Property Update – June 2011

Darling harbour, Sydney
Darling harbour, Sydney

In my last update in December 2010, we observed a year of robust growth in 2010 although much of the surge in property prices happened in the first half of the year. The successive interest rate rises eventually took hold of the surging market in the second half of 2010 and we predicted that 2011 will be a year of consolidation. That is, a year where prices will stabilise as the market takes a breather from the boom.

It may be a opportune time to now examine the state of the property markets as we hit the half way mark in 2011.

Key Observations

Some key observations during the first half of 2011 include the following:

  • Fragmented markets and the two-speed economy in Australia

There has been a marked slow down in the property markets across Australia which has been widely expected. The boom which started in late 2009 was predicated on very low interest rates and pent up demand from earlier periods. What is worth noting is that, in general, property markets in Australia are currently flat and  further pressures on households will dampen prorperty prices.

It is also official that Australia is in a two-speed economy where the mining and resources sectors have been powering ahead whilst manufacturing, retail, education and tourism industries are experiencing very difficult times from a combination of the strength of the Australian dollar, consumer sentiment whereby people are more cautious and have curtailed spending to a large extent.

Mounting debts of $440 million - Colorado Group

Mounting debts - Colorado Group plans to close 140 loss-making stores nationwide (Source: The Daily Telegraph)

As I write this article, the retail chain, Colorado Group which owns iconic Australian brands including Mathers, Williams & Shoeman, Jag, Diana Ferrari and Colorado is riddled with a $440 million debt and its future is hanging on the balance. Receivers Ferrier Hodgson is expected to close 140 loss-making stores across the country and shed more than 1,000 jobs.

The evidence is mounting that consumers are cautious and sentiments remain fragile because people are still uncertain about the future of the world economy. The spending culture of Australians has been reversed where it is reported that Australian households have saved some $80 billion dollars over the last 18 months.

  • Strength of the Australian dollar

The Australian dollar has seen a jump of 25% in the last 15 months and is currently trading at around US1.06. The dollar traded to as high as US$1.10 in recent months. As a consequence, real estate agents have also reported a significant slow down in foreign investor interests due to the high exchange rate.

During the second half of 2009 where the recent boom began, foreign investor interests were at its highest where anecdotal evidence showed cashed up overseas investors, especially those from China were snapping up Australian properties when cash rates were at a 49-year low of 3%.

Although this level of investment has dwindled in recent months, prices have already surged and first home buyers are still finding great difficulty getting into the market. In general, investors are more selective whilst developers are having issues securing finance and this is sustaining price levels in certain areas.

  • Accelerating costs of living

Over the last 18 months,  food and petrol prices have increased in general which was due in part to the Queensland floods. GIO has increased premiums for most segments of its general insurance to recoup claims and losses from the natural disasters. The debate on the carbon tax, mining tax and impending increase in electricity prices and council rates are also making households think twice about getting into the property market.

Rising costs of living have been keeping many would be buyers out of the market. The difficulty of getting into the property market is generally sustaining rental markets across Australia. Most states have very low vacancy rates of around 1% although it should be remembered that markets are fragmented. Popular suburbs are always in demand while less popular areas are experiencing vacancy rates as high as 10%. This augurs well for investors although it is also not an ideal situation where renters are always under pressure from rent increases.

  • Strength of the Chinese economy

The Chinese economy has performed well and the government is concerned about its property markets which have seen a tremendous boom over the last 24 months. Measures are being taken to contain property price growth as well as inflation which some analysts are tipping to accelerate to more than 6%, bringing the full-year CPI to around 5%. The impact for Australia is obvious in the event of a slow down in the Chinese economy. However, there is little signs that a slow down is imminent as the Chinese government is generally looking to gently apply the brakes on the economy. Investors would be prudent to factor the potential of this issue happening in their investment strategy.

When and where to buy?

The million dollar question is still be asked as always. Hindsight is always easy and the best time to buy was obviously in early to mid 2009. My research at the time pointed to strong fundamentals in the Australian economy but what put investors off was the looming GFC and an uncertain future.

However, interest rates were at record lows and investors would have done extremely well had they invested in suburbs and properties with good credentials, that is areas where there is a solid growth history that is in demand from both owner-occupiers and tenants alike, strong public transport and amenities such as shopping centres, parks, beaches and other local attractions. Buying off-the-plan then was a good strategy provided the developments are in strategic locations and have strong developer credentials.

It is a generally a buyers’ market at the moment because prices are generally flat and some suburbs have retreated from its highs. But it should be remembered that prices have boomed in the last 24 months. First home buyers can drive a harder bargain for certain strategic locations where stocks have increased because it is now taking a longer time to sell a property.

Special reports

I would still caution investors about areas which have been touted as boom areas such as mining towns. I have received numerous emails over the last 6 months and a marked increased in the demand for the special reports in towns like Gladstone in Queensland and Orange in New South Wales. I have carefully reviewed these reports and the long term fundamentals of investing in these areas have generally remained unchanged. That is, one needs to do the hard yards by researching strong growth history and fundamentals for suburbs within these areas, choose the right location, then the right type of property and finally the right price. However, the short term risk profile is a little different because markets have softened and the future of the world economy is still uncertain.

In general, I would avoid house and land packages and off-the-plan projects because the boom is over and it is a lot more risky when the future is uncertain unless one is looking to be an owner-occupier and is taking a much longer term view.

I believe investment strategies in light of all the above have not changed from what I found in December 2010. These strategies include:

  • Exercise prudence and reduce risk by reducing debt and leverage and value-add to property portfolios, if at all possible. Renovating your properties, subdividing and developing are great ways to “manufacture” equity and grow your portfolio during flat markets.
  • Research and target emerging suburbs with good credentials. As markets are flat, it is crucial for investors to take a longer term view rather than looking for short term gains and buying properties off-the-plan. Real estate in popular areas around the CBDs with good public transport and amenities will continue to hold its value in the long term. These properties are also popular with tenants.
  • Consider alternative markets overseas. Due to the strength of the Australian dollar, many Australian are taking advantage by going overseas for holidays and considering investing in overseas markets. This option is strategic provided research and due diligence is carried out and the relevant laws and regulations of those foreign countries are understood and its implications factors into the equation.

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Disclaimer: Views, opinions and comments expressed in this article are general in nature and do not constitute investment, legal or financial advice. Readers are advised to seek their own professional advice as and when required.

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