PROSPECTS FOR RESIDENTIAL DWELLINGS

The Reserve Bank has recently issued a paper “Conditions and Prospects in the Housing Sector”.  This report reproduces some of the charts from that report.  We also attach (at the end) some charts and quotes from the ANZ’s March quarter property outlook.

The first RBA chart shows that expensive suburbs have suffered a price decline of perhaps 10%, but less expensive suburbs have fallen by less than 5% - and have perhaps now stabilized.  This obviously compares very favorably  with the collapse in values of other asset classes, and is particularly good news for property investors, who tend to target lower priced product.

The next chart looks at a typical measure of housing affordability.  On this index, the zero line is the long term average ratio of: (a) average household disposable income, to (b) principal and interest payments (on a new mortgage for a median priced dwelling).  The red line shows that at  end December 2008 (latest data for income) the income/cost ratio was a bit above average.  The red dot adjusts for interest rate changes since December, and estimates that current affordability is much higher than average.  It is clear that affordability has improved considerably.  Moreover, the improvement for first home buyers is much greater than the chart indicates, because the chart does not take account of the recent grants.

The next RBA chart provides a measure of the distress faced by Australian home owners, compared with those in the US.  It shows that the volume of non-performing loans in Australia is far, far less than in the US, and this is why Australian dwelling prices are not under the downward pressure experienced in the US.

The next RBA chart is an indicator of the capacity of households to survive the current downturn and hold onto their dwellings, or indeed buy new ones.  It shows that income has been growing faster than consumption for most of this decade, resulting in significantly increased savings.

The final two RBA charts demonstrate the undersupply of dwellings.  The first chart shows that the supply of dwellings is very low, both in approvals and commencements.

The second shows the impact that this undersupply is having on rental vacancies, which are now at very low levels.

The signs of severe undersupply of dwellings are clear.  And Australia’s population keeps growing.  We all know what happens when demand outstrips supply.  The following quotes from ANZ (March 2009) illustrate.

Conclusion

It is true that the world (and hence Australia) is suffering an economic downturn.  But in our view the collapse in sentiment is far greater than is warranted by the fundamentals.  The productive capacity of the world (land, labour, equipment, factories, etc) has not fallen at all - all that has fallen is the perception of what this capacity is worth.  During booms, prices are overvalued; during downturns they are undervalued - now is the time for great buying opportunities.

It is also worth noting that there is no recession for those with jobs.  For the employed, home loan repayments are lower, taxes are lower, and fuel prices are lower.  The employed (if you remove the negative sentiment) are actually far better off than in many years.  This is why, overall, dwelling affordability is high and household disposable income is high.

The charts above are national average figures.  Each region performs differently to the average, and follows different cycles.  Our research has highlighted, in several areas of Australia, opportunities for outperformance:  not only very sound capital growth potential, but also brand new, high quality, residential investment property that is cash flow positive, even if 100% of the purchase price is borrowed. 

We have sourced one opportunity that is actually cash flow positive before tax when everything is borrowed including legal fees, government duties, and funder fees - and Australia’s largest independent valuation firm advises that this region is in the “rising market” stage of the cycle.  In our experience, this is unprecedented. 

We have detailed research reports to support all our recommendations.

In the current environment, we believe that the medium term investor has a great opportunity to acquire well-researched, cash flow positive property now, and reap considerable capital gains once sentiment realigns to the economic fundamentals.