Property recovery will start with the blue chip assets

It’s been hard yakka in the residential property industry these last 18 months. Few sellers. Even fewer buyers. Understandably, there have been outpourings of relief – and even signs of giddiness – from real estate commentators about the prospects of better days now that interest rates are falling, and the spigots of credit are opening.

Buyers will need to brace themselves. Every property firm will be redoubling their marketing and sales efforts to entice buyers their way.

But while lower interest rates and easier finance may be necessary conditions for capital growth, they aren’t, on their own, sufficient.

One needs to drill down to demand and supply fundamentals to see which assets will continue to struggle and therefore should be avoided, regardless of the purveyor’s sales pitch.

The high-rise apartment sector remains dangerously oversupplied.  As of December 2018, the ABS reported that there was a near-record $38 billion pipeline of attached residential work. Now, there has been an admirable rearguard effort by developers to shelve, downscale or delay plans, as illustrated by a 27% shrinkage of attached commencements in the three months until December 2018. But given a Reserve Bank estimate that apartments take about 18 months on average to build, there will be major overhang of supply expected in next 12 months.

It is also a sector that can’t get a break. Federal Labor’s plan to exclude new property from its negative gearing changes looked like a marketing opportunity for developers to differentiate themselves from established property, but that’s now a non-starter. Meanwhile state governments are comfortable squeezing demand from overseas buyers, most recently illustrated by the just-delivered Victorian state government budget matching settings in New South Wales by raising overseas buyers’ stamp duty rate to 8%.

On the flip side – looking at demand – we’re now seeing a cyclical cooling in interest for regional properties in most parts of Australia. Having outperformed capital cities over the last two years off the back of comparative affordability, it is likely that these areas will have to work through their own correction over the next year or so, notwithstanding the fillip of interest rate cuts.

Indeed, a cyclical weakness in regional markets may be exacerbated by the property equivalent of a share market ‘sector rotation’. Experience shows that property market recoveries tend to start in traditional blue-chip areas – often in Sydney and then Melbourne – and then ripple out through the middle and outer suburbs. So don’t be surprised if erstwhile regional investors abandon original plans and head to the cities, especially if they see some price growth green shoots appear there in late winter or early spring.

With a little more confidence in the capital city suburban market, watch for the change in conversation. The focus will turn to the positive fundamentals of this sector – superior long-term economic outlook, strong population growth and restricted supply – casting aside the dominant theme of further price falls and unaffordability.

Saying that, I believe this will be a measured recovery. Talk of fear of missing out (FOMO) in some quarters is giddily misplaced. Buyers remain in the ascendency for a little while yet, and well-prepared investors have every chance of buying quality assets at good values over spring – as long as they apply a skeptical and critical eye to the marketing claims they hear in coming weeks. R Wakelin