10 minute read
Expect the unexpected with property
PER AMUNDSEN is head of research at Thinktank.
Property will continue to be a major part of the equation as SMSF trustees brush off their investment strategies. But Per Amundsen warns care will be needed because the world has changed.
With Victoria out of lockdown and some green shoots of recovery beginning to appear in other states, now seems an opportune time for SMSF trustees to revisit their investment portfolios. Although 2020 has been a year many would wish to forget – and not just on the investment front – overseeing an SMSF’s investment portfolio is a race that never ends.
In this investment critique, property will be front and centre of the thinking of many trustees. On the latest ATO statistics, it comprises more than $110 billion (15 per cent) of total SMSF assets, with commercial property accounting for $73.5 billion and residential $50.2 billion. Only cash/term deposits and listed Australian equities, at 21 per cent and 26 per cent respectively, have bigger slices of the SMSF asset pie.
That trustees are attracted to property is unsurprising. Leaving aside the fact most have experience in this market via the family home, for a sizeable number investing in business real property can neatly dovetail their business goals with their retirement income strategies. The introduction of limited recourse borrowing arrangements (LRBA) in 2007 has helped facilitate this type of investment.
But past knowledge of the property market, whether it be commercial or residential, does not automatically translate into getting future investment decisions right. And certainly not in the current climate. Thinktank’s quarterly property update for October to December 2020 recognised SMSF trustees are in a brave new world, to borrow the title of English author Aldous Huxley’s 1932 dystopian social science fiction novel.
This economic reality was brought home in the latest International Monetary Fund (IMF) “World Economic Outlook”, which estimates global gross domestic product will shrink by 4.4 per cent (previously forecast to be -5.2 per cent) this year followed by an above trend recovery of 5.2 per cent in 2021 (previously forecast to be 5.2 per cent). In its outlook, the IMF said: “The global economy is climbing out from the depths to which it had plummeted during the Great Lockdown in April. But with the COVID-19 pandemic continuing to spread, many countries have slowed reopening and some are reinstating partial lockdowns to protect susceptible populations.
“Improved forecasts for the United States economy now call for negative growth of 5.8 per cent in 2020 (up by 2.3 per cent) and rebounding to 4.5 per cent in 2021. China is now forecast to grow slightly better at 1.9 per cent in 2020 (up 0.9 per cent) and surge 8.2 per cent in 2021, while India is now worse and forecast for a negative 10.3 per cent for 2020 (down 5.8 per cent) but to pick up strongly to 8.8 per cent in 2021 (up 2.8 per cent).”
In Australia, the second quarter national accounts released by the Australian Bureau of Statistics (ABS) on 2 September told a similar story. The second quarter (April to June) had negative growth of 7.0 per cent (negative 6.3 per cent annual) compared with a 6.3 per cent contraction in the first quarter of 2020. On the federal government’s figures, it is forecasting a 3.75 per cent contraction in economic activity for 2020 before rising to 2.5 per cent in 2021.
It’s worth stating all these numbers are predictions. As several European countries descend into a heavy second lockdown (and this has occurred post the IMF report) and in the US the spread of COVID-19 remains unchecked (its death toll is approaching 250,000, the highest in the world), no one can predict what economic damage this pernicious virus will continue to exact or over what time frame. The world economy might rebound strongly in 2021, and then again, it might not.
So, what does this mean for property markets? What should investors be alert to? On the residential front, markets continued to fall during the third quarter of 2020 as prices for housing softened nationally, more so in Sydney and Melbourne. The long-term impact of COVID-19 on property prices is still not known, but Thinktank has moved from a “softening trend” across the board as further declines are less dire, but retained it for Sydney units and both houses and units in Melbourne – a graphic illustration of the impact of the coronavirus lockdown on the southern capital’s property market.
Houses in Sydney were down 1.7 per cent for the past three months and 3.7 per cent in Melbourne. For the nation, the fall was less at 1 per cent. Only one of eight capital cities’ houses were down for the year (Perth fell by 0.9 per cent). Notably Adelaide was up 3.5 per cent, while Brisbane was up 4.5 per cent for the year. Regional prices were up 4.5 per cent. Perhaps rumours of more Australians looking to live and work in the regions have some truth to them.
Unit prices are down by less than houses in Sydney and Melbourne in the previous quarter (July-September), according to Core Logic, at 1.5 per cent and 2.3 per cent, respectively. Adelaide was up 1.3 per cent and the combined capitals were down 1.5 per cent.
With the evidence showing residential prices for houses and units in all capital cities either starting to decline or just peaking, we remain wary of this market, especially as we are still uncertain how the economic impact of COVID-19 will play out. Longer term, the issue of population growth and migration, so critical to the supply and demand equation of housing, is another wild card, with the numbers set to remain lower than what has been the historical norm for some time. And even with a strong V-shaped recovery, which is looking much less likely, growth will be diminished. Notwithstanding all of this, consumer sentiment has shifted regarding property with more feeling now is a good time to buy. To this we would say, caveat emptor.
Commercial property, too, has not been immune to COVID-19. In July, the Property Council of Australia’s “Office Market Report” showed office vacancies rising in all capital cities, with Sydney and Melbourne heading the list. Fast forward to a more recent survey by JLL Australia and the vacancy numbers are up in all capital cities, with a flow-on effect on incentives and net effective rents. “The vacancy rate in Sydney has been inching upwards for several quarters before jumping from 5.8 per cent to 7.5 per cent. The situation in Melbourne is more dramatic yet, where the vacancy rate has more than doubled from 3.4 per cent to 7.7 per cent. In Brisbane, Perth and Adelaide, vacancy has also increased, but more moderately,” the study said.
HTW’s most recent “Month in Review” describes Sydney as facing rental oversupply with contracting economic conditions, while Melbourne has large oversupply and faces severe economic contraction. Their markets are both described as starting to decline while the other capital cities are further into the cycle. Yields are now softening slightly in most locations, but ultra-low interest rates, which are expected to last for years, are offsetting lower returns.
For SMSF trustees, there are some critical questions to be asked about investment in office space. The coronavirus has forced many people to work from home. Is this a long-term trend or a one-off response to the pandemic? We noted above the solid rise in regional residential prices. Does this herald a shift from the cities to the regions with a flow-on effect on central business district (CBD) office space? Blue-chip property companies such as Charter Hall saw their share prices savaged in the stock market sell-off earlier this year, only to recover much lost ground over the past eight months. Does this mean investors believe CBD office space remains a viable investment option?
Whether listed or unlisted, in a record low interest rate environment, commercial property has provided SMSF trustees with much-needed yield as well as capital gain. Whether that continues to be the case remains to be seen.
Recently released ABS figures for retail sales in August, in current price terms, fell by 4 per cent in what was described as a second-wave setback, following a rise of 3.2 per cent in July. Victoria was down steeply by 12.6 per cent following its second lockdown. Despite being up 7.1 per cent for the year, weak private sector business surveys suggest conditions will remain difficult. By state, Victoria predictably lagged the others, down a massive 12.8 per cent, with New South Wales down 2.0 per cent. Western Australia was only down 0.4 per cent, South Australia 0.9 per cent and Queensland 1.1 per cent.
In this economic environment, store closures are being announced almost everyday. To quote JLL: “We remain cautious about the outlook for discretionary retail as stimulus measures roll off later in the year, which is likely to contribute to an upward trend in vacancy rates. The events throughout the past few months have led to many discretionary retailers planning to shrink their store network that will likely polarise the retail sector even more.”
Even before COVID-19, online shopping was exacting a toll on the retail sector, and the pandemic has magnified this. But to what degree remains uncertain. CBRE reported yields have fallen by 35 basis points in the retail sector since the end of last year, with rents also falling by up to 10 per cent year-on-year. But this is not uniform, with neighbourhood shopping centres bucking the trend. Thinktank has kept all its retail ratings and trends at Weak and Deteriorating on the basis that eventually we would expect declining earnings must lead to a further softening of yields and we will see lower capital values in general.
Industrial remains the standout performer. In the ACCI-Westpac Survey of Industrial Trends for the September quarter, it rose strongly from 24.0 in June to 42.4, recovering from the most negative reading since the series began. This is consistent with the Westpac-MI Leading Index, which also recovered to minus 0.48 from minus 2.56 in August and minus 4.42 in July.
Unsurprisingly, Victorian manufacturers continue to report the weakest results among Australia’s large manufacturing states. Manufacturers in NSW and Queensland also reported a decline in activity, while in South Australia, the index rose further into expansion. CBRE reported it was the story of the commercial property market in a pandemic: industrial is surging as investment in office property slowed to a trickle amid uncertainties over longer-term workplace occupancy. Likewise, lockdowns have put a brake on retail investment.
According to CBRE, industrial yields are tightening in all locations and for both prime and secondary properties. Rents for prime properties will show little change, while secondary properties would initially see yields tighten by 50 basis points and face rents would stay the same, but with incentives rising slightly to 16.6 per cent. In its most recent monthly review of the Industrial sector, HTW sees Perth remaining in oversupply and is rated as Weak and at the bottom of the market.
We have kept our ratings for Sydney at Good and Stable, as well as Adelaide, with a similar trend for Brisbane, but rated Fair. Melbourne, understandably, has been cut to Starting to Decline, but we have kept it at Good, expecting a short-term recovery once restrictions are lifted.
To complicate matters more for SMSF trustees, the domestic situation is overlaid by overseas factors. The certainty is that international growth has plummeted, with high unemployment and underemployment with interest rates to stay low for some years to come. Much of the world is still grappling to contain COVID-19 and until that happens or a vaccine is found, it’s hard to see a sustained economic recovery.
It will be no easy task for SMSF trustees to pick the wheat from the chaff when they contemplate property investment, whether it be commercial or residential. Getting professional financial advice would seem a good starting point because if the past nine months has taught us anything, it’s expect the unexpected and plan for it.
