THE FINE BALANCING ACT
The turnaround in the housing market this year has been truly remarkable, with Melbourne and Sydney leading the way. Growth in house prices in both these capital cities during the last twelve months has been greater than their annual average growth rate over the last ten years.
Auction clearance rates are up and now seem to be firmly locked into the 70% band. Investor activity is also back in play and this is clear from our level of customer inquiry as to where is best to invest and the purchase of our well regarded predictions and best rent reports.
Total sales of units and houses across Australia are back to levels not seen since mid 2007 and housing stock shortages are significant. This situation is not going to improve in the short term. Property listings in the major states are lower than earlier in the year but in recent days there seems to have been a slight improvement.
If we annualise the growth in Sydney for the last quarter then we have an outcome of over 12% and for Melbourne the result would be 18% This very clearly puts the last quarters result into perspective. That is, if it continues at this level then we have a housing boom in a period of economic uncertainty driven by Government spending and a low RBA interest rate setting. It becomes reasonable to suggest that a housing “bubble” is forming. Normally I wouldn’t suggest this but it is happening at a low point in our interest rate cycle where debt levels are high and interest rates are becoming higher.
Basically the cause is demand in a market where there is insufficient housing stock and it has been fired by improved affordability and Government grants.
The worst fear of the Reserve Bank Governor may be coming to pass. In a speech given earlier this year to the Anika Foundation Luncheon he said:
“A very real challenge in the near term is the following: how to ensure that the ready availability and low cost of housing finance is translated into more dwellings, not just higher prices. Given the circumstances – the economy moving to a position of less than full employment, with labour shortages lessening and reduced pressure on prices for raw material inputs – this ought to be the time when we can add to the dwelling stock without a major run-up in prices. If we fail to do that – if all we end up with is higher prices and not many more dwellings – then it will be very disappointing, indeed quite disturbing. Not only would it confirm that there are serious supply-side impediments to producing one of the things that previous generations of Australians have taken for granted, namely affordable shelter, it would also pose elevated risks of problems of over-leverage and asset price deflation down the track.”
The speed at which our market has recovered is both remarkable and present risks. Consumer confidence is good but too much confidence and over leveraging presents some real issues for Government and all.
The above growth numbers and sales activity suggests to me that we may see further interest rate rises next year, yet the RBA’s recent actions may already have taken the edge off current activity. Further, it seems to me that The Governor was right in that we must stimulate development of new stock. Perhaps the first housing grant for existing property should be stopped sooner rather than later and the grant for new stock extended.
It is rare that actions taken by Government and the Reserve Bank unless they are dramatic have any immediate effect. Hence an interest rate rise of anything other than say 0.5% is unlikely to slow this market. It has already built up too much “steam”. Is this type of increase realistically possible? I think not, simply because interest rate adjustments are such blunt instruments. Considerable care is needed as too large an increase could turn the success story (recession avoided) into a disaster. Housing has been used in the short term to stimulate the economy and keep us out of recession. Equally, it has been shown in England and the US, take action, that causes house prices to fall as a consequence of mortgage stress and the economy is imperilled.
Given all of the above it is likely that we will see further growth in housing prices over the next couple of years. This is in line with our predictive models. Hence it would be inappropriate for those of us who are professional investors to simply withdraw from the market due to perceived risk of a bubble developing. If we did then we would without doubt miss some quality growth opportunities.
It is time to get back to basic defensive investment strategies. These are:
· Avoid investment areas where there will be potentially mortgage stress. That is, stay clear of the first home owner grant territory;
· Don’t over leverage. Develop your cash flow needs based on interest rate increases of 1.5%
· Invest in well positioned unit properties which have a cost which is within 10% of the city median value
· Avoid large new development complexes;
· Seek out older properties which allow refurbishing;
· Use our reports to find the best potential investment areas; and
· Finally, don’t pay too much for any property.
The point in all of this is that based on what I see I believe there is likely to be a short period of growth followed by increasing rental yields. This presents a unique positive investment environment where immediate equity build up is possible and positive gearing will result in a relatively short time frame. If I am incorrect then we effectively have had a bet both ways as properties will simply grow in value until the new un-affordability level is reached. If we are selective in the areas where we invest then even if interest rate increases cause problems then we will be insulated to a large extent.
The trick in all of this is identifying the right properties in the correct investment area and be cautious.
John Edwards
CEO Residex and FMAH founder
