Sydney Apartment

Beware over paying for assets

Sydney_Apartment1The Australian economy is facing a number of head wins as we enter 2015 and therefore is expected to grow below long term averages.  Whilst consumer spending is improving and residential construction and prices are rising, consumer confidence remains weak. Business confidence and investment is also weak.

Australian bond yields have fallen to historical lows. The RBA cut the cash rate by 25 basis points to 2.25% in February concluding that growth is continuing at a below trend pace, with domestic demand growth overall point weak.  The financial markets are expecting the RBA to make further cuts to interest rates in the coming months.

As a result, investors seeking yield will continue to reallocate from cash and term deposits into higher yielding assets, including real estate.  Demand for both residential and non-residential assets should continue and competition for both income generating and development assets will remain high.

According to the PCA/IPD Property Index, non-residential property has generated a total annual return of 10.6% in 2014, and Folkestone expects a similar return in 2015 as investor demand continues to underpin capital values.

Investors need to be cognisant that they do not overpay for assets in a market being driven by capital hunting for yield.  The market runs the risk that if the disconnect between capital market and real estate market fundamentals widens, the price some investors pay for assets may overshoot the underlying fundamentals.

In the residential sector, the housing boom has not been uniform across Australia.  Whilst Sydney has been the stand out performer with prices up 13% in the year to January 2015, price growth across the rest of Australia’s major cities was between -0.3% in Canberra and 7.0% in Melbourne.

There is no doubt the Sydney median house price has risen to levels that make it difficult for first home buyers to enter the market, but we should remember that the average annual growth in Sydney house prices has only risen by an average of 4.5% per annum over the past 10 years.  Sydney is now paying for a gross undersupply of accommodation as a result of poor government planning and high government levies which have restricted the release of land and pushed up land prices.

Low interest rates are certainly driving the investor market, with investors taking over owner occupiers as the largest borrowers of finance in the December quarter.  We expect investors will continue to invest in the residential sector in 2015 but in doing so, they need to ensure that they do their homework.  There are certain markets such as inner Melbourne and inner Brisbane where an oversupply is looming.

The recent APRA announcement around investment lending may go some way to restricting the availability of finance to investors.  Overall we are expecting another solid year of housing market conditions and further capital gains, albeit at a more sustainable rate than we have seen over 2014.

 — via the FINANCIAL STANDARD, Mar 30