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Cashflow comes to the rescue

Cashflow comes to the rescue

Many commentators hope that property market prices are on the rise again, but there’s a much more likely prospect in store for property investors, because rents are about to start rising dramatically.

Property investors have two strings to our bow – cash flow and growth, and the recent media focus on prices has pushed cash flow into the background. This is understandable, because capital city rental yields are currently at lows that landlords haven’t had to deal with since the early fifties and seventies.

There is currently little incentive for investors to get excited about property, but while we don’t always experience both cash flow and growth at the same time, our major cities have always consistently delivered either high cash flow or good price growth at different times.

This is clearly demonstrated in the graph below, showing you the average annual rental yield and house price change for Australian capital cities from 1901 to now. 

Rental_Yield_and_Price_Changes

The graph shows that during the years when Australian capital city house price growth was low or even went backwards that rental yields boomed at the same time. The correlation is close because our capital city populations (apart from Darwin in 1975 after Cyclone Tracy) have always been rising. This in turn means that if new households can’t get housing finance the demand for rentals rises.

How many years does it take for rent to equal a house price

The years are grouped together in the way that they appear in the graph because they show you another statistic – the number of years that it took for the rent received by a landlord to add up to the value of a house. In other words, from 1936 to 1939, it took just four years of rent to be the same as the value of a house. But right now, it would take twenty-four years of rent to equal a current house price.

Years_Rent=House_Price

The stats are out of kilter, as the table below shows. Rental yields are way below their historic long-term average, housing prices have gone up too much, although they certainly haven’t boomed, and rents are too low to make housing a viable option for investors.

Rental yields are well below their long-term average

Table

Yet our big city populations keep growing, with most of the new households coming from overseas and interstate, generating an immediate rise in the demand for housing, especially in Sydney, Melbourne and Brisbane. The issue is that most of these new arrivals can’t buy houses or units – they have to rent for a number of years, until they are sufficiently established to be able to obtain housing finance.

While the last few years have seen a massive fall in investor owned housing stock in our major cities, rental demand from new arrivals has been shooting up. History shows us what happens next – that massive increases in rent are highly likely to occur over the next few years.

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Why our governments are building useful things

Why our governments are building useful things

In its July Statement, the RBA has stated why it has cut the official cash rate twice in just two months: “Easing of monetary policy will support employment growth and provide greater confidence that inflation will be consistent with the medium-term target.’

If you turn this “bank speak” into plain English, it means that the RBA thinks that unless we spend more, we are in for rising unemployment and may well slide into recession.

One of the main reasons for this unhappy situation is that, according to the latest HILDA survey, average Australian incomes have not risen in real terms (after being adjusted for inflation) since 2009. And so, the RBA is doing all it can to increase the amount of spending money we get each week. 

The value of safe haven assets keeps rising

We are not responding to this stimulus by buying more, so the Federal Government has chimed in with tax cut incentives, including a big once off income tax refund. But rather than planning huge spending sprees, most consumers are apprehensive.

They sense that the economic mood is changing and rather than spending more, they are spending even less, putting their spare cash into safe havens such as bank shares and gold (the graph shows the rise gold’s spot price in US$ since August 2018.)

The RBA can do little to prevent this decline in spending and in its July statement urged our governments to spend more money by building useful things to stimulate jobs and growth.

Build freeways, railways, tunnels and airports

The government knows that spending more, while foregoing revenue with its cut cuts will delay the long-awaited return to a balanced budget, but the alternative is far worse – being the first government to lead us into recession in thirty years.

That’s why the Federal Government, in concert with most State Governments are committed to an infrastructure-based approach to economic growth, building freeways, railways, tunnels and airports, all of which will help to reduce unemployment and put pressure on real wages to rise at last.

Real income growth will increase both housing affordability and buyer incentives, something which our exhausted housing markets are desperately calling for, but it’s going to be a very slow process. Investors would be wise not to seize on any slight rise in housing prices over the next few months as proof of a recovery, especially as potential sellers are likely to flood markets hoping to get higher prices, only to find their hopes dashed as buyer demand remains sluggish.

The “two-tiered housing market will soon return

This is why we are likely to see a “two-tiered” housing market dynamic occur once again over the next few years. The losers will be those capital city housing markets which experienced the highest price growth in recent years and also have large supply overhangs. The winners will be those areas which are likely to benefit from current or fully funded government infrastructure projects creating more housing demand. This is where rents and prices could rise dramatically.

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The armchair dream of set and forget property investing

The armchair dream of set and forget property investing

With housing prices continuing to slide in most major capital cities, many investors feel exposed and threatened, because they have gone heavily into debt to purchase their properties.

This is when we get reassurance from some armchair experts who insist that the property market is merely subdued, that it’s marking time and growth will return soon. To support such “set and forget” buy and hold strategies, these theorists point to the long-term performance of property and state that growth is about to return, because it always has in the past. But how has the market really performed in the past? And what does this actually tell us about the future?

The theorists show us graphs such as the one below, proving that regular and consistent price growth exponentially increases your equity over time.  

They then assure as that this is how the Australian housing market works, with prices doubling every eight to ten years. Because the market has behaved this way for so long, they argue it will continue to do

But has the market actually performed so reliably in the past? The graph below shows the rate of price growth that has taken place in every capital city other than Sydney and Melbourne over the last fifteen years, according to ABS published data.

Quite clearly, the buy and hold reality is nothing like the buy and hold dream at all.

The differences between the dream and reality are more extreme when we compare the performance of different suburbs to each other, even in the same city, and different types of property in the same suburb.

“Buy and hold” can certainly be a workable investment strategy if you purchase the right type of property in the right area, at the right time and pay the right price, but the evidence shows that jumping in and buying anything, anywhere on the assumption that all housing markets and all types of properties will perform the same over time is totally flawed. Investors who follow such an armchair investing strategy are likely to find that their dream soon becomes a nightmare.

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Pumping and dumping schemes

Pumping and Dumping schemes

Faced with the prospect of little price growth on the horizon, property investors are starting to see innovative get rich quick schemes being promoted which offer huge returns.

It has always been true that if the property market can’t generate a return for investors from market driven growth, then investors can make some growth themselves. We have traditionally done this by improving the value of our investments through cosmetic or structural renovation or even developments.

The issue is that the buy and hold costs for such projects can deter most new investors, and there’s always the threat that if prices fall, they may cancel out the value we have added, or even lead to a loss.

But some new investment alternatives have recently emerged, bringing us glitzy promises of high returns from property investment without the need to outlay any significant cash up front. The risk seems low, the opportunity to participate is high and many of us are sucked in, usually at free so called “investment” seminars.

One clever land banking scheme offers you an easy way to get into the property market with one low upfront cost and the promise of eventual riches. The promoter sells you an option to buy land which is slated for future development, showing you the concept plan and glossy “artist’s impressions” of the finished project. All it takes is one affordable fee and no repayments. Then years later, when the land is subdivided, you can exercise your option and sell at a huge profit.

You can even participate in the property market without any upfront cost at all, by searching for and finding property owners who are willing to enter into an options agreement with your mentor. Your mentor signs and pays for the agreement, which gives them the option of buying the property at an agreed price and future time from the current owner. Then by agreement with your mentor, you will be handed a percentage of the profit.

There are also adverse possession schemes using what is known as “squatters rights” where you search for and find long vacant or abandoned properties for your mentor who then improves and rents them out, taking title to the property when the legal waiting period has expired. By agreement with your mentor, you will then split the profit from the sale of the property.  

These sorts of schemes pump you full of confidence and then dump you when they fail. For example, if the land banking property is never developed, or the option for a property you have found is never exercised by your mentor, you receive nothing. Similarly, if the owner of a property which is in the process of adverse possession suddenly turns up before your mentor can legally claim title, you end up with nothing.

You can avoid getting pumped and then dumped by sticking to tested and proven property investment strategies which offer worthwhile rewards and incur risks which are manageable.

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Playing the long game

Playing the long game

If it’s true that the best time to buy is at the bottom, then now might be a good time to buy Crypto currencies, especially Bitcoin, which has undergone a dramatic plunge in value over the last year. But will crypto prices fall further?

Crypto currencies have lost more than $400 billion off their peak values in late 2017 and some analysts are claiming that now is the best time to buy, because the bloodletting appears to have ended and prices have stabilised.

Bitcoin

The chart shows how Bitcoin prices have moved since the boom started in 2016, with prices dropping dramatically since early last year. In fact, the Bitcoin buying craze had all the hallmarks of a boom-bust scenario, being enthusiastically embraced by a whole new generation of investors for all the wrong reasons.

“Bitcoin is high tech,” they told us. “It’s innovative, it’s blockchain based and best of all, it’s disruptive.” Given this sort of talk, demand was always likely to evaporate once the novelty wore off and the cracks appeared.

Now the supporters of Bitcoin are claiming that recent price falls are due to “market volatility” despite the fact that Bitcoin was somehow supposed to be immune from such dramatic demand related price shifts. Other analysts have come up with the term “crypto winter” to describe the current lack of demand for the commodity. While this describes the phenomenon, it does nothing to explain why such a freeze out of buyer enthusiasm has occurred, or whether we will ever experience another crypto spring.

The facts are that Bitcoin is a commodity and must therefore follow the laws of supply and demand like all other asset classes, but this seems to confound its proponents. To keep the commodity viable, they need continued demand, so they are now expounding the long-term benefits of buying bitcoin. They are playing the long game, as the saying goes.

This strategy will sound familiar to followers of the property market where prices have been falling as they have in Sydney and Melbourne. The focus of the discussion quietly shifts from recent high performance or promises of imminent growth to the fact that prices always rise over time, that they are at the bottom of the cycle, and those who play the long game will still be ahead.

Yet Bitcoin is an asset that is quick and easy to trade, and must suffer from high price volatility as a result. It was never designed to be a long-term investment like property, so it is really interesting to hear the Bitcoin barrackers change their tune completely, and now refer to Bitcoin as a buy and hold asset.

I know which I would rather be holding during the tough times, because in ten years’ time Bitcoin may just be a historical quirk, but property will still be a valuable asset.

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The truth about good yield and bad yield

The truth about good yield and bad yield

Good_yield_bad_yield

Given the current lack of growth in our property markets, many experts, educators and advisers are pushing cash flow as a good investment option. The trouble is that most of the suburbs and towns they put forward are selected purely because of their high rental yields – but there’s good yield, and then there’s bad yield.

Bad yield is not going to deliver you positive cash flow, because rental yield is a function of both prices and rents. Rental yields can rise if prices have fallen, even if rents haven’t risen, or if rents have not fallen as much as prices. This is bad yield, and some of the highest rental yielding suburbs put forward in various glossy promotions are in locations where housing prices have crashed in the last five or so years.

These “high yield” lists feature towns such as Broken Hill in New South Wales, Blackwater, Collinsville and Dysart in Queensland, Newman and South Hedland in Western Australia and Rosebery, Zeehan and Queenstown in Tasmania. Investors seeking positive cash flow might be tempted to buy in these towns because they have high rental yields and extremely low house prices. If you are amongst them, remember that the high yield in these markets has nothing to do with rental demand and everything to do with falling prices.

Good yield is driven by rent demand not by price falls, so if you seek positive cash flow from your properties, look for high rental yielding areas with high rental demand, such as tourist destinations, infrastructure construction zones and locations favoured by overseas arrivals.

All of these households create genuine rent demand. Some of the highest good yields can be found in coastal suburbs where prices have risen in recent years, but these are seasonal holiday locations, and the high yield is only obtained during the peak summer season. Watch out for such seasonal variation traps.

Permanent and semi-permanent rental areas such as ex-Housing Commission estates or the older affordable outer suburbs of our major cities provide consistently high yields with solid rental demand. These areas might seem unattractive to some, but they have strong rental appeal to others.

Remember, that although some of these locations may not appeal to you, what matters is that they do appeal to someone else. For example, Risdon Vale is an outer suburb of Hobart with a constantly high good rental yield and it’s also where Tasmania’s maximum security male prison is located.

The secret to Risdon Vale’s high rental yield is the demand for rental accommodation there, coming from the girlfriends, partners and wives of the prison inmates. They want to live in Risdon Vale so that they can more easily make conjugal and family visits to the prison. You might not wish to live near a maximum security male prison, but the secret to Risdon Vale’s high rental yield is that many others do.

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What makes a potential investment area attractive

What makes a potential investment area attractive?

Some investors will avoid areas because there’s a high proportion of rental properties or it’s a dirty looking industrial town. They might favour suburbs where they would like to live themselves, but this is not relevant. What matters is whether other people want to live there, because this is what makes an investment area attractive.  

Risdon_Vale

Risdon Vale is an outer suburb of Hobart and it’s also where Tasmania’s maximum-security male prison is located. It’s not what most would call an attractive place. The area is dominated by massive walls skirting the jail’s perimeter, topped with coils of razor wire and the night sky is penetrated by floodlit guard towers and the howling of ferocious guard dogs.

Coupled with the constant threat of rampaging escapees running amok through the town, surely here is a place that could be called “unattractive” and deter any potential residents.

Yet, here’s the thing, Risdon Vale has the highest housing rental yield in Hobart and it’s driven by genuine rental demand. The source of housing demand comes from the wives and partners of the inmates, who rent properties in Risdon Vale to be near their incarcerated loved ones for conjugal and family visits.

The irony is that the higher the incidence of burglaries, murders and other serious crime in Tasmania, the greater will be the demand for rental properties in Risdon Vale.

The importance for investors is not that you might find such places unattractive or even dangerous, and that you wouldn’t want to live there – what matters is whether other people want to live there, creating housing demand in the process. 

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Property maths made easy

Property maths made easy

There’s so much confusing and conflicting property forecasting information out here, I thought I would simplify matters with a simple equation.

Maths_equation_Jan_2019

This equation uses the latest published Australian Bureau of Statistics data, and dramatically shows us that we are rapidly approaching a critical shortage of rental accommodation in the major eastern cities. Record population growth is combining with the effects of savage cuts to investor and new housing finance to reduce the available stock of rental properties.  

The maths is alerting our State and Federal governments that it’s high time to stop punishing and start encouraging property investors, because it is investors who provide virtually all rental accommodation. If our governments fail to respond, they can expect a rapid escalation in asking rents in Sydney, Melbourne and Brisbane.

This graph shows just how much rents have fallen behind price growth in our capital cities, with the gap between growth (the black line) and rent return (the red line) steadily growing since 1999. Right now, the shortfall is the worst it has ever been.

Perf_house_prices_rents

Cash flow is about to become king again

This situation occurs because rent growth tends to lag behind price growth in our big city markets, and indeed, rental yields in Sydney, Melbourne and Brisbane are now lower than at any time since the post-war housing boom. They do catch up, however, whenever prices stop rising.

When capital city housing price growth slowed down or stopped in the past (for example from 1910 to 1916, 1929 to 1941 and from 1951 to 1965), you can see from the graph what happened next. Rents rose quickly and dramatically, as indicated by the red line. This has occurred because our capital city populations have always been growing, and if new residents can’t buy, they have to rent.

The equation and the graph would indicate that rent rises are highly likely to occur again in the eastern capital cities. It also shows that this is likely to happen very soon and that cash flow will replace capital growth to become king.

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The farmer and the fox

The farmer and the fox

The current standoff in our property market is quite bizarre. On the one hand we have increasing demand for housing in our major cities created by record population growth and on the other hand, buyer demand in them has slumped. Let me share the story of the farmer the fox with you, to shed some light on what could be going on.

A farmer captured a fox that had been taking his chickens. To teach the fox a lesson, the farmer tied some dry grass to the fox’s tail and set it alight, then let the fox go.

But the fox ran straight into the farmer’s wheat field, which was ready for harvesting and as the burning grass fell off his tail, it set fire to the farmer’s crop and destroyed it. The moral of this fable is to be careful with acts of revenge as they can often backfire.

We can easily refashion the story. The government decided to punish the big banks for the way that they treated customers, so it held a Royal Commission into their bad behaviour to teach them a big lesson. But instead, the banks responded by slashing housing finance so much that the whole economy was threatened with a recession, to teach the government an even bigger lesson.

Now I don’t think that the banks want to send the economy into recession, but they obviously want to make a point about their power and importance. So, just like the fox, they are sending a strong message to the government to leave them alone.

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The half time break is about to end

The half time break is about to end

During the last year property buyer demand fell because of:

´      
The big banks self-induced housing finance squeeze
´       APRA’s controls on investor and interest only loans
´       Huge stamp duty hits for overseas property buyers

These restrictions have caused property prices to fall in some cities and fail to rise in others, but this situation is only temporary, because the demand for housing continues to rise strongly. What we are experiencing right now is like half time at the football – a temporary lull before housing demand forces prices up again. 

The demand for housing is increasing because of one inescapable fact – we have one of the highest population growth rates in the world – at 1.6% per annum, it’s easily the highest in the western world, (more than double that of the UK or USA and three times that of China, according to the latest United Nations figures). 

Change_in_population

What makes these stats even more significant is that over sixty percent of our population increase now comes from overseas arrivals, and most of them (according to the latest ABS data released 20 December 2018), prefer to live in our three biggest cities, with one third heading for Sydney, one quarter to Melbourne and another ten percent to Brisbane.

People are also moving from the west to the east

That’s not the end of the population boom story either, because many immigrants to cities such as Adelaide, Perth or other regional centres, make another move a few years later, seeking better employment prospects or more affordable housing.

This results in a net interstate migration of around 40,000 people to Brisbane, Melbourne and Tasmania each year, in addition to those directly arriving from overseas and all those arrivals from other States and countries need immediate housing, most of which will be rental accommodation.

Huge housing shortages are about to emerge

These huge numbers of new residents have obvious implications for our housing markets, especially the rise in rental demand it will generate in our eastern capitals, such as Melbourne and Brisbane. Because most of these new residents will become aspiring first home buyers when they are settled, there will also be a rise in buyer demand which will continue for years. That will occur even if the Federal government makes such a policy change.

The inevitable outcome of our rate of population growth is that we are about to face a huge housing rental stock shortage in our major eastern cities, accompanied by a surge in buyer demand when the housing finance controls are lifted and the banks seriously start lending again.

What are our governments doing about this?

We are facing major conflicts with our migration and housing policy, but our governments are doing nothing, and they will continue to do nothing, because migration is a Federal issue and housing is a State matter. High levels of overseas migration are economically good for our nation – new arrivals create work, keep labour costs competitive, keep our nation young and active.

Australia currently derives over sixty percent of its annual population growth from overseas arrivals, which is the highest relative intake of all the major nations in the world. Our Federal politicians see overseas migration as an economic benefit which has kept Australia out of recession for nearly thirty years. Even better, they don’t have to worry what happens to migrants after they have arrived, because creating and providing transport, health, education and housing services are State matters.

This is why State governments are not so enthusiastic about high levels of overseas migration, but even though most arrivals end up in the already population challenged cities of Sydney, Melbourne and Brisbane, State politicians are powerless to control this in any meaningful way.

State governments get financial benefit from property buyers

The situation is even more confused because State revenues are heavily reliant on stamp duty from property transfers and so a rise in property sales is in State government financial interests. Many of the huge transport infrastructure projects currently underway in New South Wales, Queensland and Victoria rely heavily on stamp duty revenue from property sales.

So while State politicians publicly sympathise with frustrated potential first home buyers, they are really on the side of the big developers and investors who buy properties and generate the stamp duty revenue they need.

What should property investors do about this?

This is a unique period in our history. On the one hand, demand for housing is rising strongly, and on the other, our ability to buy property has been curtailed. It’s like half time at a football match, with everyone taking a breather before the siren goes and the game continues, with an inevitable rise in both prices and rents in the eastern capital cities.

This temporary halt in buyer demand is not going to last very long, and the rising pressure of demand for housing is likely to have several different effects.

Firstly, asking rents in the big three eastern state capital cities will increase over the next year and lead to a renewed influx of property investors seeking higher rental yields.

Secondly, rising prices in these cities will encourage investors to look at the cheaper capital cities for affordable bargains.

Thirdly, opportunities for profitable renovations and developments as well as for long term buy and hold investments will grow in all capital cities as market driven growth picks up.

Market conditions now favour buyers in many suburbs of our capital cities and some suburbs also offer great cash flow potential as well as a strong medium-term price growth outlook and excellent buy and hold investment opportunities.

Where can you find these suburbs? In our just released Lindeman’s Best Buy and Hold Suburbs reports, the only predictive reports personally produced by property market expert, John Lindeman.

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