This is no property bubble

PORTFOLIO POINT: The factors that have sunk housing in other parts of the world do not apply in Australia.

Well there’s no doubt about it, Gerard Minack’s recent column on Australian housing (see Australia’s housing bubble) has certainly set the hares running. Newspapers and letters from Eureka Report subscribers have been coming in thick and fast, proclaiming bubbles, no bubbles or what a load of nonsense this all is.

So what is on our horizon? It will come as little surprise to read that I don’t think there is a property bubble; but nor am I about to breezily dismiss Minack’s analysis. The amount of debt being piled up by households is something we should all take seriously.

First we should determine what we are talking about, however. “Bubble” has become an explosive word recently, but in economic terms, it means a market where the price has accelerated beyond a point sustained by supply and demand. Asset bubbles are usually formed when governments intervene in the market with subsidies or artificially low interest rates.

Over the past four years we have seen several property bubbles burst overseas, most prominently in the US, but also in several European counties, notably Spain. So far, we have remained immune despite many commentators assuming that wherever the US goes, Australia must follow. The last time we saw a genuine bubble in the Australian property market was in 1988-89, when we had high inflation, high interest rates and an overheated economy with no proactive economic or interest rate management by the government of the day.

None of these factors are in play now. Much of Minack’s argument for the existence of a property bubble rests on measures he uses to compare current prices with long-term values. He uses the ratio of house prices to gross domestic product (GDP) per capita, and the ratio of the value of housing stock to household disposable income, to theorise that houses have become “too expensive” since the year 2000.

I asked Minack whether these measures take into account the growth in two-income households and the increasing number of investors in the market. “Well yes,” he replied, “these measures should reflect that growth but there are other issues they won’t catch. For instance, they don’t reflect the statistical anomaly of comparing a mean average income with a median house price, and not all of these measures are capturing non-labour income, which can be important.”

So is your argument mainly about debt? I asked him “Yes, that’s my concern,” he replied. “After 20 years without a recession, house buyers are increasing playing a game of financial chicken, competing with each other to have the most imprudent mortgage to buy the house they want.”

For my part, I think that the relationship between income and house prices has fundamentally changed from 30 years ago. Not only do the increasing numbers of dual-income couples have higher incomes and proportionally lower expenses than the single-income households of old, they are also less likely to have children. This undoubtedly forms part of the reason some are able to borrow more and pay more for housing.

Minack moves on to label the proportion of owners claiming a tax loss on investment property at 70% as another weak spot, saying: “Losing on rental property investment is largely a middle-class affair.” I took him up on this point and he said: “We’re often talking about someone losing 10–20% of their taxable income to support an investment and that’s significant.”

The problem with this analysis is that most investors, from all walks of life, understand that property is not about earning rental income in the next 12 months, it’s about making capital growth over the next five to seven years, and ideally longer. I next asked Minack why he had highlighted the four years of flat capital growth in Sydney from 2004 to 2008.

“That period was certainly uneven and the southwest of Sydney saw the worst outcomes from the loss of manufacturing and trades jobs. For me, this is a local illustration of the kind of effect an income shock could have on Australia. In some ways we are seeing a little of this happening on the Gold Coast now, with the decline of tourism leading to localised real estate woes.”

“Essentially, the chart that shows Australian house prices being well above those of comparable Anglo countries captures much of my concern. Even with Australians’ penchant for living in cities factored into this data, this chart shows me a house market that is over-leveraged.” (See chart below, from Gerard Minack's column.)

I respect his view, but I’m afraid I’m going to have to differ, as I will with those still saying that because it happened in the US it’s Australia’s turn next.

I’ve written in Eureka Report before about damage caused by the oversupply of American housing built up through a speculative construction boom, the diametric opposite of Australia’s persistent housing shortage. But housing bubbles also emerge as a result of overly cheap or free money to fuel asset prices. While we’ve seen inflationary housing grants in Australia, mortgage rates have averaged about 7% for the past 10 years.

Compare this to the US, where the 30 year fixed rate mortgage (FRM) rate spent much of the decade below 5.5% as the Federal Reserve pushed interest rates down in response to the dotcom stockmarket fall, the September 11 terrorist attacks and the Lehman Brothers collapse. Australia simply hasn’t had a sustained period of artificially cheap money or an oversupply of over-priced property to build a housing bubble on.

Nobel Prize-winning American economist Vernon L Smith succinctly points to another factor in the US housing bubble: non-recourse mortgages. “If you can buy a home with almost nothing down then you do well if the prices continue to go up”, he said in July this year. “If it goes down '¦ well, then you have an incentive to walk away and let the bank have it.”

That’s quite different to Australia, where banks pursue defaulting mortgagees, and borrowers have proved stubbornly reluctant to give up their homes when they’re in financial difficulty. It’s a major reason why panicked real estate sales have been so rare in Australia.

Finally, I think Minack’s example of the Sydney market is pertinent to both the bubble debate and the ongoing argument about investors’ role in the Australian housing market. During the 2004–08 period, the outer southwest and the Blacktown-Penrith corridor saw falls in property values of up to 25%.

What’s largely been overlooked is that these suburbs have the highest proportion of owner-occupiers in the Sydney basin. During this same time, areas with the highest proportion of investors, namely Sydney’s eastern and inner west suburbs, saw a 12 month stagnation followed by a resumption of growth.

Undoubtedly, an income shock such as mass job losses would have an impact on property prices, but that shouldn’t come as a surprise. Nasty economic downturns always come with a price. But evidence from our past shows that shock property losses are mainly confined to the urban fringe estates and trophy house precincts, except when the economy is firmly locked in recession.

Even then, the broader middle of the Australian property market generally survives reasonably well and bounces back. This is evidence that Australia’s mix of property investors (27%), mortgagees (34%) and those that own outright (31%), along with the income profile of buyers in the market leads to stability in residential property.

Property Q&A

This week:

• Where can I find out about Broome property?
• I want to rent a property to my daughter at mate’s rates.
• I’m unhappy with my managing agent.
• What are Apollo Bay’s prospects?

Broome

Where can I get good advice about property investment in Broome? We don’t often hear much about our town in the mainstream media?

I’m always interested to hear from investors no matter where they come from.

Broome, like much of Western Australia, saw a meteoric rise in real estate prices in 2006-07, which has slowed somewhat since. Five years ago the median house price for the Broome urban area was $421,000; now it’s $577,500, slightly down from its 2009 peak of $600,000, but a 37% rise is not bad over five years.

The best parts of the Broome area have been Cable Beach, which has a median house price of $692,000 – a 55.9% increase from five years ago; and Djugun, which has a median house price of $650,000, up 54.7% over the same period.

Broome has a population of 15,000 and an economy based on tourism, agriculture and mining. It’s more diverse than many other regional centres of the northwest and the local economy is a little more balanced than other centres, which focus almost exclusively on mining. But the town is still vulnerable to sharp declines in one of its industries. For this reason, I usually recommend investors stick to major urban centres because they have a long history of more consistent capital growth performance and strong underlying demand.

It is often hard to find truly independent advice no matter where you are, let alone in smaller towns. If you know Perth reasonably well, I suggest you find a reputable independent adviser there who should be well placed to advise you more specifically. The most important thing to ensure is that they are independent and have no ties, financial or otherwise, to any of the properties they recommend or advise you on.

Mate’s rates

I own an investment unit in Fitzroy in inner Melbourne, which I bought four years ago for $318,000; it is now valued at about $470,000. I want to buy a small three-bedroom house or townhouse/villa in the northeast suburbs to rent to my daughter at mates’ rates. Should I sell Fitzroy to finance the new house or borrow the lot and use the unit as security for the loan. Is there room in the market for Fitzroy to go up?

Fitzroy is a classic high land-value inner suburb, with continual high demand from tenants, investors and home buyers alike, but with a finite supply of properties. There are new developments in this area but this is unlikely to affect the positive supply-demand equation. That doesn’t mean all properties in Fitzroy are investment winners, however, as there are many compromised streets and properties.

The first thing you should do is seek guidance from your accountant or financial adviser about your borrowing capacity and to help establish a budget to buy another property. You should also try to make a considered assessment of the prospects of your current property holdings.

As you haven’t told me how much equity you have in the Fitzroy property or whether you own another property as a residence, it’s a little hard for me to advise you on a strategy, but there are three things you should take into account.

First, renting a property to a family member at “mates’ rates” is inviting problems from the tax office. If you are assessed to have charged a family member below an “arm’s-length market rental” you could be liable to face an assessment for the difference between the market rate and “mates’ rates”, plus costs and interest. Second, you should always think carefully and take advice on how you finance different properties, what collateral you use for the mortgages and which holding entity is the most appropriate. If you get the structure wrong, it can affect your tax status, your repayments and prove quite restrictive if you want to change any plans in the future.

Third, and most importantly, you seem to be confusing whether you’re buying a property chiefly for investment or primarily to help your daughter. Investing in property is primarily about making money, not about housing your children. I always advise parents to avoid this “two birds with one stone” strategy, as the result is often a property that makes substandard capital growth, that the relative only lives in for a year or two and inevitably life is less predictable than we’d all like it to be.

If your unit in Fitzroy is investment-grade, I suggest you keep it. If it isn’t investment-grade, then you should sell it and decide whether buying an investment-grade property or a house for your daughter to live in is the higher priority.

Mis-managing agent

I have two investment properties in Brisbane, handled by the same managing agent. I have been working in Hong Kong for the past five years and I was not happy with the condition they were in. I had left money in the agent’s account to ensure repairs could be carried out where necessary. I want to know how I can ensure proper action is taken in my absence.

As a non-resident property owner, you are always reliant on a professional managing agent to some extent, even more so when you are overseas. If a property manager fails to recommend minor repairs or maintenance, they are neglecting their duty as the manager of your assets. There is no excuse for not reporting back to you regularly. A professional managing agent should be carrying out regular inspections every six or 12 months and sending you a professional written report, including photographs of the property.

Before you leave the country again, I would reassess the choice of managing agents and interview a few other accredited managers experienced in the area.

Whether you find a new reputable agent or continue with your now chastised agent, insist on inspecting your properties with them and ensure they clearly understand what condition you expect the property to be in and what will be needed in your absence. If you are going to be overseas for an extended period, you could look at appointing an independent party to inspect the properties along with the managing agent, such as a trusted relative or an independent property adviser to ensure your new agent does their job properly.

Property management is one area a lot of investors neglect, even though it often saves them a lot of expenses down the track. Well-maintained properties deteriorate less, saving money on renovations. Well-maintained, presentable properties tend attract more tenants, which often results in higher rents and the correct level of capital growth, all things being equal.

Apollo Bay

Is beachfront property in Apollo Bay, three hours southwest of Melbourne, a good bet? Even though prices seem high, the Geelong bypass is now finished. Is this a growth area or will the spectre of global warming dampen beachfront interest in the years to come?

The first thing to get into perspective here is that the Geelong bypass, although undoubtedly helping traffic in Geelong and nearby communities, won’t have much influence on Apollo Bay, which is another 90 minutes’ drive away. In the grander scheme of things, it will cut about 10 minutes off the trip from Melbourne.

Apollo Bay is a magnificent place with ocean beaches and the nearby Great Otway National Park making it a popular spot for beach-going families, bushwalkers and surfers. In terms of the global warming spectre dampening beachfront property prices, I would tend to think his is a minor issue, which I wrote about last year (see Coast watching). Interestingly, the Victorian Civil and Administrative Tribunal has also recently ruled on development policy for coastal properties in a small part of Gippsland. I suggest you contact the Colac Otway Shire Council or the Western Coastal Board for their assessment of the relevance of this factor in this area.

The primary issue in Apollo Bay is that most properties are holiday homes and not the owner’s primary residence. If any of these owners get into financial trouble during a broader economic downturn, the first thing they will look at selling is the holiday house rather than their family home.

The result of this profile is that the capital growth experience for Apollo Bay property tends to see a good year or two followed by two or three flat years. Property values tend to lag coastal areas closer to Melbourne over the long term and the market can fall quickly during downturns. If you are looking for investment property, I would stick to inner Melbourne and, if necessary, compromise the physical size of the property to get the right location and building style.

Monique Sasson Wakelin is Media and Communications Director of Wakelin Property Advisory, an independent firm specialising in acquiring residential property for investors.

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 Wakelin? Send an email to monique@eurekareport.com.au.