The best investment suburbs in a changing market

Founder and Publisher of the Switzer Report
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The long predicted recovery in house prices is yet to emerge despite years of relatively low interest rates, a mining boom and a supposed undersupply. While many hold onto hopes of another bull run, some analysts say the market is oversupplied and will not only remain patchy this year, but possibly for the next decade, causing rental income and not capital growth to become the main source of return.

They could be onto something. Morgan Stanley’s economists, who have been bearish on housing for some time, have attracted attention in recent weeks for arguing that the widely trumpeted national housing shortage is in fact an oversupply. In June, the National Housing Supply Council (NHSC) reported an undersupply of 228,000. However, Morgan Stanley points out a massive disconnect with the recent 2011 Census figures, which suggest an oversupply of 341,000.

Oversupplied

John Edwards, CEO of property information provider Residex, agrees. His figures suggest Victoria, South Australia, the ACT and Tasmania are oversupplied, while NSW and the Northern Territory are relatively balanced, and Western Australia and Queensland show signs of undersupply.

Mr Edwards says it will be two years before the decline in building activity and growth from the mining industry pull the country as a whole back into undersupply. However, he says poor housing affordability will continue to limit capital growth in many areas.

“Housing values throughout Australia are in a changing position where they’re not going to grow; rent is going to become more important over the next 10 to 20 years,” he said.

While oversupply and affordability may be dampening the housing market on a national level, the latest Residex figures (see links to tables below) show there are many pockets experiencing growth in rental returns, capital growth, or both. Rents in Clayfield, Brisbane have surged 51% in the 12 months to June, and are up 48% in The Ponds, Sydney, and a whopping 106% in Flinders, Victoria.

Meanwhile, house prices in Teneriffe, Brisbane, are up 18% in the past year, and up 29% in Tom Price, WA, and 14% in Roxby Downs, SA.

Even so, house prices in capital cities across the country were down 4.1% year-on-year in the March quarter, according to the Australian Bureau of Statistics.

Housing market supporters can be forgiven for being bullish; after all, an economic growth rate of 4.3% is nothing to scoff at, and while the jobs market may be softening, an unemployment rate of 5.2% remains historically low. Meanwhile, wages are rising and consumers are spending – just not at overpriced stores.

The benchmark interest rate, currently at 3.5%, has also been sitting below its historical norm since the Global Financial Crisis, and this combined with the pullback in house prices has improved housing affordability to some extent.

So why has the housing recovery failed to materialise?

Dented affordability

The role of the stock market can’t be underestimated, particularly where it concerns high net worth individuals or those whose super nest eggs continue to suffer in the wake of the GFC. Many of these investors took a big hit, with the S&P/ASX200 still down 38% from the peak in October 2007. However, this doesn’t explain why prices in suburbs comprised predominantly of young families with little stock market exposure have also declined.

The oversupply theory, which is in a large part also due to affordability, fits this bill.

“Capacity to afford housing is more important than the supply metrics in general – meaning an environment of gradual housing deleverage, housing volumes and price growth are likely to remain constrained, despite low supply volumes and falling interest rates,” Morgan Stanley economists Lou Pirenc, Todd McFarlane and John Meredith argue.

The economists say more Australians are willing to bunk up together in order to keep living expenses affordable. The average number of people per dwelling rose to 2.9 in 2011, up from a bottom of 2.7 in 2006. Until recently, those figures had been trending down with conviction, registering 4.1 in 1946 and at 3.4 in 1976. Add to this an increasing demand for rental property, and you can go a long way to explaining the lull in purchase demand.

Secret listings

But the evidence of general oversupply doesn’t stop there. Deirdre Macken from the Australian Financial Review points out that “never have there been so many properties for sale and so few sales.” And that’s based on ‘official’ figures. On top of that, she says agents have lists of “secret” properties up their sleeve and these are growing by the day. By secret, she means sellers who are on the books, but not listed for public view unless a buyer willing to pay above market rates comes along. This means supply in the resale market is much greater than commonly thought.

Given these conditions, Morgan Stanley is quite comfortable to retain its bearish stance on housing, although they firmly state they do not expect a crash.

“We continue to expect house price growth in real terms over the next decade to be meaningfully lower than in the past decade,” they said, adding they “assume flat to negative growth in real terms in the medium term as wage growth outpaces price growth.”

Stocks

For stock market investors, they remain cautious on companies with “meaningful” residential exposure, including Stockland (SGP), Mirvac (MGR) and Australand Property (ALZ), taking an “underweight” position in a stock portfolio.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should consider the appropriateness of the information in regards to their circumstances.

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