To assist you in developing a blue print
for an investment strategy, it seems necessary to apply theory to practical examples in
predicting which market to invest in and when.
This can best be done by selecting a
market, applying the principles and translating the findings to a trend in that market.
We have selected the Sydney residential
market to demonstrate. Selecting Sydney residential was not difficult. It is
Australia’s largest residential market, so affecting a greater proportion of
population, and is the city of your authors’ greatest experience.
If we can provide you with insight into one
specific market, it will assist you in applying the process to any other property market.
THE SYDNEY
RESIDENTIAL MARKET MODEL
The Sydney Residential property market at
the time of writing this book, is recovering from a period of static activity which
occurred primarily due to high interest rates and economic recession over the last five
years. With progressive declines in interest rates in recent years and low levels of
construction over the last eighteen months, there is now a shortage of quality property
available in the market.
Reflecting these conditions, the vacancy
rate in the Sydney rental market is currently the lowest of any city in Australia, and
rents have begun to increase.
Land shortages in the Sydney Metropolitan
area, which are occurring as a result of the significant cost to Government of providing
water, sewerage and social infrastructure, are also impeding new development and therefore
contributing to the shortage of dwellings.
The other fact which will always contribute
to the scarcity of serviced land in Sydney, is the geographic restrictions which contain
Sydney into a finite area. Sydney is surrounded by natural boundaries with national park
and gorge country to the north, ocean to the east, national parks and water catchment
areas to the south and the Blue Mountains to the west.
Unlike other cities in Australia, which
tend to be relatively flat in the topographic sense, and have a constant availability of
new land by subdivision and servicing, Sydney cannot easily continue to urban sprawl.
It is this imbalance in supply and demand
factors, whereby supply of new land and dwellings have been unable to keep pace with
rising population, which will drive values higher, particularly as the general economy
improves over time.
A FUNDAMENTAL
APPROACH
These forces of supply and demand have
always been and will always be, the engine that drives residential prices. All things
being equal, which in economic terms simply means ignoring all the minor variables and
fluctuations at work in any economy, if demand exceeds supply, prices will rise. If supply
exceeds demand, prices will fall, or remain the same. If demand equals supply, nothing
much will change. But in property terms, what is supply and demand?
If we stay with residential property as our
case in point, let us break down supply and demand into their various components. By doing
this, we can identify the likely direction of price movements at any point in time. This
was the basis of a market model which we developed over many years to assist us to predict
market movements. It became an indispensable tool for making investment decisions, proving
to be extremely accurate.
SUPPLY
Supply of property in a residential market
means the total stock of dwellings which exist in that market. For example, in Sydney
there are currently around 1.2 million dwellings.
Forecasting changes to the number of
dwellings is the important point. This involves quantifying the likely rate of completion
of new dwellings, the number of demolitions of existing dwellings, allowing for second or
holiday homes which are not primary residences and for any rental vacancy factor.
DEMAND
Demand in a property market relates to the
number of households which require a roof over their heads, and how that may change over
time. Sounds simple, but in fact, is quite complex and strangely fascinating.
Consider these points, all of which
contribute to that demand. They are, the current number of households, the shrinking size
of those households, the explosion of single person households due to people living
longer, high divorce rates, the immigration cycle, interstate migration patterns, children
living with parents longer than in the past, marrying later, having children later, the
birth rate, changes in employment locations and the effect of the information revolution.
All these come together to tell us the rate
of new household formations for a given area, and therefore the number of dwellings that
are required to house that population.
THE IMPACT OF
HOUSEHOLD FORMATIONS
We know over the last couple of decades the
average household has shrunk from around 3.6 people to about 2.7 people today. You could
quite rightly conclude that even if population did not increase, this change alone has
been generating increased demand for housing.
Falling household size is the result of
many changes in the demographic make-up of our population.
Longevity is an obvious factor, where life
spans are increasing meaning more people are around longer. This has another impact on
property, in that we are also healthier and more mobile in retirement, causing us to
remain in the family home longer than our parents might have.
A high and increasing divorce rate is also
a major contributor to falling household size. One household separates to form two
households.
People marrying later in life is leading to
the growing incidence of younger people in single household situations.
NATURAL
POPULATION INCREASES
We also know the approximate rate of new
household formation likely to occur from natural population increase, that is, ignoring
immigration and other factors. This is because people do not form households when they are
born. We form new households when we leave the parents’ nest and this, on average,
occurs when we are in our late teens or early twenties, although it has been getting later
- especially during economic recessions. Therefore, we can predict how many households may
form from this source in any period because we know how many people were born say twenty
to twenty five years ago.
INTERSTATE
MIGRATION
Interstate migration has been a variable
factor in recent years, with, at one point, about thirty eight thousand people a year
leaving Sydney, in the majority, for Queensland. In recent years this has reduced to a
more normal fifteen thousand a year. Interstate migration seems to be closely linked to
the property price cycle in that when, say Sydney prices are high, some will sell and move
north, buying a cheaper home in Queensland, often with cash left over. Of course the
problem has been the lack of employment, or lack of friends or family in the new location.
Many have returned. Many would like to, but cannot return to the Sydney market, having
spent the leftover cash on survival in the promised land.
IMMIGRATION
The interesting thing about immigration is
the extent to which it is an obvious political football and the myths which surround the
effect of immigration on the property market. In the late 80’s when prices were
rising strongly and immigration was at very high levels, the conventional wisdom said the
strong price rise was specifically caused by high immigration. There can be no doubt that
the 1987 to 1989 boom in prices was extraordinary with prices rising probably far more
than they should have, but high immigration, or for that matter the share market crash of
October 1987 was not the cause. At its peak, immigration during that period increased from
around one hundred thousand to one hundred & sixty thousand people per annum into
Australia. The effect of that increase on the Sydney market is simple.
| Total additional people |
60,000 |
| Around 30% settle in Sydney |
18,000 |
| Number per household (at that time) |
2.8 |
| Number of additional dwellings required |
6,428 per annum |
This figure then has to be set-off against
the ability of the construction industry to supply those dwellings. Queensland is again a
good example. When Queensland was claiming huge population growth the building industry in
that state still managed to produce so many new dwellings that in the end supply well and
truly exceeded even incredibly strong demand. This has led to a soft market, high vacancy
rates in the rental market and some areas of falling values. It does not logically follow
that a population surge from any source will necessarily lead to growth or boom times. It
is the overall equation of supply and demand which determines the final result.
In Sydney, when immigration was generating
an additional demand for 6,428 dwellings per annum, it was at a time when there was a
chronic shortage of dwellings which had built up over a six year period. Sydney required
27,900 additional dwellings per annum just to meet normal demand and the construction
industry did not have a chance of catching up. Immigration was a factor, as it always will
be, but it was not the single cause.
THE BALANCE
All the factors which make-up supply and
demand can be estimated, quantified, calculated, predicted, extrapolated, massaged and
brought together to create a most informative picture which indicates the likely
oversupply or deficiency of housing stock in the market.
Where an underlying under-supply is
indicated, "all things being equal", the natural conclusion can only be that
given reasonable economic conditions, the growth engine is fuelled up and prices will
rise.
Equally, if the market is oversupplied,
even in strong economic conditions, the tank is empty and growth other than perhaps
keeping up with inflation will not happen.
The best example of these forces at work is
the comparison between the Sydney and Melbourne markets during the 1980’s, which we
previously demonstrated.
The Sydney residential property market has
a strong history of value growth over time, with a growth rate since 1960, including
periods of low inflation, of around 10% per annum compound.
This is well above the rate of inflation,
and when combined with rental returns, places residential property as the strongest
performing form of investment available.
It is also one of the safest forms of
growth investment available, showing less volatility than other forms of investment. One
of the main reasons for this high level of security is that residential property is the
only market in which we can invest, which is not dominated by investors acting purely with
financial motives.
The following commentary is extracted from
a late 1996 edition of "The Real Estate Analyst", a newsletter published for our
private clients.
Remember the last major upturn in Sydney
residential property prices? It ran from early 1987 to mid 1989. Those who invested in
Sydney residential property in 1986, just before the boom, have done extremely well.
During 1986 market indicators, which were
emerging at the time, told us the market was preparing to rise. Interest rates had risen
and the economy was patchy. Vacancy rates in the rental market were falling, reaching a
low of 0.9%, reflecting a shortage of rental stock. New construction levels were
low, exacerbating the shortage, and prices were below the long term trend line and clearly
had some catching up to do. Interest rates began to fall. The economy started to improve
and the rest is history.
A "1986" opportunity only comes
along about once every decade. It is the optimum time to invest in property for growth,
tax savings and income.
At the time of writing, our research
indicates the market has again reached that point. All the indicators are telling us the
market is turning.
Low vacancy rates, falling construction,
increasing rents and prices below long term value. All the same conditions that existed in
1986.
Although nothing can be guaranteed,
acquiring property now for investment purposes should establish an investment which will
perform well, no matter what happens in the future. As part of an ongoing plan to build a
property portfolio, it is the best possible start. Let us look at the facts.
The fall in the vacancy rate, reflects an
emerging shortage of rental property, and is one of the first indicators of a market which
is consolidating, and always precedes a major upturn in values. The similarities between
1985/86 and the current market are evident.
As the vacancy rate falls, rents start to
rise and again, this is very similar to the 1986 experience.
The forces of supply and demand are the
main ingredients in fuelling prices. This is why the market is cyclical, at times, rising
strongly. When current prices are below the long term trend the buying opportunities are
greatest, and the next direction of the market becomes obvious.
Market surveys for the June quarter 1996
indicate the median price of an established house in Sydney has risen to $210,000, an
increase of 3.96% on June quarter 1995.
The median price of an established unit in
Sydney in June quarter 1996 increased to $175,000, to be 5.4% higher than the June quarter
1995.
INVESTOR
ACTIVITY
Investment in the Sydney market continues
to grow, accounting for better than one in four of all residential sales during early
1996, and more recently, rising to around 30% of all transactions. Investors are taking
advantage of the low vacancy rates and strong yields. Residential investment property
continues to be viewed as an attractive investment, due to it’s relatively low risk,
security, taxation advantages, stable income and capital growth.
VACANCY RATES
The average Sydney vacancy rate of 1.7% as
at October 1996, continues to reflect the shortage of rental accommodation. Rents have
started to rise. Sydney’s vacancy rate is the lowest of any city in Australia.
INTEREST RATES
The interest rate war continues between
lenders, forcing three year fixed rates on investment loans as at February 1997 to drop to
around 8.25%, compared to around 10.0% in late 1995.
YIELDS AND RENTS
Estimated gross yields, that is percentage
of rental income to market value of investment property, for Sydney are currently 5.7% for
houses and 5.8% for units. Attractive yields and the prospect of capital growth continue
to draw increasing numbers of investors to the residential property market.
The shortage of rental accommodation in
Sydney is being reflected in rents. The median rent for a two bedroom unit in Sydney has
risen from $185 per week in late 1995, to the current figure of $195 per week. Median rent
for three bedroom houses in Sydney has risen to $287 per week.
THE BUYING
OPPORTUNITY
The opportunities in the property market
right now are the best we have seen in ten years. Do not wait until any upturn is well
under way before adding to your property investment portfolio. Perhaps that privilege
could be left to the majority who rely on the popular press as a source of so called
reliable property information.
Given the cyclical nature of supply and
demand, this optimum buying opportunity only happens once every eight to eleven years
making the next one probably somewhere around 2003 to 2006. Even though in a long term
sense there is probably never a bad time to invest in property, especially if the
alternative is to do nothing at all, by taking advantage of the current market you could
be one of those who look back and say "I bought in 1997".
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