Investing In Shares

Buy Property When Approvals Start Rising Again

In the past I’ve made it clear that I’m bearish on Australia’s property market and I’m bullish on Australian shares. However I was recently asked by a friend would I ever consider buying property? And if so when?

The short answer is yes. I would buy Australian property under the right circumstances.

As for “when”, that’s much harder to know, because when it comes to investing, I believe one must be patient and wait until the market provides “good value” before entering the market.

For me, “good value” means owning a property that is free cash flow positive (after all costs; interest, insurance, rates, depreciation, management, body corp, etc) to a point that the its return offers a reasonable compensation for the risk of owning property (ie liquidity risk, regulatory risk, risk of damage, interest rate risk, vacancy risk etc), which I think should be 3% to 6%.

I think at that point owning rather than renting would make more sense, but we are a long way away from those sorts of yields at the moment.

At present, I believe that most newly built Australian apartments have a negative carry (ie their operating expenses are higher than their revenues). So patience will be required before entering the Australian property market.

So how would one know when we are closer to the bottom?

For a better idea of when we are closer to the bottom, I’d be keeping an eye on building approvals. I’d want to see them start rising again after this next correction (they only just started falling again after surging over the last 5 years to to new record highs).

Why watch building approvals?

Well even though 90% of Australians fancy themselves as experts on property, I’m willing to bet that the average property developer and their activity better reflect the state of the market. If they can’t find buyers for their projects (or they can’t get funding from banks), they’ll stop building. If demand starts picking up, so will new builds and prices usually follow.

For example, here’s the US housing starts during their housing bubble and subsequent collapse along with US house price (adjusted for CPI):

 

us-housing-starts-vs-us-home-prices

Buying US property between 2010 and 2012 would have been a wonderful entry point into the US property market and by that time prices had fallen markedly and Nationally US rental properties had a gross rental yield of over 8% (many regions of the US were much higher)!

 

In comparison, gross rental yields in the largest Australian cities are closer to 3.5% with no shortage of rental properties hitting the market (ie Perth rental rates have already fallen by 30% from their highs) and here is Australia’s latest building approval numbers vs price growth rates:

 

australian-unit-and-house-approvals-vs-price-changes

As can be seen above, just like the US, prices correlated pretty well with total building approvals.

In recent months approvals have started to fall in all states of Australia and the rate of house price growth is slowing.

Some states, like WA, approvals have already fallen markedly:

wa-house-prices-vs-approvals

And as can be seen above WA’s house prices have been contracting since March 2015, with the latest figures from SQM Research suggesting that Perth property prices are already down by 10%!

So with an avalanche of housing supply set to hit the market in the next 18 months, I suspect it will be some time before the market clears and improves the attractiveness of property as an investment.

Until then, there are lots of bargains to be had in the share market.