After the first rate cut: Smart property strategies

With interest rates finally on their way down, MICHAEL LAURENCE gives eight strategies for intending property buyers and sellers who want to maximise their investment return.

By Michael Laurence 

With interest rates finally on their way down, here are eight strategies for intending property buyers and sellers who want to maximise their investment return.

Astute owner-occupiers and investors should, at last, see clearer trends and opportunities beginning to emerge in the residential property market following the Reserve Bank’s first cut in official rates since December 2001.

The first of an expected series of rate cuts should begin to lift consumer confidence from its doldrums and slow the fall in property prices. And the next cut in official rates, as early as next month, is likely to put a floor on the market and set the scene for a recovery in average national prices that could be up to 12 months away. That is if leading analysts interviewed for this column are right with their forecasts.

But even after successive rate cuts, the state of the residential market will remain fragile given the true state of the economy and the widespread weakness in housing affordability.

Would-be buyers and vendors should not overlook that the Reserve Bank has only cut official rates because of its concern that the economy is experiencing a sharp downturn. The reality is that consumer confidence is “shot” – to use the word of one property analyst interviewed – another analyst describes consumer confidence as “diabolical”.

The latest-available statistics for housing finance show just how much buyers have been retreating from the market. Lending for housing experienced its lowest growth in more than 21 years during the 12 months to July, with growth of investor lending being the lowest on record.

Average residential prices fell over the seven months to July in every Australian capital bar Adelaide, reports the latest survey jointly prepared by researchers and analysts RP Data and Rismark International. And the number of house and unit sales is now 30% below its 10-year average.

Other signs that do not augur well for the property market include the staggeringly high levels of household debt and the extent of the slowdown in Australia’s economic growth, which averaged 2% for the first six months of the year on an annualised basis against 4.6% for the first half of last year.

However apart from the cut in interest rates, there are definite positive signals for the eventual recovery in average residential values, including a grave undersupply of rental property in every capital city, rapidly rising rents and rental yields, and overseas migration remaining at a record high.

Here are eight strategies prepared with the assistance of leading property and economic analysts to help you make the most from the prevailing market.

ONE. Don’t over-estimate the positive power of one rate cut: The Reserve Bank’s 25 basis point cut in official rates last week will not trigger a stampede of buyers back into residential property; far from it.

Despite the arrival of spring, together with the rate cut, this is not yet the environment for a recovery or for a remarkable turnaround in the market.

Most analysts interviewed say that the one rate reduction will not be enough to stop average national prices from falling but should begin to restore some buyer confidence.

TWO. Expect back-to-back rate cuts to put a floor under the falling market: Two rate cuts totalling 50 basis points should be enough to stop average prices from continuing to fall, says Robert Mellor, director of building services for economist, business researcher and forecaster BIS Shrapnel.

Louis Christopher, head of property research for investment researcher Adviser Edge, also believes there is a “very good chance” that another 25 basis point cut before Christmas – as widely expected by economists – will bring a halt to falling average prices.

And Cameron Kusher, a research analyst with RP Data, agrees. “Even one rate fall [last week] will see the market flatten somewhat. And two will see prices stop falling.”

Matthew Hardman, head of portfolio management and research with Rismark International, also expects that back-to-back rate cuts should put a floor under average prices, and even last week’s cut alone should significantly reduce the possibility of large future price falls. Hardman believes that the traditional bounce in spring sales will assist this stabilising influence.

Hardman says poor affordability will put a ceiling on price growth and ensure that it will not be dramatic. But he underlines the importance to the market outlook of the “pressure-cooker” factors of low unemployment, solid wages growth, and the excess of demand over supply.

THREE. Don’t expect average prices to begin to rise until at least well into next year: Prices should begin to rise by mid to late 2009, according to property analysts interviewed. This forecast should help guide investors and owner-occupiers with timing their entry or exit into and out of the market.

Mellor, for instance, expects that once the Reserve Bank has cut rates by a total of 75 basis points, average prices will begin to rise. “This could provide the stimulus that the market needs,” says Mellor. “[But] there won’t be a quick turnaround in the market.

“The biggest fear for the economy is a sharp rise in unemployment; which we don’t think is going to happen. I think the concern is over-stated.”

BIS Shrapnel forecasts that Australia’s unemployment will rise from 4.3%, the latest available figure at the time of writing, to 5% by June next year. Mellor believes that particularly given the cost of employing and training new staff, employers will be reluctant to lay them off – only to have to employ others when the economy picks up. “We think there will be an economic slowdown; nothing more.”

Another key issue hanging over the property market is consumer or buyer confidence, which Mellor describes as diabolic. Kusher names consumer confidence as a brake on the property market’s recovery. “Confidence is shot, and that’s why people aren’t buying.”

Kusher agrees that rate cuts of more than 50 basis points are necessary before the market begins to swing into recovery. “It will take four or five months, if not longer, before prices begin to grow,” he says. And Hardman adds: “We should start to see real growth with more than two cuts.”

FOUR. Look now for buying opportunities: This is unquestionably a buyers’ market. Buyers should be searching now while they have the pick of the market – which will be lost when it enters the recovery phase. Select with extreme care and then negotiate hard.

Kusher says intending buyers should not feel under pressure in this market to buy. “There are lots of properties on the market and you can negotiate yourself a good deal.” Mellor adds: “The prospects for buyers are pretty good; they are probably as good as it gets.”

Mellor is convinced that intending buyers should try to get set in the market over the next six months. He says that after 12 months, or even earlier, the bell may have sounded for its recovery after another stretch of strong rental growth.

Louis Christopher of Adviser Edge also says there is “no rush whatsoever” to buy for fear of missing out. He thinks that it will remain a buyers’ market for the next 12 months. “Be selective. A property that might seem like a bargain today could be more of a bargain in six months.” Taking a highly selective approach is a smart move for buyers in this market, he says.

FIVE. Hold back if you are a seller: Unless you are under extreme financial pressure, there seems little logic in selling when average prices are possibly still falling or even after the market begins to level out.

“There is no need to be a desperate seller”, suggests Mellor. Wait until the market begins to pick up before considering putting your unit or house on to the market.

SIX. Favour inner-city and near-city units and houses: Buyers who stray from near the city centre could be entering riskier territory unless they are buying into particular property hotspots with plenty of potential that have been earmarked for growth. (See SmartCompany’s feature on the best hotspots in this issue.)

“The inner-city is definitely a safe haven for property,” says Kusher. “I think that 75% to 80% of people want to live there.” And he says this should guide intending property buyers. “There is always demand for these properties.”

For investors seeking high yields, Kusher favours inner-city and near-city units. And his hotspots for such properties include The Rocks and Prymont in Sydney; Carlton and Southbank in Melbourne; and, in Brisbane, Fortitude Valley, West End and South Brisbane. Inner-city houses don’t produce the yields of units but can have excellent long-term prospects for capital growth, he says.

SEVEN. Make sure you can really afford the repayments: Household debt is already extremely high, making families, and in turn the property market, vulnerable to a spike in unemployment.

Louis Christopher of Adviser Edge urges intending buyers who are considering taking on a bigger mortgage not to ignore what has happened in the United States with plummeting prices as borrowers have been unable to meet their repayments. And he emphasises that would-be buyers should keep forefront in their minds that Australia is now entering a time of greater economic uncertainty.

EIGHT. Research interest rates with extra caution: When interest rates appear to be moving down, lenders tend to fall over themselves to promote their latest offers. But there is a danger here; there can be a big difference between the headline or nominal rate and the actual or real amount paid by borrowers once all the costs are taken into account.

So-called honeymoon rates, in particular, can give an unrealistic impression to borrowers. Once the honeymoon rate ends after six months to three years, most borrowers go straight on to the lender’s standard variable rate. And standard variable rates are typically 0.7% higher than most borrowers pay after doing a little haggling and careful product selection.

Harry Senlitonga, a senior financial analyst with interest rate researcher Cannex, urges intending borrowers to compare real rates when selecting home loans. (This can be readily done with Cannex’s help.) Real rates comprise cost of interest, loan application fees, ongoing fees, and discharge fees where applicable (typically when terminating a loan within four or five years).

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