Is property still a good investment?

Over the last few weeks I have noticed increasing nervousness among the property investors I speak with. And it’s not just beginning investors wondering whether they should get into the market. I’m also noticing concern from some investors with substantial property portfolios.

Only yesterday I got a phone call from a professional colleague who has been investing for years, but now has the jitters after reading that US economics commentator Harry Dent’s warning that the world’s economies are going to fall into recession and Australia’s “property bubble” will burst, causing prices to come down by something in the order of 40%.

Is he right? Are our property markets going to crash?

Well, before I give my thoughts (for what they are worth) let me share some other concerns I’ve heard over the last few weeks…

Some investors are worried that property prices have remained flat for some time now, indicating that they rose too high too quickly, and that they must now drop. While others are concerned that they have been priced out of the market and it’s too late to get in.

Yet others are anxious about all the issues playing out overseas and how this could affect us over here. They recognise that we’re now dependent on China and ask what happens to us if the Chinese juggernaut slows down.

Why investors are nervous

I understand why so many investors are nervous…

It wasn’t that long ago, while the rest of the world was suffering after the GFC, that Australia avoided going into recession. We felt confident, in fact a little smug and thought the worst was behind us. With all the good news in the media at the time buyers were out in force and set some of our property markets on fire.

But for most of this year the messages were different. It’s no longer just good news.

There is bad news, followed by good news, followed by some mixed messages. Most people, even some experts, don’t know exactly what’s happening or, more importantly, what’s coming next. No wonder most investors don’t know what to do.

We’re in good shape for a downturn.

While Australia’s economy has performed well and is likely to continue to do so, we don’t operate in a vacuum. We are part of a global economy; one that is still having lots of problems.

America is taking longer than expected to work its way out of its economic problems and has a long way to go yet. And the extent of the problems in Europe are bigger than many anticipated and it is likely we’ll see some sovereign defaults in the coming months.

If history repeats itself there will be plenty more surprises ahead – maybe even some shocks – and these may have a negative impact on the Australian markets and in particular our stock and finance markets.

The good news is that Australia is ready for almost anything the world economy throws at us. We’ve been battening down the hatches anticipating further financial problems.

As a country, we have low debt levels – the International Monetary Find estimates 24% of GDP this year as opposed to 100% in the US and 150% in Greece. And even though we have a small budget deficit, our Government could spend its way out of another economic crisis. Plus the RBA has the ability to lower interest rates to help stimulate our economy as it has done in the past.

At the same time the average household is in much better shape than a few years ago. We’re saving more than ever. On average we’re stashing away around 10.5% of our disposable (after tax) income, paying down mortgages faster than needed and paying off credit card debt.

While small retailers are battling, many of our larger companies are in a strong financial position, particularly our banks, who have bolstered their balance sheets. This means our major banks are no longer as dependent on overseas funds and could keep lending to us even if overseas interbank lending dries up.

What could cause our property markets to crash?

Despite all the predictions of a property collapse, over the past year capital city dwelling values fell by only 3.2% according to the latest figures by RP Data.

Clearly we’re at a stage in the property cycle when prices will be flat for awhile, and some properties will still fall further, but that doesn’t mean property values will crash.

If you look at it logically, there are really only four things that could make our property markets collapse:

1. A recession – when people lose confidence in the future and stop spending. No one I know is suggesting that is likely to happen in Australia over the next few years. Not with the mother of all resources booms buoying up our economy.
2. High unemployment – when people can’t afford to keep up their mortgage payments they have to give away their houses at any price. Again there is no evidence to suggest this is likely. If anything there is a shortage of skilled labour that will require us to increase immigration, which of course, will be positive for property.
3. High interest rates – with interest rates likely to remain steady or fall over the next year, this risk to our property markets has been eliminated in the short-term. Of course as our economy picks up over the next few years it is likely the RBA will once again have to push up rates to slow us down a little.
4. An oversupply of property – too many new properties built by exuberant property developers on the Gold Coast has shown how an oversupply can cause property prices to collapse. But, other than in selected areas like the Melbourne CBD and Brisbane CBD where an oversupply is looming, we don’t have more properties than buyers or tenants.

Sure property prices got a little ahead of themselves in some areas, but putting all this together means it is more likely that our property markets will remain flat for a while as they get back into equilibrium, in contrast to a sudden sharp fall as some of the doomsayers are predicting.

And if property values start to fall significantly, it is unlikely that the Government or the RBA would allow such a correction to occur. They will introduce stimulatory packages, or drop interest rates as they have in the past.

What about all the talk regarding affordability?

Sure it’s hard for first home buyers to get into the property game, but that’s nothing new.
Despite what some are suggesting, one of the economists I respect, Paul Bloxham HSBC’s chief economist and a former RBA economist suggests that since late 2003 the dwelling price to income ratio has been broadly stable at between 3.5 and 4.5 and has averaged four.

He is forecasting growth in disposable income per household of around 5% per annum over the next couple of years as a result of strong employment and wages growth, and suggests that house prices will grow at this pace over the next couple of years.

Property analyst Michael Matusik www.matusik.com.au says that on average, Australians hold 80% equity in their dwellings – even higher for their principal place of residence. He goes on to explain that when looking at Australians’ leveraging – when playing mortgage size against household income – this has declined over the last five years.

He makes the insightful comment that unless we see our banking system collapse, he can’t see how house prices across Australia will lose close to half their current value in a short, sharp crash. And even over the longer-term, such deflation seems very unlikely.

So what should property investors do?

Firstly it is worth remembering that the fundamentals that a strong medium- and long-term property market are sound.

We still have a strong economy, full employment and rising wages, lowish interest rates and a growing population, yet at the same time we are not building the right type of properties in the right areas to meet this growing demand.

But one important factor that boosted the market in the past – consumer confidence – is now faltering.

The growth of our property markets, especially in some segments of Melbourne and Sydney in particular, was unsustainable. In some ways, the property markets have gotten ahead of themselves. They are now taking a breather. This is normal. Property prices don’t increase in a straight line. They go up in little booms then catch their breath and sometimes even drop a bit, but then they move up again.

But not all properties will react the same.

Currently the upper end of the market is suffering and prices have dropped back significantly in many of our more expensive suburbs.

The lower end of the markets are holding their own, but they are never as volatile as the upper end. By the way… this doesn’t make them better areas to invest. In general these suburbs don’t exhibit the same strong capital growth as properties in the middle and upper price brackets.

Properties in the middle range have varied in performance. There is still a scarcity of well-located properties for sale. This means well located homes and apartments are snapped up by owner occupiers and investors. On the other hand secondary properties, and there are lots of those for sale, aren’t attracting buyers.

Is property still a good investment?

So back to the original question – is property a good investment? My view of the property market could be summed up simply as follows:

1. I have very strong positive views on the property markets in most of our capital cities in the medium- to long-term.

2. I am certainly aware of potential short-term problems related to poor market sentiment which means that…

3. You should be looking for property at the right price, in the right location, with the right rental income. One that you would be happy to hold in your portfolio in the long-term that’s bought sufficiently below intrinsic value, so that even if the market fell a bit further, you would still have bought well.

Are you ready to exploit the opportunities that will arise during this market lull?

Michael Yardney is the director of Metropole Property Investment Strategists , a best-selling author and one of Australia’s leading experts in wealth creation through property. He also writes the Property Investment Update blog.