Special ECONOMIC UPDATE Edition...

Twice each year, in March and September, members of the Investment House team meet with senior economists from BIS Shrapnel to review recent happenings and gaze into the economic crystal ball.  BIS Shrapnel have long been regarded as one of the leading economic forecasting groups in Australia, particularly in the areas of construction and property investment and have quite an enviable record for calling trends accurately. 

This September, Investment House Managing Director Colin Ferguson spent a half day with Chief economist Dr Frank Gelber and Senior Economist Mr Matthew Hassan. 

Forecasting is not an exact science
Before exploring the forecast, let’s get one thing on the table up front.  It’s important to understand that economic forecasting is not an exact science.  Economic forecasters are a lot like weather forecasters – the further into the future we look, the more general the forecast becomes.  And in the same way that it sometimes rains in one suburb whilst another doesn’t get a drop, there will be different economic outcomes in one area compared to another.  We need to listen to their message and apply the trends and approximate timings to our investment decisions rather than pin our hopes on exact highs and low occurring on exact dates and times.

Additionally, we need to be mindful that they represent just one professional opinion.  Much of the “professional opinion” is broadly in line with BIS Shrapnel, but that is not to say there aren’t some significant dissenters.

So what is it they are saying?
In a nutshell, on the national front, the economy is growing well and will accelerate over the next few years to a boom in 2007 before heading into a downturn in 2008.  In Queensland, the resources boom is fuelling growth coupled with very strong population growth and job creation.

Dissecting that further, they see

• The economy has been strengthening since 2001 driven principally by the residential housing boom and consumer spending.  The reserve bank stifled this activity with its very public rhetoric about worrying consumer debt levels and the threat of housing interest rate increases.  Residential activity has now softened and next phase of the growth cycle will be driven by Business Investment comprising expansion of production capacity (warehousing, racking and shelving, telephone systems etc) as business faces capacity constraints and expands to keep up with continued strong demand.
• Employment levels are very strong with unemployment currently running at a low 5%.  Business is being confronted with skill shortages and this is expected to put upward pressure on wages which in turn will flow through to inflation.
• Headline Inflation (CPI) is currently 2.5% which is well within the Reserve Bank’s target range of 2-3% but is forecast to rise to 3.3% by mid 2006 and 3.7% by mid 2007 causing the Reserve Bank to raise rates.
• Interest Rates are forecast to increase as the Reserve Bank responds to inflationary pressures – variable housing rates are currently 7.3% but are forecast to rise to 8.1% in mid 2006 and 8.3% by mid 2007.  It’s noteworthy that this forecast peak has been downgraded from earlier forecasts.
• Population migration to Queensland has remained strong with net international migration of 22,000 and net interstate migration of 32,000.  The forecast is for it to remain strong (at about this rate) which provides a platform for continued high demand for housing.
• Queensland dwelling approvals are currently around 38,000 pa which is still 5,000 less than that required for demand flowing from population gains.  To meet demand, it is estimated supply would need to increase to 43,000 pa.  This stock deficiency has been growing for several years and has now amounted to an underlying stock shortage of 38,000 dwellings (representing 10 months demand).
• Residential Capital Growth for Brisbane Houses was 2% to mid 2005 which was much slower than the massive 31% for the year to mid 2004.  House prices are forecast to grow at 4% to mid 2006 followed by 2% decline through to mid 2008.
• Residential Vacancy for Brisbane is very low.  Effective June 2005, Inner Brisbane was 0.9%; Remainder of Brisbane was 1.8% and Brisbane Surrounds was 2.3%.  Vacancy for all of Queensland was 3.3% (Note – vacancy stats sourced from Qld Govt – OESR)

Getting a little closer to home
That’s the picture as seen by BIS Shrapnel.  As property investors we are generally interested in very local areas in specific cities.  BIS Shrapnel’s perspective is much like looking at the market place from the moon – they see the big picture but they don’t see what’s happening at a street to street level.  The big picture is valuable for overall trends, but to get a feel for the real winners and losers you need to be on the ground.  In this regard, the Investment House team can offer valuable feedback.

So what is it like “on the ground” in Brisbane? 

Investors are primarily concerned with two things:

1. prices growth, and
2. the rental market. 

Let's address Price Growth first
In recent newsletters we’ve described the last six to twelve months of the retail sales market as being “confused”.  There have been mixed signals.  On one hand there have been some quite healthy sales prices, but these have been intermingled with other sales at lower than expected prices.  The current sales environment remains a buyers market despite the massive influx of people and some recent promising anecdotal evidence that a firmer price floor may be returning. 

Aside of the warmer weather bringing buyers outdoors, there are two likely contributors to this improving scenario.  Many new arrivals to Brisbane over the last twelve months (plus) declined to participate in the booming market and made conscious decisions to rent while they settled in and got a feel for the area (jobs confirmed and schools ratified etc).  Many of these people suggested they would consider buying after settling in.  It is possible these people will now survey the “buyers market” and look to purchase a home, and this may contribute to a more stable price floor returning.  Additionally, we may see the increasingly tight rental market contribute to a new floor as new arrivals are confronted with the limited availability of quality rental accommodation and are surprised by rents being asked.  It is quite possible these new arrivals may shift gears and elect to buy rather than rent. These elements may work together to re-establish some forward momentum, but it must be said this is purely anecdotal conjecture.

One key measure of a local market is Sales volumes.  As would be expected in a soft market, these are well down across the board on recent years.  The following table provides an illustration of sales for the sample suburbs in Brisbane - they are illustrative of the wider market.

And on the Rental front
On the Rental front, the story has been quite the opposite.  Responding to demand, vacancy rates have fallen and weekly rents have increased dramatically over the year (generally in the order of 10%) and upward price pressures continue in line with the strong migration element.  As was previously mentioned, vacancy for Inner Brisbane was down to 0.9%; remainder of Brisbane was 1.8%; and Brisbane Surrounds was 2.3%.  These are very low vacancy rates.

So what does all this mean to the property investor?
The first key element is to recognise the market has changed significantly from recent years.  The double digit growth rates are unlikely to return quickly and the forecast for the next few years is for flat to modest capital growth.  As the rental market responds to increasing demand Rental Yields are returning to more respectable levels.

Psychographics Put Brisbane At Odds With Fundamentals?
The current Brisbane market appears to be running against the fundamentals.  Clearly, there already exists strong demand and short supply of housing, yet we have a soft market.  On face value, this runs against the law of supply and demand.  It is “psychographics” (the reason people do things on mass) that appears to be holding people back.  Perhaps it was the robust public rhetoric of the reserve bank that successfully stifled the market.  Perhaps it was the massive price growth over the couple of years that eroded housing affordability and caused people to pause to catch their breath.  Either way, they are simply not in “buying mode” at present.  More people are choosing to rent.  More people are staying at home. 

These elements impact on household formation and such changes act as shock absorbers to the market.  If the “occupants per dwelling” increases by 10% (from 2.0 to 2.1 persons per household because they’re staying at home longer) then the “shock absorber” effect amounts to a reduction in demand of almost 4,000 dwellings. 

The other major shock absorber is people choosing rental accommodation, which is already at boom-time levels as illustrated by the very low vacancy rates. 

It is important to understand that both of these “shock absorbers” can only take so much before the trend reverses.  The day will come when these psychographics change again and the “fundamentals” will be let loose – exactly when is the key question.  And that’s where opinion is divided.

So what do you do?
Clearly it is not an ideal time to be selling a property.  Investors having to sell, and Developers with stock completing imminently should note the BIS Shrapnel forecast peak in mid 2006 and be prepared to meet the market to get sales in place or run the risk of holding projects in a softening market.  Those looking to acquire sites and undertake developments in this environment must buy well and capture their profit early.  Those who bought in the boom and are selling now may just have to grit their teeth.

Be aware there are good buying opportunities from distressed sellers that must sell in this market.  Now is the time to prepare for the next wave of capital growth. This is where the counter cyclical investors make a stand.  Take advantage of the confused market – it wont last forever!  Select quality projects to establish a portfolio that will be positioned to take full advantage of the next rise in prices.  Most commentators agree the combined effect of strong demand coupled with the compounding stock deficit positions Brisbane in the box seat as the next big capital growth winner.  Where these commentators differ is in there forecast timing.   

BIS Shrapnel are saying Brisbane is set to be the first out of the blocks when the next phase presents following the downturn in 2008.  The continued strong population growth will generate further pent up demand.  There will be significant supply constraints (with the existing Stock Deficiency being compounded by continued new dwelling undersupply).  And these elements will almost certainly combine to deliver huge price increases to property owners when the next growth phase presents.  Just don’t miss the boat!  

Aside Of Residential?
Outside of residential properyt, consider commercial and industrial opportunities.  These carry higher risk (and generally higher price tags) but are likely to enjoy strong demand from the booming economy to 2007.  Be careful not to be caught with them when the downturn presents. 

What Of Interest Rates?
Interest Rates also deserve your attention.  Consider fixing (at least part) of your loans portfolio.  Sensitivity analysis show a 1% rise in interest rates has a bigger impact on net cost of ownership (your out of pocket cash flow) than a similar increase in vacancy rates – yet most investors are not aware of this.  Be careful to consider the potentially negative impact of break costs in the event you do need to break a fixed loan before the fixed period has expired.

Disclaimer

All information in this report is general information only. Nothing in this report is meant to be specific investment advice, nor should you treat it as such. Everyone's individual circumstances will vary widely and you must seek advice from your own independent licensed investment adviser before investing into any form of investment. Investment House, its employees and representatives take no responsibility for the result of any actions taken by the readers of this report.

Investment House and its related businesses makes no representation and gives no warranty as to the accuracy of the information in this document and accepts no liability for any errors, misprints or omission herein (whether negligent or otherwise).