Friday, July 10, 2009

The Allure Of Sydney And Melbourne

Source : The Business Times, July 9, 2009

However current asking prices are still above palatable levels; market expected to bottom out in about a year at best

AUSTRALIA'S currently under-supplied housing market will see increasing demand in the coming 12 to 24 months, which is likely to result in residential price increases as owner occupiers enter the market, and investors attempt to realise asset growth and secure strong yields.

Reaching up: The long-term investment fundamentals are quite solid for high-density projects in Australia's capital cities

Residential price growth in most Australian capital cities has been strong for the best part of six years, with house and apartment prices holding up relatively well, albeit at a slower pace over the past 12 to 18 months. House and land 'packages' continue to dominate as the preferred housing type as has been the tradition in Australia, with large swathes of undeveloped land remaining around the main metropolitan regions set aside for development for future generations.

Higher density living, typically in CBD and inner suburban locations, has gained acceptance over the past 10 years in Australia. However, its uptake has fluctuated considerably as a result of market over-supply and price issues.

The provision of high-density projects in CBD locations has seen CBD populations grow from a virtually non-existent base to several thousand persons in a relatively short time.

House and land packages as investments are more likely to be attractive to those investors who want to hold assets for long periods, achieve consistent returns and potentially occupy the asset in the long term.

By buying 'off the plan' homes, investors can benefit from significant tax deductions and may lead to cash flow positive returns for those wanting to contribute minimally to holding a residential asset.

For example, display homes are often leased back by builders for several years at a fixed rate of return, often up to 2 per cent above lending rates. The combination of the current low cost of borrowing (around 5.5 per cent in Australia), tax depreciation benefits and a high guaranteed return (for residential), makes this an attractive investment for many Australians and foreigners alike. For many foreigners, Singaporeans included, high-density apartments in inner city or CBD locations are the preferred investment type due to the familiarity of their built form.

High-density apartments developed in the CBDs of Melbourne and Sydney have historically had around 70 per cent of their sales to investors. In Perth and Brisbane, large-scale high-density residential apartments have predominately been developed in the past five years.

Irrespective of location, the early stages of this market activity has been dominated by off the plan sales. Relatively low initial prices and tax depreciation incentives make the relative scarcity and above average quality of new apartments appealing to investors. In many cases, early investors attempt to sell properties prior to settlement.

This potentially enables them to benefit from the price growth resulting from increased demand during the 18-month or so development timeframe, while only having to fund the initial deposit.

There are hundreds of completed apartments across Australia's capital cities currently competing with new stock and projects being marketed for sale.

Purchaser demand is stalling. However, in light of continuing strong population growth and historically low interest rates, investors are beginning to find value in this type of property asset again.

Gross yields for CBD apartments are around 3 per cent to 4.5 per cent. However, the yields vary considerably with building age, location and cachet.

A significant additional cost for these types of premises are body corporate fees (building maintenance, security, facilities, insurance) which are typically around 1.5 per cent of the purchase price per annum. These fees are tax deductible. However, they can significantly limit the attractiveness of potential long-term capital growth due to the relatively high holding costs.

The truism that increased risk equates with increased return holds true for CBD apartments. Purchasing at a time of oversupply in the market may limit short-term price growth, whereas investing when prices have bottomed will provide an increased chance of capital growth in the longer term.

The geographic separation of the Australian capital cities is likely to result in demand improving at different times across the country.

For example, Sydney and Melbourne are expected to see demand improve in the coming 12 months as the lack of stock and government grants drives up house values in the middle and outer suburbs.

Demand for CBD properties is also expected to improve with the investment fundamentals proving attractive for many.

In both cities, vacancy rates are at historic lows with few new large- scale apartment projects expected to commence marketing or construction in the coming year. While globally the economic climate is uncertain, there are many investors who are satisfied that both locations are likely to experience improving demand in the medium term.

Pent-up demand is significant for CBD apartments in Melbourne and Sydney. However, the palatable price for the majority of apartments is below current asking prices.

It is expected that demand will rapidly return once sentiment and market evidence suggest that prices have bottomed, which in the current climate will be around 12 months at best.

Brisbane and Perth are historically a year or two behind the larger cities at different points in the property cycle.

The recent resources boom in each state has generated high demand for housing. The improvement in demand in each of these capitals has been considerable from very low bases.

Overzealous developers seeking to make the most of strong conditions has resulted in an oversupply of CBD apartments. Accordingly each market is still absorbing the significant apartment supply marketed and developed in the past two to three years.

This is resulting in current asking prices falling as investors attempt to sell assets in the weaker economic climate, often at below purchase price. Both markets are likely to observe falling asset values in CBD locations for several years, as prices are driven down by the over-construction and falling demand.

To conclude, the long-term investment fundamentals are quite solid for high density projects in Australia's capital cities.

Past the current economic hurdles, pent-up demand is likely to see appropriately priced apartments sold quickly, and high construction costs are likely to limit the number of new projects commenced.

Short-term investment horizons of typically less than five years have the potential to realise limited asset growth.

However, with careful research and an understanding of the risk involved, this can be minimised.

Long-term investors are likely to see strong capital growth in their assets over a 10-year period. The long- term stability of Australia, along with its favourable lifestyle, is likely to see it continue to be on the radar of local and overseas investors for many years to come.

The writer is associate director, research, DTZ Australia

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