Property goes up as shares go down

I’m not in the business of comparing residential property investment with other asset classes; there are simply too many differences, ranging from lead times to measures of performance. 

However, given the ongoing volatility of the sharemarket in the midst of the credit crunch and continuing talk of a US recession, we may see a stronger investor return to the relative safety of residential property this year than previously predicted. In fact, this year is shaping up as offering a quite unique set of circumstances that could provide an extremely solid base for investors who enter the property market.

For many years now I have sought to educate investors about the long-term nature of investment property assets, hence the hesitation about making direct comparisons with the faster turnover and profit pace associated with more liquid assets.

What I have consistently put forward to illustrate the returns from long-term compounding capital growth on property has now been backed up by the latest research from the ANZ Bank. Over the past 24 years, the performance of residential property has offered a compound annual total return over that period of 13.4%.

The ANZ – not me! – has sought to compare this to a 13.8% return for equities, 10.3% for commercial property and 9.4% for bonds over the same period. In risk-adjusted terms, the bank says in its latest property outlook, “residential property has delivered vastly superior returns to all other broad asset classes”.

What this analysis does is give us the opportunity to review what occurs in the property market when other asset classes take a tumble, which is just what’s been happening in the sharemarket over the past month.

According to ANZ, since 1984 there have only been two major property price tumbles – the largest falls in national median values being -0.3% during the recession in the early 1990s and -0.9% in 1996. The research shows us that Australian equities fell 43% between September and December 1987, by 15% in 1992, 17% in 1995 and 18% in 2003.

My tracking of the timing of property market upswings shows there was a price surge in 1988; the residential market picked up again in 1993 and; there was another rise in late 2005, which appears to be ongoing.

Each property cycle over that 20-year period has had its own set of economic and social circumstances at play and 2008 will be no different; for instance, this year it is not merely a case of investors seeking a safe harbour to park some of their funds while the international credit crunch plays itself out.

Domestically, there is the widely acknowledged shortage of new housing stock and the flow-on demand back into the established sector, coupled with record low housing affordability levels that continue to push rental demand and yields higher in a tight rental market. In fact, rental yields have hit their highest levels in 17 years; average rents increased by 6% in the year to September 2007, according to Australian Bureau of Statistics figures.

In spite of the home construction industry itself talking up hopes of a turnaround in new dwelling completions, many observers foresee shortages worsening as developers hold back in the face of low affordability and low profit margins.

At the same time, increasing immigration and first-home buyers battling that low affordability are placing considerable pressure on available housing stock, especially in the outer suburbs and the inner urban apartment market. The ANZ predicts a record shortage of 200,000 homes by 2009-10. So how will this play out for investors?

Investors entering the property market this year are likely to see an unusual combination of rising capital values and rising rental yields brought about by the housing shortage and lack of new rental stock. In the current cycle, values have risen relatively quickly.

For instance, during 2007 it was not unusual for us to see price spikes of 20% or more in the most in-demand areas. But, it would normally take longer for this price activity to filter through to rental costs. As low affordability and the stock shortage bites deeper, we can expect to see this upward trend in rents and capital values continue throughout 2008.

The main obstacles that could cause investor hesitation hinge mainly on Federal Government economic management, particularly its ability to manage inflation and how it tackles ongoing low affordability, Reserve Bank monetary policy, and future tax rulings for investors. Rising interest rates undoubtedly caused some investor hesitation in 2007 and will probably continue to do so in 2008.

As long as a buffer is built into investors’ financials, a small rise alone should not be viewed as a negative factor. Even though we haven’t seen an end to the increasing interest rate question yet, bear in mind that rates will come down – eventually! What investors can bank on is a market where property prices for the prime assets are not going to take any significant tumbles and rental yields have not yet reached their peak.

This story first appeared in the Eureka Report.