Investors look to houses as unit problems loom

Tax benefits and low rates are adding to the lustre of the suburbs.

You might call it the investor’s dilemma — property finance conditions are pretty close to perfect but warnings in the sector are coming thick and fast … what to do?

As everyone from “apartment king” Harry Triguboff of Meriton to AMP’s chief economist Shane Oliver sound warnings on looming trouble spots, perhaps the outgoing RBA chief Glenn Stevens captured the mood of the market best this week. He described the property market as “a mixed picture” and reiterated his view that the prospects for property would be left to the market — certainly the RBA won’t be moving anytime soon to lift rates.

GRAPHIC: Houses up, units down

Stevens, now free to speak his mind, in the final days before he hands over to successor Philip Lowe, is a voice of reason in an increasingly shrill debate about property prices: It is beyond doubt Australia faces an oversupply of apartment towers, but at the same time pockets of opportunity dot the wider market. Despite fears only a few months ago that residential property was cooling the ABS “finance for owner-occupier” figures are showing a 6 per cent year-on-year lift while in so-called inner ring suburbs of Sydney, for example, clearance rates are back over 80 per cent. Melbourne too just had its best clearance rate of the year at 79.3 per cent. (Clearance rates monitor the percentage of auctions where there is a successful sale).

For long-term investors the attraction of houses and townhouses remains powerful — especially when returns are set against cash, bonds or the regularly disappointing returns from Australian shares.

Clearly, the trouble spot is going to be city-centre apartments — apartment towers across the major cities are vulnerable as a combination of oversupply and fading interest among Chinese buyers looks set to worsen.

Angie Zigomanis of BIS Shrapnel says: “The apartment sector is where you find the downside risk — it’s where there will be problems if we see a rate rise.”

More broadly there is a general concern about apartment oversupply and the degree to which soft prices in unwanted inner city towers will lead to weaker prices in neighbourhoods throughout the major metropolitan centres.

The AMP’s Shane Oliver warned some days ago that apartment prices could fall 15 to 20 per cent in the next two years in Sydney and Melbourne.

Not everyone agrees: “I don’t think AMP has a great track record in forecasting property ­prices,” says Louis Christopher, managing director at SQM Research.

Where are the opportunities?

Analysts suggest the wider residential market will start running at different speeds depending on sector and location in the months ahead: solid prospects for houses, townhouses and exceptional apartments — uncertain pros­pects for apartments, especially inner-city towers.

On a regional basis there are dangers of overpricing in Sydney and Melbourne but opportunities in Brisbane, Perth, Adelaide and Canberra. So the message is surely that property investors who want to optimise the opportunities presented by exceptionally good finance terms and a broadly supportive market will minimise risk in the immediate future by concentrating on houses and townhouses while further down the track bargains will appear within the apartment sector.

For investors who want to minimise maintenance chores it’s worth knowing that townhouse prices more often than not align with houses rather than apartments. The difficulty here may be entry price which is obviously lower in apartments — but modest suburban homes and smaller townhouses can often be priced in a similar range to metropolitan apartments.

Seasoned property specialists take the view that there are selected brackets of value to be found for long-term housing investors — Zigomanis at BIS Shrapnel nominates suburban houses in the long term, Christopher at SQM opts for outer-ring suburbs where he explains investing conditions are very strong. “Looking at housing investment — outer-ring suburbs, beyond 10km from the CBD are greats plays, we know the inner suburbs of the major cities are fully priced ... so as a result more and more people have to accept they have to move further out if they want to own a house.”

What’s the deal?

For Australian investors facing rock bottom cash deposit rates and drifting stock and bond markets, residential property presents three key attractions:
• First, there is the prospect of total returns (potential price appreciation and rental income). Industry analysts expect a big range in price appreciation this year from 3 per cent to 8 per cent while rents are flat and between 2 per cent and 4 per cent (gross).
• Second, there is the “tax factor” where negative gearing allows tax deductibility on expenses beyond the costs relating to financing and maintaining the property: expenses include mortgage costs.
• Third, rates remain at the bottom of the cycle — even fixed rates are available below 4 per cent.

It’s this combined appeal which substantially explains just why our prices remain among the highest in the world and why investors keep coming back to this asset class.

The deal remains intact — the Turnbull government has explicitly ruled out interfering with the negative gearing rules (if the ALP gains government in the future there will be restrictions).

Putting these three factors together there is little to see why long-term investors with reasonable ambitions in terms of total returns would not revisit residential property — that is houses in metropolitan suburbs.

Certainly the prospects for both price growth and rental growth in housing are subdued: But then again as any financial analyst will tell you that goes for every asset class in an era of negative interest rates.

FINANCING

As the residential property markets gets tougher, financing property has never been cheaper. In addition, smarter advisers are showing investors new ways to access money. Here are four stand-out examples:

1 INTEREST-ONLY LOANS

Once reserved for high-net-worth investors, they are now commonly used by both investors and upgrading owner-occupiers. This option optimises tax breaks for high income earners, but narrows the investor exposure solely to price appreciation on the capital invested.

2 SPLIT LOANS

Banks don’t advertise them but investors often now split between fixed and variable loans. At its best the move allows investors to calculate the bulk of their payments in advance, yet if there is the option of paying back principal it can be done on the variable mortgage. The downside is two mortgages with two sets of fees.

3 UNIT TRUST ARRANGEMENTS

A joint-venture unit trust between the individual investor and their own DIY fund means investors can use SMSFs to put forward the deposit on a property and then use personal funds (including personal mortgages) to finance the ongoing payments relating to the property. The procedure is increasingly suggested by sophisticated financial advisers. The downside is administration fees for the unit trust.

4 USING DIY FUNDS AS A BANK

A recent innovation (explained elsewhere in the section today by Andrew Zbik) is that individuals can lend to DIY funds (which can in turn buy property). The recommended interest rate guideline for the ATO this year is 5.8 per cent, more than double the best cash rates in the market. Alternatively, DIY funds can be used as lending vehicles to individual. An individual can receive a loan from the DIY fund for up to 5 per cent of the funds value. The issue here is you must have a DIY fund to access these facilities.