Will property rise in the east?

PORTFOLIO POINT: Expect Sydney property to lead the way during 2012, in this review of east coast capitals.

Just before the summer break I proffered a cautiously optimistic view on the outlook for the Australian metropolitan residential market in 2012 (see Good property stands firm), culminating in an overall aggregate capital growth forecast of 2–5% for our capital cities.

Little has happened over the holidays to change this outlook. However, I stress that the likelihood of the property market outperforming the upper band of my prediction – 5% – is low due to the ongoing US and European economic and financial malaise.

Quite simply, Australian investors can just about cope with either the US or Europe struggling. But when both are misfiring, local investors become very cautious, and consequently the Australian property market will remain subdued – a circumstance I believe will now persist until there is a sustained run of good economic news out of the US economy and Europe’s rolling crises abate. The outlook will also be helped if local interest rates fall 50 basis points or more in coming months.

This week I’m going to focus on Sydney, Melbourne and Brisbane – and I will consider the other capital cities next week.

Incidentally, in my predictions last year (see And the winner is '¦) I correctly picked the order of these three cities ranked by descending price growth: Sydney, Melbourne and Brisbane. I was, however, too optimistic about price growth, which failed to materialise in 2011 anywhere except Sydney.

In 2012, I once again see Sydney as leading the field. It is then a difficult call to determine who will prevail between Melbourne and Brisbane. From the soundings I have taken and my subsequent analysis, conditions favour Brisbane most, with Melbourne close behind.

Sydney

The Sydney property market has been a sleeping giant in recent times. Coming off very strong growth in the late 1990s and early 2000s, demand has been curtailed by ultra low affordability and an indifferent economic performance due to a failure on the part of policy makers to reform the New South Wales economy in recent years.

While Sydney needs more revitalisation, it is making good progress, and its economic outlook will be helped by last year’s change of state government. Meanwhile, rising incomes have seen affordability improve markedly. Further, a housing shortage is leading to rising rents and rental yields. This will attract investors to buy properties for rent as well as encourage renters to become first-home buyers.

On the downside, Sydney seems to have lost its lustre as the only place to be for the overtly aspiring and ambitious. No longer could you reasonably claim that “if you're not living in Sydney, you're camping out”, as the ever-acerbic Paul Keating once said. It may remain the dominant city for international headquarters for the foreseeable future, but it is also a victim of the structural decline of finance and traditional media industries – big employers in Sydney – that we have witnessed in recent times.

Combined with the economic, creative and population resurgence of Melbourne and the shift of economic gravity to the mining states, it means that the Harbour City may have some serious competition. It may therefore not reap the entire migration-driven upswing in performance it might have achieved 10 years ago, given how comparatively expensive it is today.

Rich Harvey, managing director of Propertybuyer, believes the good news will outweigh the bad. “I’m tipping that Sydney’s median price will rise by 5–6% given falling interest rates and barring any other catastrophic economic event,” he says. “This growth will largely come from the lower to middle segments of the market. The prestige market will continue to languish, but it will provide excellent opportunities for upper end buyers.”

Melbourne

The 5% drop in property prices in Melbourne over 2011 is likely to be a necessary tonic after the strong price growth in 2009 and early 2010. I believe that prices will remain subdued in Melbourne over 2012, especially in the fringe suburbs and inner-city apartment markets, where oversupply is even greater than usual. Nevertheless, I think lower interest rates will provide a backstop to values and keep the market steady, if rather flat. Anecdotally, there is some evidence, albeit patchy, of improved buyer sentiment, with some agents reporting to me an improvement in current buying enquiries relative to January 2011, so don’t be surprised if Melbourne performs a little ahead of my prediction.

Brisbane

Last year was Brisbane’s annus horribilis. Truly a perfect storm of environmental and economic factors – particularly a fall in tourism due to the floods and strong dollar – combining to send property prices down around 7%. But really, when you think about it, that fall was remarkably measured given the circumstances.

Brisbane’s property market has demonstrated a fair degree of resilience in the face of adversity, and is also due to bounce back. There are signs that this is under way, according to Meighan Hetherington, director of Brisbane-based Property Pursuit.

“We find that a steady increase or decrease in our customer commitments usually foreshadows change in broader Brisbane market prices four or five months later,” she says. “We saw a big drop in investor commitment in November 2010, which correctly predicted negative price growth around April 2011.

“Throughout 2011 buyer commitments have remained relatively low. Enquiries have picked up since September 2011 and commitments have increased month on month since October. We believe this will translate to a steadying of prices throughout 2012, with mild growth back to 2010 levels.”

Although Brisbane still faces ongoing economic headwinds from the strong Australian dollar, I believe it will be well placed. Indeed, it may end up being the top performing market in 2012.

This will be a year for the astute property investor who is prepared to play the long game. Regardless of the city in which one invests, 2012 may be a year of lower-than-inflation gains or even further easing off the back of overseas-driven skittishness. However, the fundamentals of our major capital city property markets remain solid, and although we may not see much price movement in 2012, it will only be a matter of time before our intrinsic property values are reflected in renewed strength.

Property Q&A

This week:

• Getting a foothold in the property market.
• Is my positive return an aberration?
• My Jervis Bay investment property.
• Sydney apartment with a few.

Property foothold

I read with interest your views on what represents the best value investment properties. You seem to always promote growth over rental. What about a situation where your financial situation is such that to get a foothold in the investment property market you have to look at alternatives that might not be considered ideal. For example, If you are able to buy a property where the rental yield gives an inflow to cover all costs and repayments, but not much growth, the equity you would build up over time will give you an asset that could be sold and allow you move to a better quality one. A friend bought a house in Launceston, Tasmania, about 10 years ago, and now has a nest egg in real estate that she could not have afforded in any other way that I can think of.

Today, entry-level investment property in our major capital cities can be bought for as little as $350,000 in some instances. If one is willing to accept some compromises on returns, good one-bedroom apartments in smaller capital cities or larger regional cities such as Wollongong in NSW or Geelong in Victoria can be bought for less than $300,000.

I acknowledge that some people do not have access to that amount of capital or have sufficient cash flow to fund outgoings. The question then becomes, do you buy something cheaper that is rent-driven as a stepping stone?

Overall, my advice is not to invest in low-cost, high-yielding and positive geared properties. Yes you may earn a positive income, but you are tying up a lot of your funds in a marginal asset, where the likely returns do not justify the risk of capital losses over the life of the holding. The other issue is that if the rental return is positive you will be taxed on this at your marginal rate.

That said, when someone has a small budget, buying a positively geared property might be OK as a short-term option (up to a maximum of five years) to get themselves on the right track. But the investor must commit to the discipline of saving all the after-tax income earned from this property to generate a deposit for the next property – a genuine growth asset. Beware, there are a lot of “ifs” to work through because this is a higher risk option, so don’t proceed without an independent analysis of your specific circumstances.

Positive experience

Thanks for the article on positively geared property (see Positively dangerous). It was an interesting insight into the relationship of yield and rental return that I had not fully understood previously. I think perhaps there are exceptions to the rule (there usually are!) because I have five places rented in Port Hedland and Karratha in WA and the rental yields continue to rise as has the house price valuation for the past three years. The homes have gone from $500,000 to at least $700,000 in this time. Perhaps this is an aberration and not the norm? My other observation is that if I am getting a higher rental yield (10% as in your example) then I have greater income (for the first 10 years at least) and this gives me a greater capacity to further increase my wealth (and lose it!) as I have higher cash flow for other investments. Is this a reasonable contention?

Yes, I believe your experience is likely to be an aberration. As you well know, there has been tremendous capital and rental growth for established houses in these areas due to the strong mining sector. But if mining sneezes these locations will catch the flu! When the resources boom inevitably pauses – as it will at some point – the scenario can change rapidly. Just ask property owners in Cairns or Port Douglas today who saw stratospheric growth off the back of surging national and international tourism, but have since seen prices plummet due to the strong Australian dollar drying up their dominant industry.

By using your cash flow to buy other assets outside of mining town property you are obtaining some diversity – but not nearly enough, in my view. Consider rebalancing the bias of your portfolio by disposing of some of your current income-driven asset base and investing in quality assets in stable growth areas in our larger capital cities to balance out your exposure.

Coastal idyll

I bought an investment property for $400,000 in 2003 in Huskisson, NSW, and am now considering my options. The agents have suggested it is now worth about $470,000 or $480,000. Do you have thoughts on the area and price proposed?

Huskisson, in NSW’s Jervis Bay, is a lovely holiday location 200 kilometres south of Sydney. Sadly, your investment has been less than lovely, with annualised capital growth of about 2% – less than inflation – over the eight or nine year holding. The only silver lining is that you have not lost money, which is quite common for many off-the-plan purchases made around this time for coastal properties in New South Wales.

Despite Huskisson’s charms, it is a victim of the strong Australian dollar and the discretionary nature of the holiday home market. When economic times are tough, there are many sellers and few buyers for these properties and locations.

While there is a temptation to hold and hope for an upswing in prices, future losses are just as likely as gains, and you may then find yourself in a position of negative equity, which can sometimes make it hard to sell and possibly harder to recover financially, depending on your stage of life.

I believe the message is clear: sell this property and consider investing in a good inner city location in Sydney, Melbourne or Brisbane.

Sydney with a view

Do you see any exceptional value in Sydney units in city with views?

As I set out in the main column, I see good value in Sydney at the moment. A harbour view is certainly worth a premium and as long as that view can’t be built out it will underpin value and capital growth going forward.

However, be careful about your choice of unit. Realistically, to obtain a harbour view you need to go for a high-rise apartment. Although I’m not usually a fan of high rise apartments as investments, in Sydney a number of high-rise units do work because they are in an apartment block that not only has harbour views, but also where the surrounding land is all accounted for and very unlikely to be redeveloped. Be sure to buy into a block that is well maintained to avoid the erosion of value that occurs if a building starts to look shabby.

Monique Sasson Wakelin is managing 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