The shifting sands of the global real estate market: Pete Wargent

Global patterns are shifting in real estate. It’s something I’ve talked about for some years now, but in the world of real estate, you gradually come to realise that people generally form their own beliefs and stick with them until they see figures which might change their otherwise held views.

Capital is flowing around the world more quickly than ever before, and with stock markets remaining volatile, more of that capital is finding its way into real estate in prime global cities.

However, for many real estate markets, there will only be misery ahead, for a wide range of reasons. Australia, for example, has an ageing population, a declining employment participation rate and seems very likely to see a steadily falling rate of home ownership.

Aussies are changing jobs and careers more quickly than ever before, and thus there may be a diminished appeal in buying a home (with stamp duty and other transaction costs to pay) only for it to be sold within 36 months with yet more fees to pay.

It’s possible that we may see an increasing trend of younger Australians renting where they live, but owning an investment property as a foothold on the property ladder.

Aussie underperformers

When I started writing my first book back in 2010, I underscored the reasons why I felt that of all the Australian capital cities, with the possible exception of Hobart, the city I would be least inclined to buy real estate in would be Adelaide.

The South Australian capital has far weaker population growth than elsewhere (South Australia’s population increased by just 15,600 heads in the year to December 2012, while the states comprising the four major capitals saw increases of 83,000-99,500 persons respectively) and given the supply/demand dynamic I couldn’t see any valid reason why property prices would rise faster than household incomes in Adelaide. And I still can’t.

Although some have tipped Adelaide as a hotspot for more than half a decade, prices have flatly refused to budge. Sure, they probably will inch up while interest rates remain at the lowest level in a generation (however long that proves to be), but my question is: what happens when lending rates begin to revert upwards? It surely seems likely than any uptrend would rapidly be reversed, or at least, stymied?

I feel the same about most regional markets – their day in the sun has come and gone with the deregulation of lending conditions and an unprecedented increase in household debt in the period broadly from 1990 to 2005. Since that time, household debt levels have levelled off and correspondingly so have most regional property prices.

My personal opinion is that the only ways property investors are likely to outperform in the future is if they (a) can find a short-term hotspot (or perhaps time an investment in a mining town skilfully), or (b) if they follow the wave of speculative capital which is heading to the inner suburbs of the major capital cities.

I grew up in England and have watched prices in London’s favoured suburbs continue to increase at a dizzying rate for two more than decades with scant regard for the state of the economy or almost any other fundamental metrics which you might care to mention.

It’s true that the UK has few barriers to inflows of international capital. In theory, Australia restricts foreign ownership of established residential stock, but plenty have suggested that the rules are being easily circumnavigated through the use of friends or family members. The absolute level of Asian capital flowing in to Australia is certainly a point for debate, but where it is happening I’d suggest that the likely destination of funds is the major capitals, and potentially some other key coastal Queensland destinations.

Is this actually unfolding?

Take a glance at property prices across Australia – is my theory starting to play out?

Certainly, prices in some capital cities have stalled badly – including, notably, Hobart and Adelaide. Canberra prices may be back at record highs, but the city faces falling demand as public sector jobs are cut. And in aggregate at least, regional property prices have not shifted for years now. Brisbane has had its confidence knocked more than once, but personally I believe the Queensland capital has better days ahead (a topic for another day).

Melbourne, on the other hand, has been a staggering outperformer. I, for one, have been constantly amazed by the market’s resilience after the tremendous boom in prices since seen from around 2006 to 2011, with median dwelling prices moving more than 50% higher at well above $600,000 today.

I note that Australian Finance Group reported this month that 49.5% of mortgages sold in NSW were for investor loans, the highest level ever recorded in any Australian state.

Investors tend to buy and hold real estate, which clogs up the established market and ultimately damages affordability – correspondingly I think inner Sydney remains set for a period of outperformance.

The global shift: following the smart money?

Real estate funds have tended to shy away from residential property. Yields are typically low as compared to industrial/commercial/retail stock, and superior fund returns can be tough to achieve, involving detailed research and frequently an ability to add value across a large portfolio.

Institutional investors have recognised the trend towards high net-worth individuals parking capital in prime location real estate, and some new residential funds have sprung up in an attempt to capitalise on the trend, such as the Coral Prime Portfolio Fund, which notes:

“Very few cities across the world can support a prime or super-prime residential market, namely those with the leading financial districts and world renowned cultural reputations."

Where are the prime global cities?

Leading Global Real Estate consultants Knight Frank prepare a Prime Global Cities Index which covers 28 cities that it believes can support prime real estate markets. 10 of its 28 cities are located in the Asia Pacific region in cities such as Singapore and Hong Kong, but to date only one of its 28 cities is located in Australasia, that being Sydney. There might be an argument to say that with its even faster rate of population growth, Melbourne could be on an equivalent level to Sydney today.

Perhaps unsurprisingly, the Prime Global Cities Index performance has been massively hindered of late by its component European cities, the five worst performers all being European capitals (Madrid, Geneva, Rome, Paris, Zurich) - indeed seven of the worst eight performers are located in Europe - while the top of the index is powering ahead with the top 10 performers containing no fewer than five entrants from the Asia Pacific region.

Despite debt crises in countries such as Spain and Italy, in its Q2 2013 Prime Global Cities Index report, Knight Frank notes that prices in the luxury property market across its 28 cities are 27% higher than they were during the financial crisis lows of 2009. Notably, Knight Frank highlights that European markets appear to be through the worst  of their problems, with losses now slowing up.

It's also interesting to note the level of regulatory interference in prime real estate markets. Some Asian markets such as Jakarta and Tokyo have seen prices rocketing, and are looking to restrict foreign ownership in order to temper gains. Meanwhile, struggling European cities have looked towards "golden visas" to attract non-EU investors and prop up prices. So, if you ever thought real estate markets will be left to find their own level without interference...think again!

Two speed markets

Coral notes that Britain has now reached the point that many of us have predicted for years – it has a dramatically two-speed market, comprising prime location London and ‘the rest’:

“Prime Central London has become detached not only from residential prices in the UK, but also from the rest of London. This phenomenon is set to continue with limited stock and rising international demand. A challenged national economy and a weaker currency add fuel. Other international prime cities benefit from similar factors.”

It’s been my position that while prices will naturally ebb and flow, I can’t envisage how Sydney land prices will become cheap while we have domestic policies so heavily-focussed on a massively booming population in only a handful of city locations. Sydney’s population is forecast to grow to a jaw-dropping 7 million over the next few decades, and while we can build upwards, it's difficult to see how the popular suburbs will cope with such a booming level of population growth.

I’m not simply “bullish on housing” as some have suggested. Australian households have already undertaken the great leveraging up and dwelling prices in most locations appear likely to underperform quite badly as this decade unfolds. But I feel that Sydney’s inner suburbs are becoming increasingly heavily skewed towards investor capital and this will push prices up sharply in that sector over the coming decades.

His new book 'Four Green Houses and a Red Hotel' was released on 1 September 2013.