Should investors worry about oversupply?

PORTFOLIO POINT: While some areas are experiencing strong supply, the broader property picture shows any oversupply will quickly disappear. If you’re planning to sell, aim for Spring.

We’re awash with unsold properties and a pipeline of construction no one will need. Or so you’d think from the recent housing commentary.

According to RP Data, there are currently 300,000 properties for sale across Australia, 5% higher than a year ago. Meanwhile, SQM Research has the national figure for unsold stock at 387,000. SQM Research paints a particularly bleak picture for Melbourne, citing a 28% increase in unsold stock levels there between June 2011 and June 2012.

Others argue there is an endemic long-term oversupply. Morgan Stanley researchers have analysed the Census 2011 results and compared it to the National Housing Supply Council’s (NHSC) recent estimates. In light of the Census showing 1.1 million fewer households than NHSC’s estimates but only 595,000 fewer private dwellings, Morgan Stanley believes Australia now has a 341,000 home oversupply rather than the 228,000 undersupply reported by the NHSC.

Evaluations about whether Australia has an oversupply or undersupply of homes requires economic modelling, using inputs such as number of households, number of dwellings, number of persons per dwellings and future projections for these parameters. Unfortunately, the results are notoriously susceptible to small changes to the assumptions made in the model. For instance, if the modellers assume a higher number of persons per dwellings than in the base case, it shrinks the number of dwellings required.

Indeed research out of the ANZ Bank, based on the new Census data, points to a current shortage of around 250,000 homes. Further, it indicates that underlying demand for housing sits at 196,000 per annum, driven by population growth, whilst completions are only 134,000 per year. So even if one was to accept Morgan Stanley’s view that that there is an oversupply at the moment, it would only take a few years to disappear given current rates of high population growth and fewer home completions.

So I’m certainly not concerned that Australia has a long-term, structural oversupply issue.

There are, however, areas where the supply of new properties is strong, namely our fringe suburbs and inner city high-rise market. That in itself is unremarkable, for that is the intention of developing these areas – building lots of properties for the new, growing population.

Of course, as I’ve discussed here before, the expanding supply of property in these areas means that one can’t expect good capital growth and therefore investors should stay clear. But we’re certainly not facing a situation of a nation or cities full of empty properties. If you took Morgan Stanley’s and SQM Research’s analysis at face value, this is what you would incorrectly surmise.

The picture is even rosier in middle and inner suburbs. With growing demand and little scope in most areas to increase supply, the long-term outlook for inner and middle suburbs in our capital cities remains strong. Ongoing scarcity underpins and supports future growth in those localities and that is what investors are interested in.

What’s especially interesting about the stock level data is that there isn’t a deluge of stock coming on the market. According to RP Data, total listings in June 2012 were 44,000, which is down 11% on the number of listings in the previous year. This indicates that the current build-up is more about old stock sitting on the market than a rush to sell by new owners. This conclusion is supported by auction clearance rates which have remained stable for much of 2012, at around 55-60% for Melbourne and Sydney. This indicates that the auction market is operating at a balanced level, and the overall high stock level isn’t stopping property from selling in the inner and middle rings. In fact, as we move around the inner suburban market, it is common to witness multiple bidders at auctions.

Lessons for vendors

The lesson for vendors looking to sell in coming months is that you must prepare your sales campaign methodically. If you do, then there’s every chance of disposing of your asset in a timely and satisfactory manner through the auction system.  But get it wrong and you risk your property quickly becoming stale and part of the older stock that’s not moving.

It is times like these when you need to employ an independent advisor and then estate agent who knows your area well, has been around long enough to have seen other challenging cyclical times, and can be candid with you about the right starting price to pitch a property so it sells. What you don’t want is an agent who gives you a flattering valuation of your property’s worth in order to secure your business, and then struggles to sell the property at this inflated price, leading to heavy discounting down the track.

Vendors can also tip the odds in their favour by listing at times when new stock levels within around 5 kilometres of their property are lower relative to demand.

Experience shows that early spring – September – is a particularly good time to list. Demand increases relatively quickly at the start of spring but new stock tends to lag, only really building over the last three months of the year.

My advice to vendors who want to list in this ‘selling season’ is to act now, as it always takes several weeks to choose an agent and to prepare the property and marketing collateral before the property can be listed.

Investors can treat with a large grain of salt the assertions that Australia has a long-term oversupply problem. The golden rule is to buy when supply is strong and sell when supply is weak. And those whose circumstances require them to sell during the soft part of the market cycle must apply some tactical nous!

Property Q&A

This week:

• Should I sell in Sydney and buy in a higher growth city?
• Buying a neutrally geared investment grade property
• Commercial office space in Noosa
• Is now a good time to buy US property?

Should I sell in Sydney and buy in a higher growth city?

I purchased a 1.5 bedroom apartment in Bellevue Hill in February 2011 to provide a base in Sydney. Our needs have changed now and I’m considering other options. I doubt values have risen enough to cover the stamp duty but executive rental returns have covered outgoings and made a small surplus. I’m wondering if values are likely to increase in the next 24 months or should I sell, accept the loss and put the $600,000 into a more productive area – either Perth or Darwin?

Do you have a genuine reason to think this property will underperform? If not, selling within 18 months of purchase will be costly due to the high transaction costs involved in buying and selling. Assuming you have successfully fulfilled the required investment criteria, property purchases should be made with at least a seven-year view and ideally, with a holding period of 10 years or more. If financially feasible for you, I would recommend you resolve to keep the property and reassess its performance in three to four years.

I counsel caution with respect to your thinking that Perth or Darwin will be more productive markets than Sydney. I presume the assumption derives from a belief they will benefit disproportionately from the mining boom. They may be doing so now, but it is highly speculative to invest in property based on the prospects of one sector of the economy.

Buying a neutrally geared investment grade property

I have a deposit of $100,000 potentially earmarked for a small investment in property. Unfortunately, I no longer have an income that can support a large amount of additional outgoings or take advantage of negative gearing concessions. Do you think that there are any opportunities available in Sydney or Brisbane (the two markets with which I am most familiar) for a neutrally geared investment grade property?

Regular readers will know that I’m not a fan of positively geared properties where significant borrowings are involved. Whilst the high percentage rental yield may cover your outgoings and deliver a modest income, there is a major downside to the proposition – the inevitable absence of sustained capital growth, the real driver of wealth creation, because key investment fundamentals are absent.

The only situation where I’m happy to see a property positively geared is when the owner has built a sufficiently high level of equity in a capital growth-oriented property – through a large deposit and/or capital growth over several years of ownership and/or significant debt reduction – such that the level of borrowings relative to the value of the property is low.

Your situation is a difficult one. You have a sizeable deposit, but to be neutrally geared whilst at the same time purchasing a high capital growth asset you would be effectively limited to a $200,000 property. Investment grade properties at this price level don’t really exist anywhere in our capitals. It may be possible to find a well-located unit in a regional city like Wollongong, but it will be a compromise. Only consider this route if you go into it with the mindset that this is a stepping stone, where you aggressively pay down debt to build equity that can be used to finance a future investment-grade property in a capital at a later date.

If you want a capital city investment now, realistically, the entry level of investment grade property is around $350,000 in the major capitals earning a gross yield of 4%. After expenses the net yield is likely to be around 3%. With mortgage rates at around 6.25% on the $250,000 you’d need to borrow, you’ll looking at a annual cost of around $5,000 after expenses and before negative gearing benefits.

Consider if either of the above approaches are feasible; otherwise you may be better off investing in another asset class.

Commercial office space in Noosa

We are currently looking at investing in a commercial office space in the Noosa (Qld) area. Your thoughts?

If you’re looking to purchase an office in Noosa because this is where your business is and you want to operate out of these premises rather than rent elsewhere, then your plan may have merit. Do ask your accountant to evaluate the risks and review whether it is a cost-effective approach.

I would be a little more concerned if your interest is purely investment. Noosa is struggling economically as a result of the impact of the strong dollar on its tourism industry, with high vacancy rates across commercial and residential sectors.

In the commercial space, blue-chip property starts at $1.5 to 2 million and is situated in a major retail or commercial zone. Unless you have this sort of budget on your own or as part of a syndicate, you are probably advised to focus on residential property.

Is now a good time to buy US property?

There’s some commentary around that the US property market has bottomed. Is this now the time to buy property in the USA?

The news out of the US regarding its property market is mixed and certainly not indicative of a definite bottom being reached. Yes, the S&P Case-Shiller Home Price Index showed prices across US cities rose 1.3% in April 2012 (the most recent data). But after falling steeply between mid 2006 and the end of 2008, property values for US cities have been trading in a tight range for two-and-a-half years – up a little some months and down a little in others.

Moreover, recent reports indicate that there will be over one million foreclosures in the US in the first half of 2012. Whilst this is down 11% from the equivalent period of 2011, there is talk that US banks will increase their efforts to tackle delinquent loans, a process that was held up by the scandal over robo-signings foreclosures. If so, this could increase foreclosure levels and further depress prices.

In light of these issues, and the fact that any investment in the US involves buying in an unfamiliar market and comes with the added complication of potential large currency fluctuations, then I would suggest it to be a high-risk strategy. That risk can be mitigated by focusing only on high-quality property in city locations with scarcity of supply such as Manhattan in New York or inner San Francisco.

Monique Sasson Wakelin is a co-founder and 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