It may be time to invest again
IS it safe to invest in residential property yet? I’m starting to think so. There are dangers. In particular, the spectre of rising interest rates. If inflation escalates next year, well, that could put a spanner in the works. But there is an overriding positive — we’re not building enough and there is already a significant deficiency of residential stock in Brisbane, Sydney and, to a lesser extent, Melbourne.
Provided that we can ride out any setbacks, two to three years from now residential property in those cities will be building momentum into a strong upswing.
It was the Reserve Bank that put an end to the last cycle. It was premature in the sense that there was no surplus of residential stock.
But, petrified at the prospect of a continuing housing prices
bubble’’, and using only two interest rate rises, they talked a blue streak and frightened investors out of the market.
Certainly, something had to be done. Prices were rising under their own momentum as investors kept up the pace and owner occupiers bought aggressively for fear of being locked out of the market.
When the downturn came, not only did investors desert the market, but all the heat went out of the purchasing decision for owner occupiers.
Market psychology switched from greed to fear. Demand for properties dried up. New development fell and the cycle turned down.
The problem was that the setback to prices was accompanied by a substantial setback to construction.
The Sydney market panicked, with prices falling by 10 to 15 per cent and continuing on a downward drift since then.
The number of dwellings under construction fell by a third, significantly below the underlying demand.
We’re not building nearly enough in Sydney. There is already a significant deficiency of residential stock and it’ll get a lot worse over the next few years.
The rental market is extremely tight, with rising rents and a shortage of stock.
These are the preconditions for a substantial upswing.
The Melbourne market was less affected, with prices falling only slightly before recovering while construction fell by just over 20 per cent.
Building fell below underlying demand, but not by as much as Sydney, so that there is now a moderate deficiency of stock.
In Brisbane, the downturn came despite a substantial deficiency of residential stock at the time.
Prices growth slowed to around the inflation rate so that prices steadied in real terms rather than falling, and construction dropped only moderately.
But here again we’re not building enough and the already severe deficiency is getting worse.
The upswing is imminent — in fact, I think it has already begun — but it will take time to build momentum.
Meanwhile, the Perth market was so strong that it didn’t notice the other markets had turned down, with the boom continuing and only now turning down.
On the eastern seaboard, tight rental markets, rising rents, insufficient building and an increasing deficiency of residential stock are setting the stage for an upturn, stronger in the markets where the deficiency is greater.
In this environment, a rise in interest rates could provide a setback, but only temporarily.
Mind you, the next cycle won’t see anything like the magnitude of price rises that were experienced in the last one.
Affordability will remain an issue, constraining the next round of price rises. But it will still get worse from here. Rents will be much higher in the next cycle.
What we will see in the next upswing is a strong rise in residential building, moderate in Victoria but much stronger in NSW and southeast Queens- land. And the real strength of the upswing will be early next decade. At the peak of the next cycle NSW will need to build 60 to 70 per cent more houses than at present to offset the deficiency of stock and cater for ongoing underlying demand. And we have to ask whether we will have enough appropriately zoned land when the demand comes through to prevent an escalation in the cost of housing lots feeding through to Sydney housing prices.
In Melbourne, the availability of reasonably priced land not too far from the city will keep a lid on price growth through the next cycle.
Brisbane is setting up for a boom.
Is it safe to invest in residential property yet? For me, the answer is yes. Certainly, rents are substantially lower than interest payments — and that tends to suggest delaying the purchasing decision for an owner occupier. For investors, yields are far too low to make housing investment attractive without substantial capital growth. It will take far too long for strong rental growth to increase yields sufficiently. And we can’t expect the capital growth experienced last cycle. But a lot of the risk has gone out of the market and returns will be excellent when they come. Meanwhile, the first lots of buyers are discouraged renters.
In some cities, it may take some time for the upswing to come through. And a rise in interest rates could provide another setback.
However, given the deficiency of residential stock, a patient investor or owner occupier could do worse.
In Sydney and Melbourne there’s still plenty of time to find the right property.
In Brisbane, there’s less time.