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May 2008 Newsletter

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The clear sense is that we are travelling through much more settled economic waters compared to the extremes of the first quarter 2008. While there are signs that the economy is slowing in some sectors, as per the goal of the RBA measures, there is a perception that the deep shocks of the immediate past have settled somewhat, and that we have seen a return to a more orderly environment. This is partially due to the continued underlying strength of the resources sector.

Australian banking sector sound

In contrast to some global banking firms, the Australian banking sector appears to have come through the recent turbulence in financial markets in relatively good shape. In recent weeks the banks have announced strong results across the board. The local banks’ lending policies have been more prudent than was the case in the USA, and local banks took additional measures to increase interest rates beyond the official rate rises to preserve their lending margins in the face of higher borrowing costs. ANZ has a provision for bad debts of close to $1bn, however, and it is probably too early to say that the local banks are all out of the woods.

While not everyone will be pleased by the actions taken by the banks to shore up their positions, their relative strength should be a source of encouragement to property investors.

Westpac/St George merger signals shake-up

The $19bn merger of the number 3 and 5 banks in Australia will signal the start of further consolidation in the banking sector. With Gail Kelly and Peter Clare both fresh from St George Bank, their knowledge of that bank’s defence strategy would be a major asset given that they were its architects. Added to that is the timing of the offer where the St George share price had suffered due to the biggest shock to financial markets in decades. This served to ensure that the 24% premium offered was certain to elicit a positive response.

If approved the post-merger entity will become the biggest bank in Australia, with nearly $550 billion in assets and over 1,200 branches. The improvement in share prices in the sector after the announcement clearly indicates that the market expects that further consolidation activity will come to the fore with moves that are certain to change the industry status quo.

Interest rates remain on hold

With a neutral first budget announcement behind us, and with the interest rate brake clearly having an impact, and with no visible evidence of a wage breakout, it is likely that the Reserve Bank will leave interest rates where they are in the immediate future. The next likely review point will be whether the tax cuts announced in the budget post-July lead to an increase in consumer spending. Petrol price increases are also having an impact on slowing discretionary consumer spending.

Housing backlogs increase

It is well known that the current backlog of homes in Australia is about 150,000, and increasing at the rate of 30,000 per annum. The demand is driven by record high numbers of international migrants (over 180 000 people arrived in Australia in the 12 months to September 2007) as well as social factors, with the high costs of housing keeping ownership out of reach of aspiring first-time buyers.

The logical short-term consequence has to be continuing rental increases, with subsequent upward pressure on house prices once the interest rate cycle turns down and yields improve off the back of lower mortgage costs and high rentals. At that point the backlog in available housing relative to demand could well be chronic, which is why in our view the fundamentals of supply and demand must continue to move in favour of landlords and why investment property remains a real opportunity.

Time for tax returns

As the financial year-end closes in on us, this is a last-call reminder to ensure that you have got all your documentation lined up to facilitate the smooth and effective completion of your tax returns.

Should you need any assistance or guidance in this regard, please call our Client Services team on (02) 9687 3601 or email info@mccarthygroup.com.au and we will refer you to the appropriate person.

It goes without saying that you have to ensure that every single expense that is tax deductible is claimed. For this reason we supply all our clients with our McCarthy Group investor file, which greatly simplifies the task of keeping all the paperwork in check. Be especially vigilant, and don’t let legitimate tax claims slip from your grasp.

Is this a good time to buy your next investment property?

We have already referred to the supply/demand imbalance in terms of available housing stock and the strong rental rise trends. With sound economic and housing fundamentals in place, the answer to the question clearly lies in cash flow and your ability to service your portion of the debt at higher levels of interest.

To assist in this regard, McCarthy Group has moved into commercial property projects south of Brisbane and in Townsville that are more affordable and carry a number of advantages. We are also pursuing options in quality residential estates in Melbourne and Townsville that similarly offer a lower entry price and hence increased holding cost affordability as well as demand from renters due to the competitive price points.

According to Craig James, Chief Equities Economist with CommSec, residential property prices will grow by 10-15% in most capital cities this year, compared to an expected share market return of just 3%.
Source: Your Investment Property Magazine, June 2008.

Melbourne an investment destination of strong interest

We mentioned in the story above that we are looking at investment opportunities in Melbourne for our clients. Melbourne recorded excellent capital growth in 2007 (some 20%). Part of the reason is that the Melbourne population has grown by 50,555 people per year since 2003, which is more than any other Australian city. Victoria’s poulation grew by 77,000 in the year to June 2007, which equates to about 1,200 people per week.

Aside from strong population growth, tourism is a major industry, employing some 9% of Victoria’s workforce. This is to cater to the 11 million domestic and 600,000 international tourists visiting Melbourne each year.

Labor’s first budget

With this being the Labor Party’s first budget in 13 years, it was certain to draw plenty of scrutiny. While opinion is divided, overall it appears to have been well received in terms of its positioning as a budget that is geared to nation-building, that honours election promises, and that caters to the needs of working families.

The opposition have called it a typical “high-spending, high inflation Old Labor” budget, yet with former Treasurer Peter Costello claiming that it has his stamp all over it.

Who to believe? The equity markets have been largely unmoved, which is a good sign, with one big question surrounding the Medicare subsidy and the impact it will have on already-crowded state hospitals, and the impact of the withdrawal of up to a million members from private health companies.

In closing, thanks for your continued support of McCarthy Group, and we wish you many happy returns in the period ahead.

Happy investing,

Stephen McCarthy
CEO