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It seems like déjà vu, we saw it all in 2007/08. The share market reaction is similar but the situation is a little different. In 07/08 it was all about businesses faltering, it was a banking crises, with banks lending to people that they shouldn’t have and too much housing being built in the U.S.
This time round it’s the U.S. and European countries that are in trouble. The corporate balance sheets are healthy but the countries balance sheets are not, they are now carrying a higher debt as a direct result of the interventions that they took following the GFC.
That’s a fairly simplistic explanation but it’s the core of the issue.
Thankfully this time round, Australia is again in a very strong position. Our financial market remains strong and our banks are well capitalised. With our cash rate at 4.75% (as opposed to say the U.K at 0.85% and the U.S. at 0.06%) the RBA has ample room to move down should their intervention be required and likewise our government has ample funds should they be required to intervene again. Whilst our unemployment is expected to rise slightly it is coming off an incredibly low base at 5.1%, so overall Australia is again looking to be in a fairly healthy position.
Shares & Residential Property:
Firstly, let’s address the volatility in the share markets. Whilst Australia’s market has performed better than many to date, it has still been a rollercoaster ride.
So, lets have a look at what has happened to residential real estate in the past when we have had this situation:
Following the 1987 Stock market crash, Australian property values rose. Following the 2001 “Tech Wreck” as many call it, Australian property continued to rise. During the GFC, Australian property was relatively stable followed by excellent growth.
In fact since 1982 the returns on residential real estate have been comparable with Australian equities, but with around one fifth the volatility. As per the graph above, over the last 29 years the average return has been 9.1%.
Let’s remember that the residential real estate market is a unique asset class, compared to all of the others. If we look at the Census data since 1966 we can see that approximately 70% of properties in Australia are owner occupied, either owned outright or subject to a mortgage.
This is the unique safety valve that residential property has, the market is not dominated by investors who either choose to sell or get margin calls when stocks lose value (which further pushes the market down), for 70% of the owners of this asset class it’s their shelter first and an investment second.
What about Australia’s public debt problem?
As you can see, the above graph gives a fairly good indication as regards the size of our debt relative to many others. As you can see we compare very well. The other interesting fact is that our debt is forecast to be reducing in 2013 & 2014, in contrast to most others.
From a property point of view whilst we need to take in to account the global situation, we also need to be considering some of the fundamentals:
Interest rates:
Where are they heading?
Well that’s a tough question.
If we look at the futures market (see graph below) as at the market close 16th August as you can see this market was factoring in a drop of 1% to the current official cash rate by December this year and further drops, bottoming out in April May next year to just under 3.5% (which would be a reduction of over 1.25% on the current rate).
We have also just recently seen the major banks drop their fixed rates, which is a further indication that they expect that rates will fall in the future.
The outlook earlier this year was very bullish, suggesting rates would be as high as 5.5% or higher by mid next year. It’s certainly a different scenario now.
Rents & Vacancy rates:
From September 2005 to the end of 2008 rental rates were typically trending upwards at the rate of almost 11% year on year.
In 2009 capital city rents increased by just 0.9%.
This was due to the fact that interest rates decreased so affordability within the market was higher. On top of this we had various government grants, again increasing affordability.
This led to a whole lot of first home buyers entering the market (many a little before they had planned too). This meant that there were less tenants and as a result, vacancy rates increased slightly and as a result, rental growth was flat. But as we know, it also led to capital growth increases.
As interest rates have risen new purchasers have tapered off (choosing to stay in the rental market)and we are now starting to see evidence of rental growth returning to the market and this is directly correlating to the fact that vacancy rates are again on the decrease.
Supply:
Over the past 5 years there has been a significant focus on an undersupply of property across the “Australian Market” as the reason for price gains and affordability issues. Whilst this is quite true we need to bear in mind that there are in fact 1000’s of markets across the country. Some are over supplied, some are undersupplied.
The National Housing Supply Council have suggested the following:
By 2014 the overall gap in supply v’s demand is projected to grow to 308,000 dwellings (based on assumptions of medium growth in supply and underlying demand), it would be impossible to increase the supply side over this period because it is hard to develop infill housing in the current housing market and planning framework.
The ageing population will increase demand for different types of dwellings – seeing a shift in demand for smaller dwellings
We have previously spoken about this issue at length in our various property market updates, the fact is that demand is shifting and will continue to do so. Away from the 4 bedroom house in the suburbs that has a long commute to amenities and the city and continuing towards smaller and more affordable apartment and townhouse accommodation that is better located close to amenities and only a short commute to work.
In a previous Property Update we we sited the National Housing Supply Council's major report issued in March 2009. The report focussed on the type of housing required over the next 20 years. What it found was that the type of housing required over the next 20 years is vastly different to what has been required over the past 20 years.
The report suggests that the following increase in housing types is required:
For Group households an increase of 28.5%.
For Single person households an increase of 63.7%.
For Couples without children an increase of 36.7%.
For Single parent families an increase of 23.7%.
For Two parent families an increase of 20%.
The Property Cycle:
The property cycle is fairly consistent and here we are again. Following the GFC we had an economic uplift, that lead to house price growth, as interest rates increased the growth tapered off, now we are seeing rents starting to rise and who knows, maybe, just maybe the market will do what it has done over the last 100 years and we will continue to see rental growth, followed by house price increases. Historically it’s a secure place to park your funds over the medium to long term, leverage those funds (as banks much prefer to lend against housing than equities) and receive a healthy return.
Lets just do a quick recap:
Historically:
When the share market has faltered, property has performed very well.
When interest rates have dropped more owner occupiers and investors have entered the market, which has pushed up property prices.
When vacancy rates have dropped rents have increased, the increase in returns means that more investors choose to enter the property market and more tenants become owner occupiers, again, pushing property prices up.
It’s a supply and demand situation and we certainly have the demand and a lack of supply.
By following the future demand (smaller accomodation) and in the right locations, in the major capitals, close to amenities and the CBD then all of the indications are fairly positive given our current situation within the property cycle.
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