RESIDENTIAL PROPERTY REVIEW: AUGUST 2011

From the desk of Compass Capital's Michael Shreeve

Recent Data on Residential Property

The charts and tables below overview recent published data on the residential property market. 

In summary, fundamentals continue to remain solid, and sentiment continues to be weak.  

Sentiment continues to impact the property market, with all major dwelling price indexes showing, on average over Australia, small price falls over the year to June of between 1 and 2%. 

However, the falls have not been even, with Sydney showing slight growth, and Brisbane showing an average fall of 6% (RPData).  

The generally weak housing market was one of the factors causing the RBA to leave interest rates unchanged during its August meeting, despite inflation edging upwards.  The inflation measure focused on by the RBA is the "trimmed mean" (see chart below) which is now approaching the upper end of the range within which it would like inflation to average over the course of the economic cycle.  Because the RBA targets an "average" inflation outcome, the RBA expects inflation to be above and below the target band for periods.   

Economists are now mixed in their views about whether the RBA's next interest rate move will be up or down.  

In comparing the current situation with the pre-GFC period in 2007, we can see that factors in favour of a rate rise include - commodity prices are extremely high; mining investment outlook is very strong; and the labour market is tight (although not as tight as 2007 when unemployment was 1% lower, and wages growth was stronger).  

Factors against a rate rise include - the uncertain international outlook; weaker activity in: in retail sales (3% growth now vs 8% in 2007 - Year on Year); housing prices (-1 or -2% vs +14% YoY) ; residential building approvals (-15% vs +14% YoY); motor vehicle sales (85k per month vs 95k); non-residential building approvals (about $1½ billion per month vs about $2½ billion); credit growth (3% vs 15% YoY); equity markets are lower (Australian index 4,440 vs 6,700); we also have a much higher exchange rate (US$ 1.10 vs US$0.93); and fiscal policy is now contractionary in persuit of budget surplus.

The long term outlook for the housing market remains positive, with continuing population growth, strong economic growth and low unemployment, being accompanied by very low levels of dwelling construction. 

However, in the short term, the outlook is uncertain, with consumers experiencing negative sentiment, which has fallen to levels similar to that during the GFC and the early 1990s (see chart below).   

An environment of subdued demand and negative sentiment, coupled with very strong medium-term fundamentals, provides property investors with excellent buying opportunities, although they should be selective. For capital cities, forecasters such as Residex and BIS Shrapnel project strongest growth for Sydney. 

Certain regional markets are also attractive. For example, Gladstone is benefitting from three separate Final Investment Decisions to proceed with Liquid Natural Gas infrastructure developments which will take several years to develop, and will operate for decades. Each of these three decisions will involve capital expenditure exceeding USD15 billion. Australia's largest independent valuers (Herron Todd White) report that Gladstone prices "have seen an increase in value across the board generally between 10% and 20% and in some instances greater. In the sub $400,000 dollar range there is currently limited stock and high demand, which has been heightened by soaring rents." HTW describe Gladstone as being in the "rising market" stage of the Property Cycle with a "severe shortage of available property relative to demand".

A detailed overview of the latest data on the residential housing market is set out below. 

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Dwelling prices continue, on average, to be generally flat or softening.  While the various market segments performed differently (see more below), the overall picture was a slight fall over the year to June, following quite strong growth during 2009 and 2010.

Capital growth has been slowing since the RBA started to increase interest rates in late 2009.  Since this period, not only have dwelling price increases slowed (and recently fallen a little in some areas) but:  - sales volumes have generally reduced, and        - vendor discounts have increased.

The general weakness was not evenly spread:  - Not across regions Results were mixed across capitals, with only Sydney showing growth over the year to June 2011.

- Not across types of dwelling   The falls were mainly in established houses, with (on average) units and project homes rising a little in value.

ABS data suggest:  established houses -0.2%   vs   project homes +2.8%

- And not across price segments   The falls were mainly in most expensive 20% of homes (down 5.4% over the year to April), with little change for the middle 60% (-0.9%) and the bottom 29% (-0.5%) - RPData:  17 June

With sentiment weak and price growth softening, the appetite to construct new homes has also been weak New dwelling starts continue to trend lower, indicating a continuing supply shortage.

Land Sales have been falling, even though the price of land has been rising

Looking further forward, new dwelling approvals, while volatile from month to month, also continue to trend lower.   Difficulty in obtaining finance also constrained developers

Loan data for new home lending is consistent with low supply of new dwellings   Loans for new housing remained subdued.

The supply shortage has been growing for some years.    Even though the cost of residential construction continues to rise, the amount spent on residential construction has not increased since 2003 (Source: HIA, ABS).

Meanwhile, population continues to grow While the amount spent on residential construction has not increased for almost a decade, population has been increasing quite strongly.  In May, the government released a report on "A Sustainable Population Strategy for Australia".  The Report failed to deliver a population target, noting that "Since the 1970s, all population inquiries sponsored by Australian governments have rejected the notion of a population target or national carrying capacity".

Commonwealth Budget:  skilled migration target has been revised upwards to 185k from 168k the year before.

With low supply and rising population, the rental market is very tight. Vacancies are below 2% in all capitals, well below an equilibrium level usually considered to be 3% (or 1-1/2 weeks per year)

Rental yields are rising. Overall, this is not bad news for investors, who are generally better off when rents rise by more than prices fall (especially when they receive the rent but do not need to sell).

 

Rising inflation caused some commentators to foreshadow interest rate rises.

But the RBA at its August Board meeting left interest rates on hold for the 8th meeting in a row.

Overall Assessment

Underlying fundamentals for residential property remain strong.  (Population continues to grow.  Australia's economic prospects are very good, with low unemployment and strong demand for our resources.  New dwelling supply remains weak which is adding to the under-supply of accommodation.)  This is leading to rising rents.  

However, prices are not just driven by fundamentals - they are also influenced, particularly in the short term, by sentiment.  Sentiment is generally weak, influenced by uncertain economic conditions in several overseas developed economies, poorly performing equities markets (both in Australia and overseas), weak consumer sentiment, concern about higher interest rates (driven by Australia's strong economic performance), and associated negative press.

At the moment, negative sentiment is proving a more powerful force than positive fundamentals.  The weakness is being reflected most strongly in expensive property (which is usually more volatile, and more sensitive to sentiment and stock market performance) and also in tourism-related markets adversely affected by the high Australian dollar.

Sustained divergence between fundamentals and sentiment provide a reason to act.  When sentiment is strongly positive, and not based on sound fundamentals, prices will inevitably fall.  When sentiment is weak, but fundamentals are strong, prices inevitably rise.   

While the long term direction is predictable, sentiment is not, which is why prices rise further than is sensible, and why prices can fall further than is sensible. 

In the current market, there are good buying opportunities in areas where demand is very strong and supply is constrained.  While some areas should be avoided, certain areas are still showing good growth (for example, Gladstone).  And areas of Sydney are still in demand and forecast to do well by Residex and BIS Shrapnel.

While we have quality property in most regions of Australia, some areas we can recommend at the moment are Gladstone (for more information on Gladstone, including $66bn of approved new projects expected to deliver up to 18k jobs in Gladstone, click here); and  Sydney's exclusive Neutral Bay (boutique off-plan development - block of only 12 apartments - priced from $497-$760k, and will yield over 5%) and Sydney's northern beaches (1 & 2 bed off-plan apartments all under $600k to benefit from the current NSW government stamp duty exemption).  

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