Opportunity knocks in Sydney

In 2003, the boom in the Sydney residential investment property market ended.

Now, four years on, there has been little but negative reporting on the Sydney residential property investment market. Indeed, until recently, investors had deserted this area.

However, all indicators are now pointing to a resurrection in Sydney residential property prices.

A sound analysis of residential property fundamentals requires taking account of three key areas.

The most important factor is not ‘location, location, location’ as commonly spruiked by vendors. For example, prime locations such as Sydney waterfront took a huge price fall in the late 1980s and early 1990s, while prices in inexpensive areas generally held their value.

The most important factor is, in fact, ‘timing, timing, timing’. When property values start to escalate, we all know it can be dramatic. But picking the bottom is not easy, because property cycles differ across both regions and property sectors.

There are a number of critical factors that compel me to give ‘two thumbs up’ to Sydney residential investment in terms of both timing and sector.

For timing, the first factor is the vacancy factor for rentals. Residential vacancies have fallen from 4.5 per cent in 2003 to below 1.5 per cent today. This is the lowest in 10 years.

Research confirms an equilibrium vacancy factor of 3 per cent. The current vacancy factor of sub 1.5 per cent means we are now experiencing a serious under supply of rentals.

In November 2006, the number of new homes approved were 2,496, compared with 6,000 in 2002. NSW housing starts is at its lowest in 62 years. This can only exacerbate the chronic shortage of rental accommodation and put more pressure on spiralling rents.

Moving to sectoral factors, the first sectoral factor is that residential property makes sound investment sense. While sectoral performance rankings will vary depending on start and finish dates, it is clear that residential property investment is a category that cannot be ignored by an astute investor or their adviser.

A second sectoral factor is that equities have been on a bull run for several years and all bull runs eventually end. Typically, when equities start to fall, the money moves into property.

The third sectoral factor involves detailed analysis of the various property sectors.

There are four main categories of street property investment (that is, residential, retail, industrial, and office).

Office, retail and industrial property boomed during 2004, 2005 and 2006 in all capital cities. Like the equity market, this bull run cannot continue indefinitely. Sydney residential has been in a slump during this time and is due for a return to historical alignments.

When a detailed analysis is conducted across both sectors and regions, one of the areas of highest potential is Sydney residential.

Interest rates (while they have a mixed and varied relationship with property prices) are close to peaking, residential approvals and starts are at a 62-year low, there is an undersupply of rental accommodation and the market has already experienced a major correction.

Of course, not all commentators will agree.

During my 40 years in the property industry I have observed that commentary is most mixed when market segments are at their peaks and troughs.

At these times, some commentators will predict a rise, some a fall, and some no change. By the time all commentators are in agreement, the opportunity to add real value to your client has passed.

Astute investors and advisers will look beyond the commentary to the facts, and to history, and move early. In my view, based on observing many property cycles, now is the time to move into selected Sydney residential property.

The next step is to decide which type of residential investment opportunity is appropriate.

Property trusts have traditionally ignored residential investments.

However, the opportunities are now so great for Sydney residential that I predict that residential trusts will emerge. Should they do so, this will further increase upward pressure on residential prices.

Trusts, of course, have the advantage of liquidity. But compared to direct property investments they have three distinct disadvantages. They charge substantial fees (that feed those in the sought-after careers of property and funds management); they deprive the investor of the satisfaction of owning, controlling, touching and feeling their investments; and historically, every few years, one or more property trusts collapse through fraud or mismanagement, leading to enormous losses for investors (sometimes a 100 per cent loss).

In contrast, while direct residential property investments do lack liquidity, they provide the investor with: full ownership; full control of their own destiny (including in regard to fees paid); and the certainty that whatever happens, the long-term value of their investment value will grow.

Direct property investment is not for every investor. And many advisers will prefer the easy and comfortable path of sticking to trusts, where there is safety in numbers.

However, for medium to long-term investors, who look to the facts and to history, who take sensible advice, and are prepared to sensibly balance risk and reward, the benefits from direct residential investment are substantial, and in my view should form a part of any sound investment strategy.

~ For more information about this topic, look out for Money Management’s direct property feature in the edition of May 17, 2007.

Brian Boardman is principal at Boardman & Associates.