The somewhat parochial nature of domestic Australian investors results in a constant pool of capital that is either invested in property, shares, or cash.
There has been a lot of media frenzy about the rise of Australian property so far this year as prices (primarily driven by Sydney and Melbourne residential property) have ended the 2014 calendar year up 8 per cent and have continued to show strength into January and February of this current year. Most investors are asking, 'can this continue and are we in a bubble?' Below are five reasons why I believe Australian property as an asset class, will continue to see increased demand and potential for strong capital appreciation in the year ahead:
1. Yield spreads. Property, like all assets, is best valued as a function of its cash flows. Especially for commercial property, the cap rate method is used. Residential property in Australia currently averages gross yields of 4-5 per cent, and cost of borrow is now below the average cost of borrow at 4-4.5 per cent and expected to be cut further. This excludes tax breaks and advantages. Therefore it is still possible to have positive yield carry on Australian residentially property. Commercial property yield spreads over cost of borrow are now at very attractive levels at anywhere from 200bps for A grade offices to 400bps for industrial. Alternatively, putting money in term deposits results in sub-optimal returns below cost of borrow, and even inflation rates in some instances. Even the average dividend yield of the ASX has narrowed to be below the spread of borrow versus property and mortgage rates. This all means that yields and yield spreads are supportive for property as one of the most attractive asset classes in Australia at the moment.
2. Foreign investment. The AUD versus the USD is 18 per cent off its 52 week high and 30 per cent off its 3 year peak. The lower AUD has been a major driver of increased foreign investment activity in Australia. The introduction of the Significant Investor Visa (SIV) available for five million AUD invested is also significant. Already since the scheme was introduced in 2012, over $3b has been invested and the monthly applications have been increasing at a rate of 14 per cent, with the majority going to Chinese nationals. Furthermore, Australia's robust rule of law, stable political environment, and strong financial markets and regulatory environment – not to mention the lifestyle benefits – make investment by foreign nationals highly attractive versus other markets.
3. Global money supply. Despite the USA exiting its Quantitative Easing (QE) program, there are a large number of other countries increasing the supply of money through non-traditional methods such as QE. This includes Europe and Japan, which combined exceed the QE program of the USA. Furthermore, monetary policy remains highly accommodative and this means plenty of liquidity in the system which will make its way to income producing physical assets such as property. Australia has a relatively deep and liquid asset market for property relative to the economy size. Therefore, Australia is expected to be a key beneficiary of increased global money supply.
4. Low interest rates for longer. Deflation risks spur the reluctance of the Central bank to raise interest rates. Speculation of when the USA federal bank is going to raise interest rates keeps being pushed out. Central banks around the world are keeping interest rates at record lows in order to rebalance economies and fuel growth. Australia is no different, with the RBA firmly on an easing path. There are some media and economic commentators suggesting Australian rates are set to fall to as low as 1.5 per cent this year!
5. Lack of alternatives. The somewhat parochial nature of domestic Australian investors results in a constant pool of capital that is either invested in property, shares, or cash. Very rarely does the average Australian investor venture offshore. Furthermore, with the tax benefits and ease of borrowing facilities available, this still makes property a good choice for pursuing a core investment strategy. With the stock market reaching record highs and cash at bank delivering almost 0 per cent nflation adjusted returns, property stil looks to attract local capital for some time yet. Overall, I expect 2015 to be another strong year of growth for Australian property and I expect average overall +8-10 per cent capital appreciation plus stable rental yields of ~5 per cent for residential property, resulting in a total investment return of up to 15 per cent. For commercial retail and office I expect 10-15 per cent capital appreciation and 6-8 per cent yields resulting in up to 20 per cent total return for the year. It is best to keep in mind these are generalised statements and performance will vary across states and sub asset classes.