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Property price boom masks risks for investors as yields plummet

Property investors speculating on capital gains need to be careful as rental yields in Sydney and Melbourne hit record lows. 

Low rental yields make property investment less affordable and investors more exposed to increases in interest rates. 

CoreLogic figures show the "gross" yield – before costs – on both houses and units reached record lows in January across Sydney and Melbourne.

The gross yield on Sydney houses in January was 2.8 per cent and in Melbourne it was 2.7 per cent.

Sydney units recorded a gross yield of 3.8 per cent and in Melbourne it was 4 per cent.

"While rental yields plumb new lows, investment in the housing market has been consistently ratcheting higher, which implies that investors are speculating on further capital gains in the housing market," says Tim Lawless, the head of research at CoreLogic.

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Price rise surprise

The continuing strength of property prices in Sydney and Melbourne has surprised most analysts.

Early last year most were expecting property price growth in those cities to moderate.

But two cuts to interest rates by the Reserve Bank in the middle of last year, continuing high levels of investor demand and an overall lack of supply in our two largest cities have overturned expectations.

Sydney house prices are 16.6 per cent higher than a year ago and Melbourne prices are almost 13 per cent higher, figures from CoreLogic show.

Apartment prices in the harbour city are 13.1 per cent higher. However, a big supply of apartments in inner-city Melbourne is probably behind apartment prices rising just 2.8 per cent during the past year in the southern capital.   

Since 2015, the banking regulator has forced lenders to restrict lending to investors, who are believed to be a major factor in the price rises.  

But they are still a big source of demand in both cities. Australian Bureau of Statistics figures show investors comprise 58 per cent of the value of new mortgage demand, excluding refinances, in NSW and 45 per cent in Victoria.

Dr Shane Oliver, the chief economist at AMP Capital Investors, says the continuing strength in Sydney and Melbourne property prices is coming from an acceleration in lending to investors and high auction clearance rates and will add to Reserve Bank concerns about financial stability.

"While a surge in housing supply to record levels will act to slow the property market this is still yet to become clearly apparent, except perhaps in Melbourne unit prices," Oliver says.

He says says the regulator, the Australian Prudential Regulation Authority (APRA) might even take further measures to restrict lending to property investors in the Sydney and Melbourne markets given the strength of price rises in both cities.

Higher mortgage rates

Most lenders have lifted the mortgage interest rates they charge investors – not only fixed interest rates for new borrowers, but sometimes including the variable mortgage rates of existing borrowers.

Lenders have also been tightening their lending criteria for investors, such as imposing higher interest rate "buffers", discounting the expected rental income and not taking into account the benefits of negative gearing.

More than half of experts and economists (58 per cent) polled by comparison site Finder say the next cash rate move will be up, however just over half of these respondents do not expect a rise to occur until 2018.

Five of the experts and economists (17 per cent) are expecting a rate rise this year, with three predicting this will happen as early as April or May.

Oliver is in the minority. "We remain of the view that the Reserve Bank will cut interest rates again but not until May, but this is likely to require either some slowing in property price momentum or a further tightening in APRA's macro prudential policies," he says. 

But there are factors that will likely stop prices rising at the current pace, Lawless says.

For one, there are "affordability constraints", particularly in Sydney, that are likely to become more pressing, he says.

And while high-rise apartment approvals have peaked, there is still a long pipeline of supply, especially in the inner-city areas, Lawless says.

However, off-the-plan buyers have to be aware of "settlement risk". 

Off-the-plan warning

CoreLogic figures show 40 per cent of off-the-plan settlement valuations are coming in under the contract prices across the Melbourne, Brisbane and Perth. 

While the large majority of these under valuations are not showing a significant gap between the contract price and settlement valuation, more significant differences can be seen in some projects and precincts, Lawless says.

Buyers who receive a valuation lower than the original contract price will generally require a larger-than-expected deposit in order to meet the loan-to-valuation ratio required by the lender, he says. 

As units in areas with a lot of supply come to settlement, the risk of buyers receiving a "finance shock" is heightened, Lawless says. 

Sam Lally​, a buyer's agent at Buyer's Advocate Australia in Melbourne, says areas like St Kilda Road, Docklands and Southbank are "fraught with danger because of the supply of apartments".

"And we don't touch-off-the plan – it's just too risky for our clients," he says.

He has been buying on behalf of his investor-clients in the northern parts of the middle ring of Melbourne; mainly townhouses with at least a 30 per cent land component.

He has bought about 35 properties in Reservoir during the past four years in the $400,000 and $600,000 range on gross yields of just under 5 per cent.

"There's still areas of Melbourne where land is undervalued – you have got to know where to look and what to look for," he says.  

The view on continued price rises is more bullish for Sydney.  Urban Taskforce chief executive Chris Johnson says Sydneysiders have to accept that their future is mainly in apartments rather than houses.

The supply of new dwellings [apartments and houses] is not enough to meet the market, with an estimated 37,000 needed this year when only 31,000 were built last year, he says.

Meriton group founder Harry Triguboff​ says: "We have a situation where the apartment supply this year is not, I'm afraid, likely to meet the demand and that can mean only one thing – buyer competition forcing prices higher."

Meriton is Australia's largest residential developer, building more than 60,000 apartments across Sydney, Brisbane and the Gold Coast.

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