Safe as houses

The Australian property market should continue to see growth across all sectors in 2015, but potential headwinds lie ahead, writes Matthew Sainsbury. 

This year should prove to be a strong year for investment opportunities across a wide range of different property sectors, with already low interest rates potentially being cut further by the Reserve Bank of Australia (RBA) as it looks to keep activity strong in a soft market. Across all markets — commercial, retail, industrial and residential — the difference between yields and the relatively low interest rates will remain a key influence on more capital coming into markets across Australia.

At the same time, there are areas of concern. A recent proposal to the Australian Government by the Financial System Inquiry (FSI) has recommended that self managed super funds (SMSFs) be disqualified from being able to leverage debt within funds — a recommendation that, if adopted, will have a sharp impact on the ability for SMSFs to purchase property (see page 48). Furthermore, drops in consumer spending and a decline in some areas of manufacturing and recruitment will create challenges in terms of demand for retail property, industrial, and office space, respectively.

Interest Rates

With any property market within Australia, interest rates will, of course be a key determining factor on the health of the market. And it seems likely that the RBA will lower the interest rate even further from the record low 2.5 per cent at some stage this year.

The RBA’s decision will be made based on the continued high unemployment levels in Australia, which is dampening consumer confidence, as well as property markets in Sydney and Melbourne which are showing signs of slowing.

Additionally, weak commodity prices are taking their toll on the national economy. Declining terms of trade are affecting company profits and tax revenues, which in turn is reducing household income. The government budget, which it argues is necessary to combat a growing deficit, is also hitting the pockets of consumers with additional fees and fewer benefits.

This all impacts on consumer spending, which discourages investment into Australia by businesses (or expansion within the country for businesses that are already operating in the market), which in turn further impacts on employment rates.

All together, Australia is in an income recession, where gross domestic income has been shrinking, wages have been flat, and company profits have been under increased pressure, which has led to some companies rationalising their workforce in order to see greater profits through cost reduction. This is why some economists are predicting a further rate cut of up to 50 basis points, or half a percentage point — to 2 per cent — at some stage in 2015.

Residential property

Such a cut would have a significant benefit to the Australia property market which, despite the signs of cooling, is still offering plenty of opportunities for investment. The strongest growth in residential property will be seen along the east coast of Australia, but pockets of opportunity lie in each capital city market.

“I believe some markets are oversupplied, and some are coming through a position where they are tracking very well at the moment,” says Col Robertshaw, national head of property finance at Commonwealth Bank of Australia (CBA).

“Melbourne has had significant supply delivered over the last couple of years and has significant additions to come for the next two or three years. There is the potential for oversupply in pockets of Melbourne which could have an effect on value and the ability to rent apartments. Meanwhile, Sydney is tracking very well although there is significant supply to come in the next two to three years. I think Sydney will track well for the medium term before supply catches up with demand, but I don’t see it catching up for the next two years or so.”

Likewise, there are some concerns regarding supply in Canberra, according to Defence Housing Australia chief operating officer, Madeline Dermatossian MAICD. “It will be steady as she goes for now,” she says. “We see established suburbs remaining firm, but there are some concerns regarding the supply that is coming in the next 12 months.

“However, in Brisbane we are seeing signs of renewed confidence.” Further west, Dermatossian says Adelaide, Perth and Darwin all pose interesting opportunities as well.

“In Adelaide, the inner suburbs are performing well and product is churning over at a consistent rate,” Dermatossian says. “Prices there are growing at a slow but steady rate.

“With Perth, we understand consumer enquiries are steady, but we are waiting to see if that translates to sales,” she adds.

From an investment point of view, Dermatossian believes that residential property will remain popular in 2015, however the challenge will be in finding locations with good rental revenue growth. “Yields of four to five per cent continues to be popular,” she says. “Areas that still have growth coupled with a steady rental yield should prove to be a sound investment. However, there was less than a one per cent rental increase across the board in 2014 so there has not been a huge amount of rental increase across Australia. It is about picking the areas where rent has increased.”

The other area where there will be some concern for residential markets will be in regional development. Traditionally, it is mining-boom towns that have seen the greatest demand for residential properties, however with the resources sector easing, some of the regional property opportunities that had previously been lucrative are slowing down.

Industrial property

A sign that industrial property markets remain steady is the lack of incentives being used to generate sales, according to Places Victoria chief executive officer Gregory Anderson. However, in Melbourne, where Places Victoria operates, there are some specific trends that, through 2015, will have an impact on the market, he adds.

“Organisations that are consolidating are choosing to do so into better places, and are prepared to pay higher rents for better locations,” Anderson says. “Additionally, we’re seeing strong demand for organisations that want to own their own land and are willing to pay a premium to buy in areas that are close to key transport links and other services.”

“Places Victoria’s eco-industrial park LOGIS is a good example. It’s located at Dandenong in Melbourne’s south-east, with non-stop linkages to all the major freeways in Melbourne, and we’ve had strong demand from companies like Systema, Paperlinx, Hobsons Engineering and Ego Pharmaceuticals.”

Across the rest of Australia, industrial yields have held up well, with some sectors enjoying an increase in demand. CBA’s Robertshaw says industrial property yields have firmed overall, with the best performer being the transport and logistics sector.

However, other types of commercial properties will be challenging in 2015. Lower employment demand and soft recruiting conditions across many different sectors have meant that demand for office space is easing when compared to the supply coming through, and many landlords are finding customer acquisition a challenge.

Vacancies rates are high in markets such as Perth and Brisbane (as high as 17 per cent) and Sydney and Melbourne are also experiencing higher vacancy levels (around 10-11 per cent). With businesses not growing from an employment perspective, the reduced need for space in buildings coupled with the new supply coming into these markets is making it difficult for landlords.

“As a result you are paying incentives in most Australian capital city markets of around 30 per cent to actually gain a tenant,” Robertshaw says. “Businesses have the opportunity to be choosy, and that is making it quite challenging for the landlord.”

Finally, the retail property market will continue to be challenged in 2015, in line with the challenges that the retail market itself faces with soft consumer confidence. “Discretionary spend market in retail has been tough,” Robertshaw says. “But in some areas of retail, such as food-based retail and the service-based retail there has been a lot more success over the last couple of years.

“What we are seeing is that consumer confidence in general is improving slightly, but retail is still a tough market to be in. If you look at the regional shopping centres they are still tracking along quite well, and equally the neighbourhood shopping centres that are anchored by major food and service retailers such as Woolworths and Coles are seeing good demand.

“The most challenging conditions have been in shopping strips and sub-regional shopping centres where there are a significant number of specialty shops. It is where the shopping relies on discretionary spend where the biggest challenges are,” he says.

Asia’s Importance

According to Commonwealth Bank of Australia national head of property finance, Col Robertshaw, another key factor in determining the health of the property market across all sectors and geographies in 2015 will be the appetite for property by Asian investors.

“The effect that Asia is having on the local market is significant,” Robertshaw says. “There are a significant number of site developments being purchased by offshore groups, as well as a number of end units to the retail markets, and that is taking up a reasonable amount of supply. Key to the market will be the ongoing confidence and capital investment from Asia into the residential market in Australia.”

SMSFs and the FSI Recommendations

One of the biggest potential disruptive factors in the property market in 2015 will be the Financial System Inquiry (FSI) recommendations that self managed super funds (SMSFs) be disqualified from being able to leverage debt within funds.

It is a recommendation that Defence Housing Australia chief operating officer, Madeline Dermatossian MAICD says would be detrimental to both the SMSF and property industries. “Investment through an SMSF trust is a great way to invest, because it provides tax advantages, growth, and a steady income stream, all of which are quite relevant to SMSFs,” Dermatossian says.

“If the recommendation is implemented by the government, then SMSFs will effectively be prevented from buying into property, and this is unfortunate because we’re currently seeing an increase in interest in SMSFs to acquire investment properties, due to the security of the yield. If that all changes, it would be a disadvantage to SMSFs.

“One of the purposes of superannuation is to generate a pool of money for people when they retire to take the pressure off public funding down the track. In my opinion, you’d want to encourage investment through SMSFs in order to achieve that goal that superannuation was initially established for.”

Another FSI recommendation – that banks be mandated to carry more cash – could further dampen the property market in leading to more risk-adverse lending behaviours by the banks. Should this be the case, some of the more speculative property markets across the country will see a softening in demand through 2015.