REITs – The back door into the property sector
Residential property developers are posting solid results this reporting season, as new housing supply is rapidly absorbed in Sydney and Melbourne. Mirvac Group, one of the Australia’s largest residential developers, reported a 36% increase in profits this year, getting a $2 billion boost from record residential pre-sales. Appetite for new residential developments is particularly strong in NSW, where there is still an undersupply in housing. Of the 4,000 lots Mirvac released in FY15, 90% sold in Sydney and Melbourne. This strong development activity is likely to continue, as rising volumes meet pent up demand. Mirvac expects to settle 2,800 more residential lots in FY16 (+25%). Their 5 year development pipeline supports a further 14,000 lot settlements. This is consistent across the sector, with competitors Stockland and Lend Lease also reporting strong gains from residential developments.
Is demand for residential property sustainable?
Double-digit house price growth has reached its peak and rental growth has fallen to its lowest point in 10 years as supply increases. However, yields from residential property remain well above term deposit rates and should support continued residential sales volumes. We’re still seeing investor activity driving the market, with sales growth over the past 12 months seeing little participation from first home buyers. The investor-led recovery has favoured apartments, with approvals at near-record highs of 220,000 in the past year. This is not unexpected when you do the numbers. Population growth is running at 1.8%, equating to 400,000 new Australians each year. Assuming 2.5 people per household, this means demand should be running at the current 200,000 per annum. For its part, Mirvac agrees that the numbers add up, particularly in New South Wales – it has seen its lowest level of net interstate outflow migration since the 1970s. Looking at residential property from the other perspective, housing affordability will remain problematic in the Sydney market as wages growth remains weak. We think there’s still some way to go for residential house prices to increase, but this should cap soon. Affordability versus house price growth The Reserve Bank of Australia (RBA) is unlikely to set interest rate policy based on the Sydney residential property market, with Melbourne and Brisbane remaining relatively affordable. Instead, the RBA has focused on bank credit tightening measures to limit investor activity. Mirvac Group CEO Susan Lloyd-Hurwitz is comfortable with what these credit tightening measures mean for her residential property business, expecting owner occupiers and first home buyers to take the mantle from investors in Sydney. While Lloyd-Hurwitz believes residential activity is close to peaking, she doesn’t expect prices to fall from here, as underlying demand in the Sydney market will be supportive.
REITS: another way to buy in to the property market
Mirvac Group’s share price performance has been strong over the past 12 months, with both FFO p/unit and dividends up 3%. Over the past three years, Real Estate Investment Trusts (REITs) have been the highest performing asset class overall, returning 21.6% per annum. This year it has outperformed the broader equities market by 2.5%. This comes as low interest rates both domestically and globally continues to drive down the appeal of more defensive assets like fixed income and encouraging investments in income-producing assets like property. While we’ve seen strong outperformance from REITs to date, investors are likely to need to temper their expectations about future earnings per share growth across the residential sub-sector as valuations peak. Although this asset class is expensive relative to net tangible assets, it remains cheap compared to bonds. However, this may be the perfect time for property trusts as physical residential investments present reduced risk/ return outcomes. Property funds allow investors to grab any future growth in the sub-sector, while also diversifying across other sub-sectors for protection and potential. For growth we are turning our focus to alternative REITs including those with activities in child care and manufactured housing. The Pendal Wholesale Property Securities Fund, of which Julia Forrest is a Portfolio Manager, has been named the Best Property Fund in the 2015 Financial Review Smart Investor Blue Ribbon Awards.