Residential property outlook solid for 2010, but commercial and industrial sectors subdued

The phasing out of the first home owner’s grant will test the residential property market, but shortages of housing and improved investor sentiment will push prices higher and keep the industry strong, the new ANZ Property Outlook report reveals.

But the country will face a massive housing shortage unless construction supply increases, with the possibility of a deterioration in affordability “beyond anything we have ever seen”, the report claims.

Additionally, commercial property investors will likely see past short-term weakness and focus on the resetting of market valuations to occur next year.

The report, which focuses on both the residential and commercial property sectors, says the official interest rate will rise over the next year as the overall economy recovers.

However, it suggests that despite the rising cash rate and the phasing out of the first home owners grant, prices will increase with investor sentiment set to grow.

“The remarkable rise in Australian house prices in 2009 has finally silenced the doomsayers. The national median house price has risen by an impressive 10% over the first 10 months of the year buoyed by low interest rates, the first home owner boost (FHOB) and tightening underlying fundamentals,” economist Alex Joiner said in the report.

The report points out the claims of an initial market crash at the start of the financial crisis failed to recognise differences between the Australian and US markets. It says the financial crash occurred due to the collapse of home lending standards, with “predatory lending, fraud and ineffective prudential supervision” involved.

“In contrast, strong prudential regulation and conservative lending practices kept sub-prime lending to less than 1% of the Australian mortgage market,” he said.

As a result, the report claims the outlook for the residential property market is quite strong. It notes national median house prices rose by 10% in the first 10 months of 2009, and expects a resilient market performance in the next year.

“While we still expect a deceleration of prices in 2010 as the FHOB is removed and interest rates are lifted towards ‘neutral’, recent momentum suggests price gains could be stronger than anticipated.”

“Despite a marked rise in properties for sale, auction clearance rates have remained high in recent weeks and an upgraded economic outlook and improved job security will continue to boost investor and homebuyer confidence,” he said.

However, the report claims the greatest issue facing the market is inadequate supply, and says unless significant action is taken to remove impediments to home building Australia will face a shortage leading to a “deterioration in affordability”.

“Moreover, each day underlying housing demand remains above new supply, the market tightens further. We estimate that underlying housing demand is running at an annual rate of 200,000 while dwelling completions are expected to fall to under 130,000 in 2009-10.”

“With the market already extremely tight (reflected in near record low rental vacancy rates in most state capitals), an additional shortfall of 70,000 dwellings will have a marked impact,” Joiner stated.

The report says it remains unlikely annual completions will reach the 200,000 number needed to meet demand, and suggests building activity will be constrained by developer levies, regulatory costs, access to finance and skilled labour shortages.

“Outside of concerted public policy action to remove the existing impediments to home building and/or substantially lower population growth, we will endure a sustained period of rising rents and house prices.”

“This will continue until the point when builder profit margins have risen sufficiently to encourage higher levels of residential construction. In the meantime, things are likely to become increasingly unpleasant for renters and first homebuyers.”

In commercial property, the report claims while valuations have fallen over the past two years prices are approaching a low point, and that capital raisings in the industry have lowered the risk of asset sales.

Office property is now prepared for a “soft landing”, with rents and capital values set to grow. The Melbourne market is “well placed on a number of fronts”, with vacancies expected to peak at just 8%.

In the retail sector, the report says the rising number of international tourist arrivals will help the market, while falls in industrial capital values over the last two years are “expected to come to an end”.

In the industrial property market, the report claims the volatile market has seen business investment in new construction fall 15% in the year to June. And while price rises seen during 2006-08 are “unlikely to be reported”, the report claims market growth is expected to remain strong.

“We anticipate demand for manufacturing and warehousing space will begin to recover in line with the economy. Demand for vacant stock has remained fairly robust and any existing excess supply should be soaked up relatively quickly given the still low levels of construction in the pipeline. “

As a result, the report says falls in rents will be minimal over the next year. It notes a drop in the September quarter of prime yields of 100-150 basis points to about 8.5-9%, with secondary yields moving 150-200 basis points up to 10%.

The report also says transaction activity is set to remain subdued for some time, which will impact capital growth, but that cautious investors will begin to return as the overall economy recovers.