Why units are smart buys in a weakening property market

Despite the worsening conditions for the residential property market, MICHAEL LAURENCE identifies an opportunity for smart, and patient, investors

By Michael Laurence

Despite the worsening conditions for the residential property market, there are still opportunities for smart, and patient, investors

Inner-city and near-city apartments in Sydney, Melbourne and Brisbane are presenting some of the best opportunities for property investors as residential property reels from the impact of high interest rates, low affordability, soaring petrol prices and a slowing economy.

There are widespread expectations among real estate specialists that housing prices will stagnate or fall over at least the next 12 months until the Reserve Bank thinks about making some solid cuts to interest rates. And when rates are wound back enough, the market is likely to begin at least a modest recovery.

But until then, buyers are likely to have their pick of the market as many vendors are certain to lower their asking prices to get a sale. This is, unquestionably, a buyers’ market.

And, according to some market analysts, highly selective, hard-negotiating investors are likely to be particularly drawn to the inner-city and near-city unit market because of its impressive growth in rental yields and its fast-rising rents, given that Australia’s grave shortage of rental property is most marked in these locations.

Adding to the demand among tenants for well-located units near city centres is record-high overseas migration. In the past 12 months alone, almost 185,000 migrants arrived in Australia.

Yet despite the burgeoning demand for accommodation, difficulties with obtaining finance and high interest rates have pegged back the growth in housing lending to a 16-year low for the 12 months to June, and approvals for new housing fell to a 28-month low in May.

Australia’s supply of vacancy rental accommodation is next to non-existent. A vacancy rate of 3% is generally considered satisfactory for a smooth transition between tenants, yet figures from the Real Estate Institute of Australia show that the vacancy rates in every Australian capital are way below this level.

Darwin has the lowest vacancy rate of just 0.5%, followed by Sydney (1%), Perth (1.4%), Melbourne (1.6%), Adelaide (1.7%), Canberra (2%), Brisbane (2.2%) and Hobart (2.3%). And these vacancy levels are likely sink much lower.

Tim Lawless, research director of property researcher RP Data, says that with some city and near-city units producing gross rental yields of 7%, selective investors with enough cashflow could be well positioned to ride out the uncertainty in the market until interest rates ease.

RP Data research shows that units in Sydney’s Darlington and The Rocks – both very small inner suburbs – are producing Australia’s highest rental yields among areas surveyed of 8.6% and 8.5%, respectively.

“A lot of investors are sitting on their hands and don’t know what to do,” Lawless says. “(But) there is an absolute opportunity for investors who are brave enough to go against the mainstream. It is always best to buy against the flow.

“If you are brave enough, there are many opportunities,” he says. “And inner-city units are among them.”

But Lawless is realistic. “Investors (willing to enter this market) would most likely have the ability to cope with a couple more interest-rate rises if these were to come through.” And they would have to have sufficient tolerance to risk.

Lawless points out that some city and near-city units are producing sufficient rental yields to be cashflow-neutral for some investors – depending upon their loan-to-valuation ratios.

Michael McNamara, general manager of Australian Property Monitors, is candid about the weakness in the overall residential market but he too sees opportunities for smart apartment buyers.

“It is unlikely that we are going to see anything remarkable in the property market (in terms of capital growth) over the next 12 months,” McNamara says. “The Australian market is experiencing a downturn.

“But there is an opportunity for buyers when the market is fairly flat. Take your time and carefully consider your investment. And get the best bang for your buck.”

Based on his group’s research, McNamara places inner-city apartments at the top of his most-favoured buys for investors.

And McNamara agrees with Lawless that the strong yields from such apartments will help carry investors through a weak period for capital gains. “A property is not going to add much to your wealth over the next few years,” he says. “But you are taking a position in the market so that when it moves next, you have a ticket on the ship.”

Here are five strategies for astute investors who are considering inner-city units:

ONE.
Seek the best combination for investors

This is likely to mean above-average rental yields, sharply rising rents, low vacancy levels and high desirability by tenants and future owners that should lead to above-average capital gains over the long term. And units combining these features are most likely found in the inner-city and near-city areas.

McNamara names Pyrmont in Sydney as one of his favoured inner suburbs for apartment investors. He says prices had been “fairly soft” in Pyrmont for some time because the suburb had largely been rebuilt a few years ago with most of the new stock coming on to the market at the same time. And Pyrmont had been considered somewhat characterless for a time because of all the new developments.

“Pyrmont is now developing a soul,” he says. “And it is becoming something of media hub with channels Seven and Ten, Fairfax and Google opening their offices there.”

(RP Data reports that Pyrmont apartments have a median price of $522,500, median rent of $540 a week and a gross rental yield of 5.4%.)

Tim Lawless of RP Data names The Haymarket and Pyrmont among his most favoured Sydney apartment markets for investors. (The Haymarket has a median price $498,000, median rent $650 and median yield of 6.8%.)

In Melbourne, his favoured unit markets for investors include Carlton (median price $321,000, median rent $365 and median yield 5.9%), and Southbank (median price $456,000, median rent $510 and median yield 5.8%).

And his picks in the Brisbane market for investors include South Brisbane (median price $420,000, median rent $470 and median yield 5.8%) and Fortitude Valley (median price $350,000, median rent $390 and median yield 5.8%).

Lawless says he likes these areas for unit investors for such reasons as their high yields, high rents and popularity.

TWO.
Take your time to buy

There is no rush into this market for fear of missing out. Cameron Kusher, a research analyst with RP Data, says investors can really take their time to know a property before they put in an offer.

THREE.
Negotiate hard

“Some owners are getting tense and need to sell,” says Kusher. “It is definitely a buyers’ market. Perhaps throw in a cheeky bid,” he suggests. It might just be accepted.

FOUR:
Be realistic about the market

This means recognising that residential property prices are likely to fall – or languish at the very best – until interest rates begin to markedly fall.

Rod Cornish, head of research for Macquarie Real Estate, does not expect investors to begin returning to the market in any significant number until interest rates begin to sufficiently fall to improve affordability. And Cornish emphasises that yields are still significantly lower due to interest rates.

“Right now, the over-riding factors are interest rates and affordability,” says Cornish. “And these are over-riding underlying demand.”

But when the residential market does begin to improve, Cornish expects that units in the inner suburbs will be among the first beneficiaries.

McNamara stresses that the transaction costs for buying a property are “hideous”. And investors should be entering the market with the intention of holding their properties for the long term. This intention to remain in the market for the long term would be a particular consideration given the state of this market.

FIVE.
Don’t leaving buying until too late

Trying to predict when the market is most likely to begin its recovery could be a costly mistake, warns McNamara of Australian Property Monitors. He says that investors who hold back because of the prevailing lag in capital growth may not pick the recovery “until it’s too late”.

Unit prices: Sydney, Melbourne and Brisbane

Read more on housing affordability, property prices, interest rates and property yields