Property investment in a new low interest rate environment

Warren Buffett has appeared on NBC recently advising property investors to shun bonds and look towards equities at the present time.

Buffett has warned that the present trend towards near-zero interest rates and the effective ‘printing’ of money in the US (known as quantitative easing) will hurt savers.

It seems hard to imagine how recently we were discussing the Dow Jones index trading around the 7,000 range and yet overnight the Dow burst on to unprecedented highs at above 15,050.

Economic data from the US and globally has not suggested such a dramatic improvement in the outlook, but with more money than ever seeking a home and some kind of reasonable return (which fixed-interest investments are not providing), money has fairly flooded into stocks.

 

A new era of lower interest rates

The Reserve Bank’s May 7th interest rate decision in Australia was to take the cash rate down to a new record low of just 2.75% and this presents Aussies with similar problems. Bond yields are low and savings accounts are not providing much of a worthwhile return either.

The likely consequence will be a flood of money into bank stocks, which pay handsome franked dividend returns, and capital city investment real estate.

And the rate cuts perhaps aren’t done yet. Westpac’s Bill Evans suggested that we may yet see three further cuts down to the previously unthinkable cash rate level of just 2.00%.

 

Property trends

There has been a long debate in Australia about this structural shift to lower inflation and lower interest rates.

Housing bears have been arguing for well over half a decade now that ‘what goes up, must come down’. That is, house prices in Australia had increased as interest rates fell, and therefore prices must revert to the mean and a lower house price to income ratio.

Steve Keen, who predicted a 40% crash, represented one of the more extreme views.

To date, at least, he has been completely wrong as was evident from the chart pack release from the Reserve Bank.

wargentmay10onethumb

Source: RBA

What those of us of a more optimistic bent have long suggested, is that a shift to low interest rates would likely lead to greater household leverage and higher nominal prices.

Although the lower rates could actually see repayments fall comparatively low.

This has been occurring as the cost of capital has fallen, and – even before our recent rate cuts – repayments on new housing loans for a nationwide median-priced home have fallen close to around only a fifth of household disposable income.

wargentmay10twothumb

Source: RBA

RP Data’s index shows that prices have increased in the past 12 months across all major capital cities, most notably in Sydney (+5.25%), Perth (+4.37%) and Melbourne (+3.36%).

wargentmay10threethumb

Source: RP Data

 

A new focus on quality

After the financial crisis, we have now entered a new period of low global interest rates, and it will be a new era too for Australian property. Gone are the high levels of inflation and thus easy gains of yesteryear when the value of debt was inflated away.

A focus on a diversified portfolio of shares in quality, profit-making companies and quality city property will be essential.

 

Asian influences

One of the reasons I have spent so much time in Singapore and Hong Kong over the last few years is to gain a glimpse into Australia’s future.

If you think about it, if the populations are to grow as forecast in Sydney (to 7 million), Melbourne (to 10 million), Brisbane (to 4 million) and Perth (to over 3 million) then our cities of the future will look markedly different from those we know today.

Source: ABS

Regional prices are dead flat

For a long time, some promoters of property have been talking up regional centres and remote-location property, but as the RBA’s chart pack release above clearly shows, most regional property growth occurred long ago during the great increase of household leverage through to around half a decade ago.

There has been no growth at all for years now – prices are absolutely dead flat – a trend I expect to continue with relatively high nominal prices already in existence.

To some extent, Australian property owners have gotten off lightly.

In regional markets across Britain prices have been slammed by more than a quarter of their value over. Those who more sensibly stuck to the populous south-east in and around London have seen a surge of foreign capital drive prices on to all-time highs.

This, I believe, is part of the new normal in real estate. Global investors looking for a safe haven for their money head to key capital city markets and drive prices up.

Much of the growth experienced in the last 12 months in Australia has been from a surge in new investors rather than from home buyers.

 

Foreign investment capital

There has been much talk in recent times of a proliferation of Asian buyers bringing ‘hot money’ to Australia.

Foreign investment rules dictate that non-residents are permitted to buy residential property which is under construction (i.e. ‘off the plan’) or for re-development, or to purchase new dwellings which have not yet been sold.

Other purchases may require Foreign Investment Review Board (FIRB) approval and the FIRB states that “foreign investors cannot buy established dwellings as investment properties or as homes” save for certain exceptions, but there are question marks as to whether these rules are enforced robustly (or even at all).

For such cashed-up buyers, the rumour mill suggests that attractive yields and to some extent even purchase price appear of little relevance as well-located investment properties are sought at almost any cost.

This accords with what has been seen in London where residential property yields are generally poor yet foreign investors continue to drive prices higher.

Reliable statistics on whether foreign (i.e. non-resident) buyers are actually purchasing existing dwellings in Australia are by definition not available, but if you keep your ear to the ground and ask estate agents and buyers’ advocates: “is it happening?”

I suspect that the nudge might well be “yes, to some extent”.

Just as foreign investors in Britain only appear interested in London, it’s likely that equivalent investment here will be focussed on the major capitals.

It’s one of the many reasons I’ve always argued that quality inner suburbs in those cities represent a far lower risk than regional or outer suburbs.

When the next downturn comes, a relaxation of foreign investment rules may support key city prices, but those in the regions, where few investors venture, may suffer.

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Pete Wargent

About

Pete Wargent is a Chartered Accountant, Chartered Secretary and has a Financial Planning Diploma. He’s achieved financial freedom at the age of 33 - as detailed in his book ‘Get a Financial Grip – A Simple Plan for Financial Freedom’. Pete now manages his investment portfolio, travels and works as a consultant in the finance industry from time to time. Visit his blog


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