Investing in property has become a dangerous game, with record low yields and other signs pointing to an overblown market. Peter Weekes reports.
A great love affair is about to sour. The security we feel when we invest in property may be white-anting our future.
A recent Westpac/Melbourne University consumer sentiment survey found that most Australians regard bricks and mortar as the best investment - a big switch from four years ago when stocks ruled.
But sentiment and reality are different beasts, with leading economists and analysts warning that the situation now confronting the property market is strikingly similar to the months just before the last stockmarket crash.
AMP Henderson's chief economist and head of investment strategies, Shane Oliver says: "The warning lights are starting to flash about the degree of unsustainability of property prices."
When the sharemarket was at its peak, stock yields fell to a low of about 1 per cent, indicating that companies were overvalued when compared with return on investment.
When the market slumped, investors swamped the property market, helped along by low interest rates and easy credit. Residential yields at that time were in double digits, but now property yields have hit record low levels, possibly signalling another crash.
ANZ Bank chief economist Saul Eslake says low yields, which show that prices are near their peak, the oversupply of stock, particularly in the inner-city apartment market and the high level of debt used to fund the investments, all indicate a big correction is on the way.
"The way to improve your financial situation is by buying things at low prices and selling them at high prices," he says. "Applying that logic now where property prices are high and share prices are low, the right thing to be doing is selling property and buying shares."
For people who have had an investment property for five years or so, it is a good time to crystallise any profit by getting out of the market, he says.
An AMP Henderson study, written by Oliver, has found that today an investment in a diversified portfolio of Australian shares will achieve a dividend cash flow of about 4 per cent of the underlying investment, or about 5 per cent once franking credits are added.
"By contrast, an investment in a three-bedroom Australian capital city house will now generate an average gross rental yield of 3.4 per cent."
Oliver says that when comparing property and shares, investors often fail to consider the cost of owning a property: estate agent selling fees, letting and management fees, rates, land tax, repairs and maintenance, insurance, and so on.
"These costs can easily add up to about 2.5 per cent or more of the value of the property each year," he says. These costs were included in calculating the yield.
Eslake says the fall in property yields reinforces his belief that property prices are at, or pretty close to, the peak of the cycle, whereas share prices are well past the peak of the cycle and may have even passed the trough and are on the way up again.
"This is a time in the investment cycle when people should be favouring shares over property."
Angie Zigomanis of the economic forecaster BIS Shrapnel says demand for housing has dried up and the market faces an oversupply, particularly in the inner-city market. Some forecasters are even predicting property prices will fall as much as 20 per cent.
Stark figures from UBS Warburg show why: approvals for new dwellings are running at a pace consistent with 200,000 new units of housing stock a year, compared with underlying demand of 150,000 to 160,000.
International ratings agency Fitch Ratings weighed into the debate last month, saying the availability of credit had fuelled property prices. It found that average home prices had risen to seven times average earnings this year, up from 4.5 times in 1993. And it warned that the consequent debt-servicing strain on households left the property market highly exposed in the event of rising unemployment or interest rates.
Bob Kelly, the head of funds management for Colonial First State Property, agrees. He says property is well overpriced for low yields, and is becoming a riskier investment. "There is a lot of capital there at the moment and if it is taken away because the market cools down, prices will drop."
It is a problem that the Reserve Bank has been aware of for more than a year.
Only last month, RBA governor Ian Macfarlane once again warned of the growing risk in the exceptionally rapid increase in borrowing to buy residential property for investment purposes. He was also concerned about the accompanying rapid expansion in apartment building, which showed all the signs of a seriously overextended market.
Loans for investment properties last year accounted for 40 per cent of the residential mortgage market, almost double the usual level of 25 per cent.
Oliver says the great influence of investors in the market may lead to instability as yields fall when supply outstrips demand for rental accommodation - particularly in the inner city, where Zigomanis estimates that investors make up 80 per cent of the market.
CBA Price at posting:
0.0¢ Sentiment: None Disclosure: Not Held
(20min delay)