Why investors are essential for our property markets

By Catherine Cashmore

Wednesday, 22 February 2012

Suggesting we need more investors in the property market is bound to evoke strong emotions from the first-home buyer demographic.  Many blame Australia’s generous tax incentives offered to property investors as the prime instigator for what’s considered to be an overvalued market.  The argument follows that if fewer investors purchased property, prices would fall and more young people would aspire to the dream of owning their own homes.

The basic premise is correct.  Take investors out of the marketplace and there’s no doubt demand would ease substantially with prices experiencing an immediate drop.  Investors currently make up about 30% of our market; therefore it’s a significant percentage to bear influence on capital movements.  However, if Australia’s real estate prices did drop and experience falls on a par with various states in the US (say some 40% to 50%) would there be a sudden rush of happy first-home buyers eager to snap up the “bargains”?  I doubt it.

Due to increasing concern over the global economic outlook and general market uncertainty keeping a tight cap on real estate price growth throughout the past couple of years, along with low interest rates easing the pressure for borrowers, housing in some states is more affordable now than it’s been for  years,  Some areas have corrected by more than 20% – and although it should be noted this has not happened nationwide, neither has it been restricted to the outer-suburban “nether-regions” where demand rarely stays consistent – inner-urban areas have also suffered from the current malaise.

Furthermore, despite the challenges of our “two-speed economy” and increased financial pressure on small businesses, the overall outlook for Australia paints a comparatively pretty picture, so expecting the slump to continue perpetually is unlikely.  As the deputy governor of the RBA Philip Lowe recently pointed out, it is not an exaggeration to say Australia is facing “a once-in-a-century investment boom”.

Aside from this, it seems our prospects over the next couple of years are also sunny.  Forecast growth in the economy is expected to remain on trend, unemployment rates low, and underlying inflation is bang on track to fall within 2 % to 3%.  Just in case this isn’t enough to inspire at least a smidgin of confidence from the initial home-buyer demographic, should there be any financial upsets resulting from a European disaster, we at least have the flexibility to somewhat buffer the resulting fall-out – so the picture’s looking rather rosy.

Yet despite all the above calling out to first-home buyers to enter now and realise their “Aussie dream”, purchasers love a bargain, but when it comes to property let’s face it, no one wants to take on the expense of a 30-year debt if there’s any hint it won’t provide healthy capital returns for the retirement fund.

Considering what’s happened to the property market in Europe and the US, many purchasers worry it could happen this side of the Pacific.  In addition, due to our modern transitional lifestyles, it’s become increasingly important that the first purchase has a large investment component in order to leverage up to the second.  You see, unlike during the 1950s, rarely is the first property a place to call home for the next 20 years or so.  We leave it longer to get married, have children later in life, and change jobs often.

All in all, first-home buyers prefer the amenity of more expensive inner urban locations than the relaxed atmosphere offered in the middle-suburban city ring “family-friendly” suburbs. Therefore, single first-home buyers struggle to afford their version of the dream and property purchases are often postponed for a later more settled period – during which couples can employ joint purchasing power.  However while a combined wage certainly helps, without that initial purchase to tap into, it’s hard to envisage even the family home will be achievable for a growing number caught in the long-term rental trap.  Therefore, with this front of mind, it’s clear where our future model of home ownership is heading – more renters and fewer owner-occupiers.

I’m not here to argue with anyone’s personal financial choices in life, but it stands to reason, if fewer people take the opportunity to buy, more will rent, and therefore as we transition into Australia 2030 with plans to increase housing supply substantially, we better hope there’s a growing crop of investors ready to pool their funds into property to meet this growing rental demand.

There’s one outstanding problem – the type of accommodation largely being built to absorb the need is unlikely to hold the future capital growth investors have been used to experiencing previously. At the moment Australia’s level of home ownership is high, at roughly 70%.  It’s been the desire to own a property along with our robust growing economy and population growth, which has underpinned house prices throughout the decades producing (even in the worst of times) healthy capital returns over a complete 10-year property cycle.

Considering our lucky economic stance in comparison to the rest of the world’s developed counties, along with a smaller pool of competitive buyers in the marketplace, generous tax deductions and the ease of restrictions enabling investors to tap into their self-managed super to purchase residential real estate, there’s more to encourage this demographic than ever before.  However while some property prices will continue to attract genuine owner-occupier demand and therefore maintain the long-term upward curve on capital appreciation, it’s important all property buyers understand the changes our town planners envisage if they’re going to avoid what could be a dangerous and speculative bubble.

Most renters are singles or young professional couples.  As has been demonstrated on numerous occasions by the ABS, the fastest-growing household statistic is the single person model.  The challenge of housing this demographic is providing our state governments with the perfect excuse to begin redesigning our capital cities into a potential (at least in the short term) graveyard of residential real estate.  What’s missed by the data is the type of property single home buyers really desire to own – and in many respects, long-term tenants want to rent – and I can assure you it’s not the accommodation currently undergoing mass construction.

If you take a look at an aerial shot of Australia’s “most liveable” city, Melbourne, it’s easy to see why it stays at the top of the yearly survey.  It’s largely a low-rise city that contains a wonderful feeling of human scale.  Streets surrounding the border of the CBD and running directly across it are lined with buildings of character and charm representing different eras and styles thereby giving the sense, not of urban sprawl, but of a wonderful liveable and personable nature.

However, instead of embracing this low-rise advantage and expanding the transport systems to enable the growing populous to move outward’s and commute, the local government is set to embark on an ambitious “mega city” of skyscrapers “stretching from the MCG to the West Gate Bridge and north to the University of Melbourne”. One in which the Eureka tower (the second tallest residential building in the world) could be dwarfed.  As I’ve pointed out numerous times before, this style of accommodation is designed, marketed and limited (due to lending restrictions) to a predominantly investor-based market – a market that attracts a large demographic of foreign investment from those buoyed up on Australia’s speculative growth.

As any astute property professional understands, these buildings can be poorly designed, have a tremendously high turnover of sales (and tenants), extortionate owner corporation fees and a lifestyle that often feels akin to living in holiday accommodation.  Furthermore, when you have a market dominated by investors, should there ever be an unforseen event to tip us over the brink, (something has simple as a sudden decline in demand for our underground resources, for example) we could be looking at a mass of sales, and a situation in our high-rise market, akin to the worst-affected countries in Europe (for a good example, look towards Sesena in Spain).

When times are tough, owner-occupiers will hold whereas investors will bail in an attempt to liquidise their assets – and considering such large numbers of apartment sales are focused on the foreign market, there’s no telling what other international influences may affect future growth.

Plans like this aren’t limited to Melbourne; inner-city rezoning allowing for a greater density of stock is happening country-wide – for example, Brisbane, the Gold Coast and Perth.  In all the high-rise markets over the course of the last 10 or so years, we’ve seen poor growth (from oversupply and low demand) and in some cases very poor rental take-up (a good example would be Melbourne’s Docklands, which currently has a vacancy of 7.9% (SQM) and has seen less than 5% capital growth over the past five years (RP Data).  Considering the abundance of planned construction, investors purchasing into this market can no doubt expect more of the same. Furthermore, many of these apartments are sold based on their spectacular views of the city surrounds.  This is an attractive aspect, however don’t be fooled! There’s no condition in the contract that states the view can’t be built out.  The better the view, the higher the price – often by hundreds of thousands – therefore, the consequent price drop is not marginal by any means.

All in all you have to fear the future potential of this market and the consequence any drops would have on the economy as a whole.  Make your own conclusions and assumptions, but I for one will not be placing my hard-earned dollars in this direction.  I maintain that good property that falls under consistent solid owner-occupier demand will continue to outperform throughout the foreseeable future. Just be warned however, that without plenty of due diligence, the risks of making expensive errors are more prevenient than ever.