for several more months. But the chances are that we will shift back into a seller’s market later in the year, barring any major economic setback in the US, Europe or China, or an unexpected weakening of the Australian economy. It’s time to start your property investment research.

Property Q&A

This week:

• Which city has the best rental yields?
• The risks around a Euro default.
• Apartments and design trends.
• What happens when rents hit a ceiling?

Rental yields

Which capital city is currently offering the best rental returns?

According to RP Data, the highest rental yields for houses are in Darwin, at 5.8%, and in Hobart, at 5.3%. Canberra is the top market for units (5.8%), followed by Darwin (5.7%). Focusing on just the larger capital cities – Sydney, Melbourne, Brisbane, Perth and Adelaide – Brisbane has the highest rental yield for houses and units (4.6% and 5.5%, respectively).

Brisbane’s relatively high yield is a function of property prices falling, in reaction to last year’s floods, while rents rose. I therefore expect to see it drift downwards towards the average of the five major capitals (4.1% for houses and 4.8% for units).

Be careful how you interpret and act on this information. High percentage yields do not necessarily indicate better investment prospects for investors. A rising yield may mean that property prices are falling and a consistently high yield means low capital growth, because the property is not investment grade. Be aware that residential property is primarily a growth asset and yields should be in the order of 3.5-4.5% to get the balance right.

Euro default

If Greece or another European country defaults, what short or long-term impacts would this have on the Australian property market?

I think that no one truly knows the answer to this question, but I can provide some observations. In some respects, the outcome depends on who defaults and the manner of that default. In recent days, the ratings agency Standard & Poor’s has judged Greece to be in what they call a 'selective default’ (cute, eh?), after the latest EU-brokered deal. Will this be the end of it? Probably not. It seems possible that the extent of the default will deepen over coming months, in a relatively orderly and controlled fashion, as the deal is continually renegotiated to give Greece better and more realistic debt repayment terms. If the default is orderly, such that the European banking system isn’t jeopardised, it is likely that there will be little long-term effect on Australian property. However, in coming months, the ongoing saga and brinkmanship around Greece’s debt may continue to give the Australian property market jitters and hold back the property cycle until the crisis is resolved in a more predictable fashion.

An Italian default would be a completely different matter – one that would have serious consequences for the world economy and the international banking system, in light of Italy’s sizeable GDP and the value of its debt in absolute terms (it has the third-largest bond market in the world after the US and Japan). Such a scenario would probably bring on a global financial crisis that would dwarf that of 2008. Property prices would most likely fall, although the decrease would be tempered by the likely slashing of interest rates in Australia by the Reserve Bank.

Of course, eventually the world economy would recover and the long-term trend that favours Australia and supports its property market – the shift of global economic gravity from the west to the east – would most likely reassert itself.

Apartment trends

Are inner-city older apartments still a good investment in a more design-conscious society?

In life, some things are in vogue forever, while others only last a season, a year or a decade. Think of the antique watch or necklace, or classic Chanel suit, compared to what people were wearing in contemporary movies made just 10 or 20 years ago.

Some things are timeless. Other fads come and go – and so it is with property.

With clothing or hairstyle purchases, the passing of fashion isn’t a big deal, given the relatively rapid frequency with which we turn over our wardrobes or attend the hairdresser – at least for us girls! But given the expense associated with buying property, you need to be wary of investing in contemporary property styles, as experience shows there is a good chance they will date quickly, fall out of fashion – and stay there.

Inner suburban apartments of the 1930s to 1970s have demonstrated an enduring appeal and will continue to attract investors and home buyers. I’m afraid most of today’s styles will fall out of favour and may not become desirable again – if they are fortunate enough to make a return – for at least another 30 or 40 years. This is well beyond a long-term investment timeline.

In the interim, one can expect contemporary buildings to depreciate in value, while timeless, antique buildings increase because they are scarce and irreplaceable. Further, older buildings tend to be built close to the centres of our cities and therefore benefit from higher land values.

Rent ceiling?

Rent has to go up for house prices to go up. What happens when rent hits a ceiling, if people cannot afford higher rent?

Does rental growth drive property prices or do property prices drive rents? Understanding the direction of causation is critical to understanding the property market.

Many commentators talk about the imputed rent on a home – how much rent a homeowner would have to pay to lease a similar property to their home – and claim that the low level of this figure relative to a homeowner’s debt service costs proves that house prices in Australia are overvalued. The Economist magazine is guilty of this error. Well, property is not like a share in a company. The capital value is not a function of discounted future earnings.

Property prices drive rents, not the other way around. That is because the vast majority of buyers – around 70% – are buying homes and around half of property buyers are trading up or downsizing rather than buying for the first time. For these people, the level of market rent is unimportant to their decision as they’re not choosing between renting and buying.

Rather, the cost of housing will be instrumental in determining the level of rents, as it is a key driver of the supply of, and demand for, rental properties. As the property cycle moves towards its peak, some new investors are priced out and the supply of rental stock falls. At the same time, demand for rental properties rises, as many prospective first home buyers find renting a better financial proposition than buying. The result is, not surprisingly, that higher property prices lead to higher rents.

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