Property prices on solid ground

PORTFOLIO POINT: Contrary to the narrative promoted by some sections of the media, Australian property prices are in fact stabilising.

I do enjoy seeing the more unusual and whimsical graphs that Alan Kohler shares with us in ABC TV’s evening news bulletins, such as the recent one that showed Apple Inc’s market value is close to outgrowing the sum of Spain, Portugal and Greece’s entire annual economic output.

This was, of course, a spurious comparison, but for a real case of comparing apples with lemons, have a look at this graph from last week:

Sourced from the inimitable Steve Keen, it purportedly illustrates that Australian property prices are on a pathway to rack-and-ruin, based on the Japanese and US experience. Now I don’t deny the data that Australian property prices have fallen about 10% since their peak in 2010. But does Keen still really believe prices will fall 40 to 60% in coming years, despite his poor predictive powers in the past that saw him lose a bet and climb Mount Kosciuszko?

The reality is that there is no downward trend in prices. Instead, prices are now stabilising, as this table shows:

I for one am feeling more optimistic about the trajectory of prices in our major cities. Even in Melbourne, one of the capital city laggards in recent months, there are clear signs – in terms of higher auction clearance rates and greater numbers of bidders – that a recovery is on the horizon. Indeed, in some pockets of inner suburban Melbourne, prices have begun to recoup the declines of the last two years, which is often a precursor to improvements in the broader market down the line.

I’m not on the outer in terms of this opinion. Saul Eslake, chief economist at Bank of America Merrill Lynch, speaking on the eve of last week’s super-sized interest rate cut, thinks prices may fall a little further, but not by much.

“The probability that prices fall another 5% or so on average across Australian cities is probably around 60%. Prices may drift down until enough people are sufficiently confident to borrow money to buy property and feel they can make money on the transaction. I think it will take more interest rate cuts and a sense that the economy has improved more generally.”

But Eslake doesn’t rule out price rises in the near future. “There’s also a 30-35% probability that we have seen the bottom of the property market. There could be very small percentage increases in prices.” Eslake adds that he doubts a big decline of the order Keen is predicting could occur: “The fact that interest rates will be going down will contribute to that,” he says.

And now we have the benefit of the Reserve Bank’s rate cut last week, despite those dastardly big four banks only passing on around 35-40 basis points to mortgage holders (even though they only recently raised them independently of the RBA). Experience shows that property prices benefit disproportionately from rate cuts relative to the rest of the economy, due to the level of debt among home owners and investors.

Of course, when those doomsayers finally and grudgingly accept that the market is improving, they’ll also declare that it’s just a postponement of the inevitable bust. But they fail to accept that the conditions and triggers for a bust that were present in other places do not exist in Australia.

Unlike the US, Spain or Ireland, there is no overhang of excess supply. Eslake agrees, pointing to the UK as a better comparison. “They, like us, have a shortage of property, in part because of the impact of planning laws. Even though UK house prices fell after the collapse of Northern Rock bank and the supply of mortgage finance was turned off, once it was turned back on, much of that loss was recouped.”
Another helpful similarity with the UK is the predominance of variable mortgage rate lending. When the central bank cuts the cash rate, the rate of borrowing paid by mortgage holders also falls. But we’re in the enviable position, unlike the UK, that the central bank cash rate can fall further, if required.

The truth is, although we criticise our local politicians for ineptitude and inaction, there is much that past governments have got right over the last 30 years that has made the Australian economy more resilient and less prone to inflation and severe recessions. Our exchange rate can and often does adjust to mitigate a faltering economy.

Compare this to individual countries in the eurozone that struggle with a one-size-fits-all currency. They cannot respond independently to the dynamics of their domestic economies.

Government debt is extremely low by world standards. It means the state isn’t devoting huge chunks of tax revenue to paying an interest bill, and it can afford to step in and support the economy if and when a recession hits.

We also have well-regulated banks (notwithstanding the big four having too much market power), reasonably flexible labour laws, and the ability to address skill shortages and add to the size of the economy through skilled immigration.
Further, the establishment of a compulsory superannuation system means we’re not facing a demographic time bomb in terms of a declining tax base versus a ballooning pension bill.

Finally, we are blessed to be on the doorstep of the world’s most promising economic zone, Asia.

Of course, we will have a recession from time to time. The three-and-a-half years since the GFC have not technically been a recession in Australia, but with GDP growth bumping along at 1-2% below trend over that period, for many Australians it has felt as such. But even so, we only saw property prices fall by 10% from their peak.

There was no crash. There was no Armageddon. The property doomsayers are wrong again. It would be comical, except they’ll continue to grab the ear of many a journalist.

Ironically, their warnings will discourage many Australians from being proactive and seeking the very financial security that would largely insulate them from the next and eventually inevitable downturn in Australia.

Property Q&A

This week:

• Neighbour extensions.
• Can you borrow here to buy in the US?
• Purchasing NRAS properties.
• Buying a first apartment.

Property extensions

The next-door neighbours are proposing a two-storey extension, which includes extending their house to the perimeter of their property. That would have a significant impact on the amount of light my home receives. There would also be a disturbance during the construction, as they would need to use my (single storey) roof. Do you have an opinion about the impact on the value of a neighbouring property with such a proposal? On one hand, there is the light impact issue; on the other, does it mean that the ability for me to do such an extension (which I do not currently intend to do) is enhanced and therefore dollar value is potentially added to my property?

You’re correct that, from your perspective, this development has positive and negative aspects to it. In the short term, the disturbance will be a nuisance, but the fact that the neighbours need to use your roof to aid construction puts you in a strong position to influence outcomes on this and other matters.
Good quality natural light is a highly valued feature for property owners and buyers, and its loss will detract from the value of your property and, more importantly, possibly your enjoyment of it. The magnitude of this loss depends on the amount of light lost and where this takes place. Losing light in a much used space, such as a kitchen or dining room, is a far bigger blow than loss of light in a rarely used guest bedroom.

On a brighter note (pun intended), your neighbour’s extension – if designed and built well – will demonstrate to the market the future potential of your property to have the same process applied to it. The extension will probably result in a positive uplift in your property’s value, especially if your neighbour’s property is sold in the near future for a significant premium over its pre-extension price.

I suggest you use the roof access as a bargaining tool to constructively work with your neighbour. Ask to look at their plans and engage an architect or draftsman to consider and advise you of the ramifications. Please note, though, that if the neighbour’s property is immediately adjoining, very careful protection work needs to be in place to protect your property, so ensure these are catered for in the plans.

Borrowing to buy US property

I am curious to know if there are any Australian lenders willing to lend on US investment properties and, if so, where to find them?

I’d suggest there are really two questions here: can you borrow locally to invest in US property? And should you?

According to a financial adviser source of mine, there is no established Australian bank that is willing to lend against US property. They see such lending as high-risk, which they are intent on avoiding since the onset of the GFC. Lending against US assets is high-risk for two reasons. First, there is currency risk; an unfavourable movement in what has always been a volatile exchange rate could see the Australian value of the US asset fall relative to the value of the Australian-denominated liability.

More fundamentally, Australian banks recognise that they don’t have a clear vision of what is happening in the US housing market or the merits of specific investment propositions. However, I suspect they, like me, recognise that many of the so-called bargains currently being marketed are nothing of the sort.

In fact, not only will Australian banks refuse to lend to you, but neither will US banks. So if you wish to invest in the US, you’ll need to use cash (either spare cash or that released by borrowing against an Australian asset such as your home). The fact that neither Australian nor American banks will lend to you probably tells you that you shouldn’t do it!

NRAS properties

I do not have quite enough spare money in my super fund to purchase a rental property. However, I have been looking at National Rental Affordable Scheme (NRAS) properties and wondering if I should reallocate some cash and purchase a low-value one. It seems to me that about $9,800 p.a. indexed for 10 years in exchange for a 20% reduction in market rent is a pretty good deal, if the property is less than about $300,000 (particularly if one can access the Queensland government’s $10,000 bonus for a new property purchase). What do you think?

It sounds like you have just under $300,000 to invest from your super fund. Correctly, you recognise that this isn’t quite enough to secure a high-quality investment property in an inner suburban part of Brisbane, so you’ll be looking to make a compromise.

Unfortunately, were you to opt for a National Rental Affordable Scheme property, I suggest the compromise would be too big. You would be giving up any realistic hope of good capital growth, the powerhouse of wealth creation. This is because the demand in the resale market is heavily curtailed by the necessarily marginal location of these properties, the NRAS-imposed restrictions on who can live in them and the likelihood that you’ll have to sell the property to someone in the small group of people interested in the NRAS scheme at any one time.

Rather than investing in an NRAS property, you may be better off considering investing in a regional city with a diverse economic base that is relatively close to a capital city, such as Newcastle in New South Wales or Geelong in Victoria. Here, entry prices are lower than in a capital city, but you are more likely to obtain a more consistent and higher level of capital growth than with an NRAS property.
Obtain advice from an independent property adviser to establish if such a route is practical. It may be that your finances are not quite sufficient, and you may be better off waiting until they are.

First apartments

I have a 21-year-old daughter who lives at home, owns her own car and earns around $45,000 p.a. She has $45,000 in savings. We live in Western Victoria and we were thinking of her investing in an inner city apartment. Currently, we’re looking at a one-bedroom apartment (about 48sqm) in Lonsdale St in Melbourne’s CBD for $280,000, rented at $380pw with an active body corporate (144 apartments in the block, all one-bedroom). From all accounts, there is good occupancy on apartments – but what about capital growth? Are we looking in the right area or should we be looking somewhere else? Should she be saving more?

Congratulations to your daughter for getting to a position at such a young age where property investment is possible. However, I recommend that your daughter passes on this opportunity and keeps saving a little longer. This property might deliver your daughter some modest net income, but it is likely to deliver little capital growth in coming years. The large number of properties in the block, plus the numerous similar properties in the CBD, the Docklands, South Bank and St Kilda Road means there is no scarcity value attached to this property. When it comes time to sell, you can be sure that your daughter’s property will face price-dampening competition from other similar properties on the market across Melbourne’s CBD.

Given the very stable conditions and outlook for property prices at the moment in Melbourne, it is unlikely prices would change much in the next six to 12 months. Ideally, your daughter would use this time to build a bigger deposit, and hopefully she will increase her earning power in that time as well, through a couple of annual pay rises. She might then be in a position to consider a prime one-bedroom investment property in the $300,000 to $350,000 range in a Melbourne inner suburb, two-to-12 kilometres from the CBD. The property would be in a small established block built at least 20 years ago. Choose an apartment with a good position and outlook and ensure it has allocated parking.

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