|By Gordon Edginton|
The property market continues to operate at very depressed levels although there has been a small sign of some lift in activity in the past two months. This may well only represent a normal seasonal improvement for the autumn period but could be a sign that the bottom of the market has now been reached.
The historically low interest rates are starting to provide some renewed impetus to the market and there are prospects for further falls in the Official Cash Rate which could herald even lower floating interest rates. Although market activity still remains very weak, the sales volumes seen in March this year have shown a rebound in activity.
Auckland’s median sale price appears to be stabilising around $420,000 and has been around this level for the past four months. This has shown a decline of around 10% in overall value since the market peaked in late 2007.
There is likely to still be some deterioration in property values over the next few months as purchaser expectations seen in the market still favour a downward bias. The number of days to sell has kept rising and now sits at 56 days. There is more pressure than ever on sellers to discount their prices to achieve a sale.
The next few months though are likely to see the market flatten out and price stability should return. There is still though considerable uncertainty in both the domestic and international economies and this will result in most investors remaining sidelined until they can be more certain of a more favourable economic outlook.
Although the prospects for the rest of 2009 still appear weak, there are some positive signs emerging. These include the historically low interest rates, improvement in housing affordability from lower prices and lower debt servicing costs, a turn around in migration numbers which are now trending upwards and improving consumer and business confidence.
Migration figures have always been one of the best catalysts for any change in the market. There is now a rising trend of improving long term migration gain. The last four months has seen a gain of nearly 4,000 people and over the past year the gain sits at 7,500. As less people are now leaving our shores and many ex-pats are returning home – it would seem this turnaround in migration figures will signal an improvement in the fortunes of the property market. There are projections there could be a net 15,000 positive migration to the country which will have clear benefit. The incentive to move to Australia seems to be waning.
In fact if it were not for the ongoing recessionary conditions, poor business activity and rising unemployment, the property stars would otherwise be very favourably aligned with the lowest interest rates for many years and a rising number of migrants.
Interest Rates Low
The other primary driver of the market is interest rates. House sales are particularly sensitive to changes in interest rates, especially where there has been significant movement in these rates. What normally drives the economy out of recession is large interest rate cuts as have occurred over the past 12 months. The start to a possible improvement in house sale numbers is due in large part to the interest rate cuts.
With interest rates now below 6% it has created an attractive environment for investment, whether it be from first home buyers who are seeing improved affordability and better “bang for their buck” or rental investors who see a positive cashflow return from their rental property.
The influence of low interest rates can be slow to affect the market because of the prevalence of fixed interest rates. 80% or more of mortgages are still on fixed interest rates and the average interest rate for these is 8.4%. However, approximately 50% of these will be coming off fixed rates over the next 12 months and with current interest rates below 6% there is likely to be a very positive cashflow stimulus to existing home owners.
The health of the economy is closely linked to house sales thus it will be in the interests of the Reserve Bank to maintain these low interest rates to ensure the property market recovers from the present cycle.
Inflation is now back to 3% and within the target band for the Reserve Bank. There are probably limited inflation risks at present with the recessionary conditions and this implies a longer period of low interest rates are likely as the Reserve Bank tries to stimulate growth through having a low Official Cash Rate. This low interest rate environment and the prospect of remaining so for some time can only be good news for the property market.
There are though still downside risks including the ongoing recession which is likely to drag out for some time yet, steadily rising unemployment and great uncertainty within the global economy. New Zealand’s prospects of coming out of recession will rely on, to a large extent, what happens overseas.
The labour market is expected to continue to worsen this year and this will impact on home buyers decision making and appetite for debt. Many ‘would be’ purchasers are likely to remain sidelined due to the uncertainty of job losses. With employment tipped to rise to 8%, the prospect of having a job or not at the end of each week is a very real threat and one that will keep a lid on any serious rebound in the property market.
With all this risk and uncertainty, home owners are now trying to reduce their personal debt levels rather than take on more. Ultimately this “savings” process will have a positive spin off for the economy as a whole and the property market specifically, but will see the market remain flat for some time.
Housing Construction Activity Very Poor
Residential construction remains in the doldrums and is at one of the lowest ebbs seen for many, many years. Consent numbers are down by nearly 50% from recent activity. A big drop in the value of vacant sections has been seen, pointing to the distinct lack of demand for new sites upon which to build. There is enough new housing stock available to meet immediate demand and reduced house prices do not make building a new home viable.
However, looking out to 2010/2011 if the low building consent numbers continue and there has been a noticeable rebound in migration, the prospect of a shortage in housing stock could arise.
Apartment Market Hit Hard
The apartment market has been badly hit. Prices in many developments have suffered huge falls, in some cases 50% down in value. This is very relevant for leasehold water front complexes due in part to current or pending ground rent reviews where large increases in ground rent have resulted in erosion in value.
In some upmarket developments the cost of combined ground rent and body corporate charges can be $10,000 to $15,000 or more for a larger unit. This has meant ownership is more costly, having to find $300 per week just for the right to occupy the unit before any other mortgage interest costs. Purchase of these as a rental investment does not stack up unless the units are bought at extremely low levels – which is being seen at mortgagee sale.
The buying public is now much more wary of purchasing leasehold apartments due to the pending ground rent reviews/increases. Furthermore, banks have reduced their lending margins on property such as this to only 50% and in some cases, banks are not lending at all on leasehold apartments. This has further undermined the value of these as an investment.
Small investment apartments have also tanked in value. Small “shoebox” units in particular have been very hard hit but ironically, as an investment, these can give the best rental return. As an example, an inner city freehold studio furnished apartment can be let at around $220 per week or $11,500 per annum. On a current purchase price or valuation of around $100,000, this shows an initial return of 11.4% before costs or vacancies. Some of these studio “shoebox” units have been purchased for as little as $75,000 showing an even greater return of 15%.
The shift in yields from investor expectations has seen yields rise on average between 0.5% to 1.5% across most sectors of this market.
But, due to the distinct lack of sales transactions occurring, it is difficult to accurately quantify this yield shift. However, there is a very real expectation from investors that they should be receiving a higher level of return now for the increased risk of commercial property ownership. These increasing yields are required to compensate the investor for the greater uncertainty which is now prevalent, the prospect of increased vacancies and nil or negative rental growth.
The result of the current fallout in the commercial market is reducing demand for space and lower value levels. The short to medium term future of the commercial market will be directly related to the performance of the economy. As the country gradually pulls out of recession there will be a corresponding stablisation of yields and values.
Although significantly lower interest rates and debt servicing costs have improved the fundamentals for property ownership, the current recessionary economic conditions have far outweighed investor sentiment. After all, falling interest rates result in falling values.
Increased vacancies are occurring across all commercial property types including office, retail and industrial. Office space outside of the CBD area has probably been the hardest hit, most notably within the North Shore (Albany and Takapuna areas) where vacancies have now lifted to above 10%. Secondary fringe city office space vacancies are also rising but at a lower rate while prime CBD office space vacancies remain relatively low.
This is good news for tenants wishing to negotiate a deal. Landlords are now needing to offer greater incentives to attract a tenant with longer rent holidays, increased fitout and tenants negotiating lower rental rates now a common theme.
Increasing vacancies will also manifest in lower rental growth or declining rents over time and a requirement for an increased vacancy allowance for any lease approaching expiry or within a vacant building.
At Risk Property
Properties at risk include vacant land, subdivisions and vacant buildings. Vacant buildings, particularly those of a secondary nature be they poorly located, older or rundown, are being the most severely hit in the current market. Significant discounts in value are being reflected from sales of older outdated vacant premises due to the risk attached in either upgrading the space or finding a tenant. This has created good opportunities for owner occupiers to purchase such buildings at well below cost.
Subdivisions or large blocks on the urban fringe are also being heavily discounted at present due to the very poor demand for the resulting sites created and longer term holding now required to progress a subdivision to completion.
Again this offers good opportunities for long term investors to gain entry at a significantly lower cost price than has historically been the case. However, banks are very wary of lending on subdivisible blocks at present, thus these opportunities may only exist for buyers who have cash reserves for purchase and are not relying on a bank.
The fundamentals of property investment – that is cashflow, tenant covenant and lease term – are the primary focus of any investor at present coupled with location and quality of building. It is though primarily the tenant covenant and ability to pay the rent into the future giving a landlord certainty of income which is the key to satisfying a purchaser’s requirement. Yields for this class of investment property, where there is certainty of income, still remain relatively strong. But secondary property – and those with short lease duration – are being discounted heavily. However, good quality investment property still remains tightly held with limited opportunities being brought to the market.
While the recession will continue to have a negative impact and the investor market will see much reduced activity, partly as a result of the reduced availability of finance, over the longer term the outlook for commercial property still remains sound. Although growth in Auckland is likely to be constrained as any recovery in the economy will be export led rather than from increasing domestic spending, regional centres are likely to perform better as a result. However, Auckland should benefit from the 2011 Rugby World Cup which will undoubtedly lift business activity and further increases in migration are likely to largely translate into the Auckland market.
But, the economy is exposed to off shore effects and the repercussions from the world banking crisis are still being felt. This has seen greatly reduced availability of finance and much tighter and more restrictive bank lending criteria; although, the cost of money has declined with the lowering of interest rates.
The commercial market has enjoyed increasing rents over the past few years on the back of spiraling land values and increased building costs. This growth has now ceased and the escalation in rents is likely to have turned negative. Whilst there has been minimal change in the cost of construction, underlying land value has fallen. Demand for vacant sites is low. Over the longer term a shortage of sites within the more favoured business locations should see the long term maintenance or appreciation of values in the better, well developed localities. Business land values have weakened over the last year as the peak in the property cycle has been passed.