Are we at the start of the next property cycle?

When it comes to conversations amongst family and friends, Australian residential property is often top of the agenda. Where are prices heading? Should I buy now? What’s happening in the rental market? While we saw a short-term dip in prices, arguably, property prices are definitely back – currently standing at similar levels to pre-COVID pricing.

And while no one has a crystal ball, there are a few things that are currently true of the property market.

1. There is an undersupply of residential housing to the tune of around 106,300 dwellings across the five years to 2027. (Source: Housing Australia).
2. There’s been a boost in immigration up 103% from last year to 681,000 people, according to the Australian Bureau of Statistics.

While the undersupply is not just due to immigration numbers, the surge is certainly doing nothing to alleviate demand for housing. According to Andrew Schwartz, Group Managing Director and Co-Founder for Qualitas, the challenges of supply and demand in residential housing are unlikely to ease up anytime soon.

“It takes time to put new supply into the market and underlying supply is probably running at 20-30% of what is demanded by the market,” says Schwartz.

But that’s also what makes it such an attractive area to invest in – after all, less supply and high demand is only price accretive.

Schwartz is starting to see a pickup in construction and thinks we are seeing the start of the next cycle. In this episode of Expert Insights, he shares why Qualitas favour residential property, the trends he is seeing and his advice to those investing in this space.

Looking for regular income and diversification?

The Qualitas Real Estate Income Fund (ASX: QRI) aims to deliver investors a regular stream of income with the added benefit of diversification beyond shares and traditional direct property investments.

Edited transcript

Why is residential property a significant exposure for Qualitas?

I think the reason why groups like ours have a substantial exposure to residential, and to put that in context, if you look through all of our funds across the board, we're more than 70% invested in the residential sector at the moment, is that I don't think it's often in your investing career that you see a market dynamic where you have very low vacancies and exceedingly high demand, supply side delays in terms of getting new product into the market. 

That dynamic is not going to change quickly given the high levels of immigration. For us, that gives rise to an investable asset class that we can have very significant comfort around. We continue to heavily focus on that, as one of the major asset classes. 

At what point of the residential property market cycle are we?

I think we're at the start of the next cycle. 

We've been through a period where we've had construction costs substantially increase, estimates are around 20% and we've even seen some projects where construction costs are up 30% from where they were pre-COVID.

We've had this real lift in construction costs with a delay in off-the-plan realisation values being able to keep pace with the lift in those construction costs. Something has to give in that equation. 

The truth of that is that what's ultimately happened is realisation values have gone up. I don't want to overstate it, but we are starting to see that uplift coming through and a lot of projects that were previously not feasible, are now feasible. I do think we're at the start of the next cycle, and we feel that's how it's going to play out over the next couple of years.

What are some of the key trends you see?

We're seeing ongoing competition for those that want to develop. We are seeing competition for those that want to rent as well. As a proportion of the total population, more people are choosing to rent because if you look at the cost of mortgage rates and home loans and compare that to the cost of rent, it's clearly saying that rent is becoming a much more affordable way to secure residential accommodation. 

We do think that the proportion of renters are increasing. We have a build-to-rent, jointly-owned platform known as GQ. We are seeing very substantial capital demand into that particular sector because long-term investors see the ability of owning a substantial volume of residential apartments and enjoying long-term escalation of rents. 

I think that will be an ongoing trend where institutions will start to own many buildings in Australia as opposed to necessarily mum-and-dad type investors owning off-the-plan strata apartments. 

These are the key trends that we see at the moment. 

When do you see supply/demand challenges easing?

I think it's going to take quite a long time. I feel that it takes time to put new supply into the market. Underlying supply is probably running at 20 or 30% of the actual amount that is being demanded by the market. It's just going to take time. I don't think any of us have that absolute perfect crystal ball on it. I'm reticent to put a number out there but intuitively, I would feel that this market is set for at least the next three to five years into this next stage because of the lag time of actually getting supply into the market, that's my intuitive feeling. 

Do you have any final advice for investors on residential property?

You need to deeply think about the cash flows of the underlying property that you're buying. 

Yes, location is really important, yes, the price you pay on acquisition is really important but we are in for a longer and higher interest rate environment. And not all properties behave the same. Therefore really thinking about what is the long-term growth prospect of the cash flow of the property that I'm buying is going to be the secret to long-term success.

I think the days where you buy a property and you raise bank debt or any debt where there's a margin between the yield of the property and the debt, and I can just make money by long-term ownership, are behind us and that's mainly because the cost of debt is now significantly higher than what it was just 18 months ago. 

So, you, as the owner of a property, really need to think about what your underlying growth prospects are for that property with the debt that you've taken on in order to finance the acquisition of that property.