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July/August Newsletter 2008

Welcome to the McCarthy Group eNewsletter

Welcome to the 2009 Financial Year

Welcome to our July / August 2008 investor newsletter. With the new financial year continuing from where the last one left off, I am reminded of the old Chinese curse, “May you live in interesting times”.

Interest rates bite

These are certainly interesting times, and the effects of the pressure and uncertainty within global financial markets as a consequence of the US sub-prime housing crisis have served to make them very interesting times indeed.

In times of risk and uncertainty, looking backwards is often a good place to start before planning the next moves forward. On reflection, it appears that the last two interest rate increases by the Reserve Bank of Australia (RBA) in conjunction with the unofficial rate increases by the banks have proved to be decisive in achieving a turn in our economic growth rate. When combined with rising prices in home rentals, fuel and food prices (all factored in as local inflation drivers that are hard for households to influence), the resulting pressure on business and individual budgets has forced adjustments in spending virtually across the board.

Interest rates seem certain to fall

After twelve interest rate increases in succession, recent comments by the RBA Governor, Glenn Stephens, have left the markets in no doubt that the upper turning point has been reached in the interest rate cycle and that the next move – in two weeks’ time – will be downwards. This move is already fully priced into the markets, and the sharp decline in the value of the Australian Dollar is a further signal that international markets have a similar view.

There is also broad acceptance that the downwards move will be the first of several before year-end. Pressure from the Reserve Bank and the Labor government is building on banks to firstly pass on the full value of any rate cuts, and secondly, to begin winding back the ‘unofficial’ increases (that total about 0,5%) that were applied to restore bank lending margins during the first year of the credit squeeze. Competitive forces should ensure that this happens. The non-banking lending sector will also be dusting itself off and getting ready to re-enter the fray now that the tide appears ready to turn.

All of this is good news for investors, and with the imminent falls in interest rates heralding the arrival of a decrease in holding costs, the strong demand for housing and rental accommodation should ensure that rental yields track upwards.

There are reports that rents have jumped by up to 25%* over the past 12 months** as landlords responded to higher mortgage rates and a weak building sector.  Most of the capital cities recorded double-digit rental growth in the same period.
*(25% is cited as the growth in Perth).
** Source; www.brisbanetimes.com.au 24 July 2008

Property prices forecast to increase

As a result of the tightening economic conditions and the cost of debt, and despite the considerable backlog in housing in Australia, investment in property as measured by new housing starts and loans to the sector has been falling.

This is an understandable reaction, as many people who would otherwise be investing choose to wait for the interest cycle to turn before doing so. This has led to a steadily increasing shortage in rental property, with vacancy rates being at 1% to 2% in many towns and cities. In all likelihood this is as low as vacancy rates can go, given that at any one time there are vacant homes awaiting renovation, demolition or simply being vacant between tenants, where there is usually some transaction time between one tenant and the next.

Respected economic forecasters like BIS Shrapnel are predicting that property prices are set to increase strongly over the next 3 years, particularly in areas where demand far exceeds supply. This includes many areas in Queensland, with Sydney also coming into the picture as a market that is primed for strong growth.

Despite the logic of the supply and demand forces driving the residential property market, there are clear (and contradictory) signs that prices have been falling in some areas. This is to be expected given the battering that families have taken at the hands of rising costs in property coupled with high interest rates, high fuel costs and inflation of the order of 4%.

Housing affordability remains a major issue, and any apparent fall in property prices will have certainly been one of the triggers behind the changed stance of the RBA on interest rates given the significant (and growing) backlog in available housing. Whatever the short-term movements, the key to success in property remains the fact that over the long term, prices steadily increase. It is this view that investors need to keep paramount, and ensure that their strategies are tailored to retaining their existing portfolio and acquiring more investment properties in the future.

1 million homes needed in next 5 years

New research from the Housing Association of Australia (June 30 2008) confirms a requirement for almost one million new homes over the next 5 years to meet Australia’s growing population.

To quote CEO Chris Lamont,  “Demand for housing is really biting as evidenced by record low vacancy rates in the private rental market. HIA research confirms that in 2008/9 190,000 new dwellings are required, this is 40,000 more dwellings than expected production.”

Looking at what’s behind the numbers, the Australian population grew by 332,000 or 1.6 per cent in 2007. Much of this increase (184,000) was due to growth in net overseas migration. This rate of increase would lead to a population growth of more than 1.5 million in 5 years. This implies demand for new housing units of 190 000 to 200 000 per annum, which is over 16 000 per month, every month, for the next 5 years.

Historically speaking, the only time that the housing market has seen new starts at over 16 000 per month has been in times of absolute boom conditions in the housing market, and then only briefly. For the past few years new homes have been built at the rate of on average 13 000 pa. This inadequate level is what has driven the annual shortfall of between 30 000 and 40 000 units.

With current short term trends turning downwards, pressure on housing can only increase, leading in the medium term to the prospect of strong capital growth and high rental returns for owners and investors.

In summary, the current economic conditions are retarding investment in housing, and serving to add to the backlog and increase the imbalance between the supply of and demand for housing. This must lead to higher returns for the sector in the future given that population growth is unlikely to slow.

Global demand for resources supports Australian economy

Often described as ”The Lucky Country”, Australia has managed to avoid the downturns since the mid-nineties that affected emerging markets, Asian markets and even major economies like the US, the Euro zone and Japan. As we move through the current global slowdown, Australia once again finds itself in a position where the demand for resources fuelled by the economic growth in China and India has supported the local economy.

The resource-rich states of Western Australia and Queensland have experienced exceptional growth, and the resources sector has ensured that the country as a whole has experienced a far softer slowdown than would otherwise have been the case. Most analysts forecast that the strong demand for resources will continue for many years to come, which will serve to underpin and support the economy as it weathers the current economic conditions.

In recent weeks we have seen a reversal in the fortunes for resources stocks as predictions of a more global slowdown are factored into the equation. Even the runaway growth of China has slowed somewhat, and analysts are raising questions about that country’s ability to maintain growth in the post-Olympic period.

Whatever the level that the growth rate settles at in the developing markets in particular, it is certain that Australia will remain a key and strategic supplier of raw materials, and that this valuable hedge against a broader slowdown in this country will be there to continue the ‘lucky’ economic pattern of the past two decades that we are so ‘lucky’ to have had.

The key to the long-term value of the resources opportunity will be the wise management of these windfall riches by the state and federal governments. Squandering these potential riches would be a real missed opportunity from the perspective of future generations looking back.

More news on McCarthy Group website

We have received positive feedback from our clients and the potential investment property community-at-large to the simple and clear communication style that has been a feature of our newsletters and booklets.

In responding to the need for more material that is aimed at the first-time investor, but which nonetheless remains relevant and interesting to our existing clients, we have re-formatted our website at www.mccarthygroup.com.au to feature news and views more prominently, and we have re-structured our Home Page for this purpose.

If you like what we are doing in contributing information and communications on the investment property and related lifestyle planning topics, drop us a line at info@mccarthygroup.com.au. We would love to hear from you as well as hearing more about topics that you would like to read about.

Happy investing,

Stephen McCarthy
CEO