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Is Australian housing a sound investment? | 1 Is Australian housing a sound investment? Housing is often seen as an attractive investment, offering positive capital growth over the long term and, for investors in particular, a steady stream of rental income. Is this still the case for the Australia? We ask Marcelle Murphy, Economist at Advance, to explore the key factors driving the Australian residential property market. The housing market collapse in the US and Europe in the wake of the global financial crisis (GFC) is a vivid reminder for Australians of the potential downside risk of property as an investment. House prices in the US for example, have plummeted 31% from their peak in July 2006, and are now considered to be largely undervalued. In contrast, the housing market in Australia has so far held up reasonably well, but the key issue gnawing at the minds of homeowners and investors alike is whether or not this will remain the case. Australian house prices are now generally regarded as very much overvalued, and have earned us the reputation of being the most expensive and least affordable housing market in the world, according to the Demographia 2011 International Housing Affordability Survey. In light of this, there is a concern that the Australian housing market may be vulnerable to a correction, which could see prices fall sharply, and leave many homeowners or investors owing more than their asset is actually worth. What are the recent trends? In determining the prospect of a downturn in the market, it’s useful to firstly look at recent trends in house prices. Chart 1 shows the trend in the ABS House Price Index from March 2003. Australian house prices have been on a broad upward trend, increasing by a total of just over 70% to December 2010. Within that period, there have been some short-term ups and downs. After showing solid upward momentum in the 12 months to March 2004, prices stabilised for a few years, before rising again from March 2006. Chart 1: Australian: House Price Index March 2003 to December 2010 80 90 100 110 120 130 140 150 160 Dec-10 Sep-10 Jun-10 Mar-10 Dec-09 Sep-09 Jun-09 Mar-09 Dec-08 Sep-08 Jun-08 Mar-08 Dec-07 Sep-07 Jun-07 Mar-07 Dec-06 Sep-06 Jun-06 Mar-06 Dec-05 Sep-05 Jun-05 Mar-05 Dec-04 Sep-04 Jun-04 Mar-04 Dec-03 Sep-03 Jun-03 Mar-03 Index 2003/04 = 100 Source: ABS & Advance Investment Solutions

Is Australian Housing a Sound Investment

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This is a newsletter given to Blue Edge Financial Planning clients. This newsletter is from Marcelle Murphy an Economist from Advance Investment Solutions on "Is Australian Housing a Sound Investment".You can follow Blue Edge on Facebook at http://www.facebook.com/blueedgefinancialplanning

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Page 1: Is Australian Housing a Sound Investment

Is Australian housing a sound investment? | 1

Is Australian housing a sound investment?

Housing is often seen as an attractive investment, offering positive capital growth over the long term and, for investors in particular, a steady stream of rental income. Is this still the case for the Australia? We ask Marcelle Murphy, Economist at Advance, to explore the key factors driving the Australian residential property market.

The housing market collapse in the US and Europe in the wake of the global financial crisis (GFC) is a vivid reminder for Australians of the potential downside risk of property as an investment. House prices in the US for example, have plummeted 31% from their peak in July 2006, and are now considered to be largely undervalued.

In contrast, the housing market in Australia has so far held up reasonably well, but the key issue gnawing at the minds of homeowners and investors alike is whether or not this will remain the case. Australian house prices are now generally regarded as very much overvalued, and have earned us the reputation of being the most expensive and least affordable housing market in the world, according to the Demographia 2011 International Housing Affordability Survey. In light of this, there is a concern

that the Australian housing market may be vulnerable to a correction, which could see prices fall sharply, and leave many homeowners or investors owing more than their asset is actually worth.

What are the recent trends?In determining the prospect of a downturn in the market, it’s useful to firstly look at recent trends in house prices. Chart 1 shows the trend in the ABS House Price Index from March 2003. Australian house prices have been on a broad upward trend, increasing by a total of just over 70% to December 2010. Within that period, there have been some short-term ups and downs. After showing solid upward momentum in the 12 months to March 2004, prices stabilised for a few years, before rising again from March 2006.

Chart 1: Australian: House Price Index March 2003 to December 2010

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Source: ABS & Advance Investment Solutions

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Is Australian housing a sound investment? | 2

By 2008 however, prices actually started to decline with the onset of the GFC. In fact, from the peak in March 2008 to the trough in March 2009, prices fell by 5.5%. In 2009, supported by historically low interest rates, the Government’s First Home Buyers Grant, a relaxation of foreign investment rules, and the fact that the Australian economy rebounded well from the GFC, strong demand for housing helped drive double digit price growth, pushing prices to record high levels. As interest rates increased from late 2010 and foreign investment rules were tightened once again, we’ve seen this pace of growth taper off. Even allowing for this however, it’s clear that house prices are still around record high levels.

What’s been the key factor driving the long-term upward trend in house prices?

Population growth

The most obvious long-term influence on the Australian market since 2003 has been the basic interplay of supply and demand, where the demand for housing has outpaced the supply of housing (see Chart 2). Rapid population growth has been integral in boosting the demand for housing. Indeed, between March 2003 and June 2010, the total population has grown by 12.6%, with an average yearly growth rate of 1.6%.

In the two years to June 2010, the average was a very high 2%. Natural increase contributed solidly to overall population growth, but net overseas

migration played a bigger role. In the year to June 2010 alone, migration accounted for 57% of the increase in population, compared with 43% for natural increase. Higher migration levels have therefore resulted in a significant increase in the actual level of underlying demand for housing in recent years.

Supply of housing

At the same time, the pace of growth in housing stock or supply has slowed. The total supply of housing in Australia as at 2009 (latest available statistics), was just over 9 million dwellings. This is based on statistics from the 2006 ABS Census and dwelling completions data for the last three years. As Chart 2 shows, the actual growth rate in the stock of dwellings slowed to an average of 1.4% pa between June 2008 and June 2010 — well below the 2% average population growth rate. There are various reasons as to why growth in the supply of housing has slowed, in particular land availability (limited due geography, zoning and environmental constraints), high infrastructure costs and long development processes.

Given the more rapid increase in the level of underlying demand for housing, and the slower growth in dwelling stock, the National Housing Supply Council’s 2010 State of Supply Report estimated that Australia currently has a cumulative shortfall of just under 180,000 dwellings. As with any product, when there’s higher demand relative to supply, the price of the product is bid up. Housing is no different, and the general upward trend in house prices since 2003 largely reflects this fact.

Marcelle MurphyEconomistAdvance Investment Solutions

Chart 2: Australian dwelling and population growth

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Source: ABS & Advance Investment Solutions

Page 3: Is Australian Housing a Sound Investment

Is Australian housing a sound investment? | 3

Will house prices continue to rise?Short-term prospectsIn the short term there’s a reasonable likelihood that house prices will show only moderate growth, and perhaps even decline moderately. Price growth has slowed to 5.8% over the year to December 2010, after a solid 16% increase to June 2010. The prospect of further increases in interest rates in 2011 and possibly 2012, along with the fact that prices remain near record highs, suggests some further deterioration in housing affordability. This will deter potential home buyers, particularly first timers, and will see some downward pressure on prices this year, and possibly early 2012.

Medium to long-term prospectsThe prospects in the medium to long term however, are encouraging, based on supportive fundamentals. With underlying demand for housing already exceeding supply, the situation is only likely to be accentuated, given the strong growth prospects for Australia in the medium term. The economy is on the cusp of a major investment boom, which will help sustain solid income growth, and support housing demand. Furthermore, the current tightness of the labour market means it will be necessary to further increase net migration levels to help service the impending upswing in activity. This again will mean increased demand for housing.

Unfortunately, housing supply is unlikely to be able to keep pace with this stronger demand. Whilst conditions conducive to new home building have improved recently, such as an easing in credit conditions for developers, other factors will continue to limit the potential for supply to increase. The development and approval process for new dwelling construction remains long and onerous, and infrastructure costs are still relatively high by historical standards. Furthermore, according to Reserve Bank of Australia (RBA) research, whilst new land has been released on most city fringes to allow for development, the cost of that land has also increased in recent years, adding to the cost of new dwelling construction. Even if these conditions were to improve in the near term, there is a relatively long delay between approval and construction, and therefore the pace of growth in dwelling stock.

In summary then, whilst there is likely to be some short-term weakness in house prices, a sharp, sustained decline in prices doesn’t appear a likely prospect. In fact, with the underlying demand for housing expected to remain strong and supply being slow to respond to this demand, the most likely outcome is that prices will remain on a broad upward trend in the medium to long term.

How does housing in Australia compare to other investments?The strong demand for housing in 2009 on the back of what could be considered unusually very supportive factors (historically low interest rates and strong government incentives), and the resulting spike in house prices, prompted a word of caution from RBA Governor, Glenn Stevens, for those contemplating riding on the bandwagon for speculative purposes. In a television speech just over a year ago he said, “It’s a mistake to assume a riskless, easy and guaranteed way to prosperity is just to leverage to property”.

Any investment carries risks, but it’s how you manage that risk that counts. Residential property has long been considered a reasonable investment for those investors with a long-term horizon. Chart 3 compares the returns on housing (using the ABS house price index, and therefore not taking into account rental yields etc), against other key investment options from March 2002 to December 2010. As illustrated, the Australian house price index has generally outperformed fixed interest over this time period investment, and has clearly outperformed unhedged international equities. In fact, an investment of $100,000 made in March 2002, would have more than doubled in value by December 2010. Unlisted property, as measured by the Mercer’s direct property index, just outperformed residential property. It should be noted that this particular index includes non-residential property as well. Australian equities and listed property both performed well for the first five years in this period, but the onset of the GFC saw these returns come back sharply in recent years.

“Residential property has long been considered a reasonable investment for those investors with a long-term horizon.”

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Adviser Services: 1300 361 864 advance.com.au

This document has been issued by Advance Asset Management Limited ABN 98 002 538 329 AFSL No. 240902 (Advance). The information provided is of a general nature only and has been prepared without taking into account the objectives, financial situation or needs of any particular person. It is not intended to constitute investment, legal of taxation advice and should not be considered or relied upon as a comprehensive statement on any such matter. Before acting on the information, a person should consider its appropriateness, having regard to their objectives, financial situation and needs. Whilst every effort has been taken to ensure that the assumptions on which the outlooks given in this document are based are reasonable, the outlooks may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. Past performance is not a reliable indicator of future performance. Information from third parties is believed to be reliable however it has not been independently verified. While the information in this publication is given by Advance in good faith, it does not warrant that it is accurate, reliable, free from error or omission. Advance is a member of the Westpac Group. An investment in a managed fund issued by Advance does not represent an investment in, deposit with or other liability of Westpac Banking Corporation ABN 33 007 457 141 or any other member of the Westpac Group. Subject to any terms implied by statute which cannot be excluded, neither Advance nor any other company in the Westpac Group and their directors, employees and associates accept any responsibility for errors in, or omissions from the information. Current as at April 2011. AD11944-0311lm

The above chart clearly shows that Australian housing is a sound investment in the long term. However, investors should exercise caution, as the nature of direct housing (ie less liquid and high transaction costs), wouldn’t suit all investors. As always, a well diversified portfolio of investments is the optimal way for investors to generate solid returns for their level of risk tolerance.

At Advance, we consider the the long-term outlook for Australian residential property to be encouraging. As an investment, Australian direct residential property has a key role to play in a diversified portfolio.

Chart 3: Comparison of Australian House Price Index to Australian and International shares, Listed Property and Fixed Interest. Index rebased to March 2002 to December 2010

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Source: DataStream & Advance Investment Solutions