Despite some superficially attractive investment return promises, Dug Higgins says investors should treat US residential property with a high level of caution.
When an investment opportunity seems too good to be true, it’s probably not true – and that’s particularly so in the US housing market, says Dug Higgins.
It has long been said that the road to hell is paved with good intentions. I believe that this perfectly encapsulates the investment opportunities being offered to Australians in the US housing market. Current conditions have created an alignment of factors that have never been seen before.
A severe market correction has seen affordability and rents skyrocket; and a robust dollar has given Australians hitherto unparalleled purchasing power in American markets. Investors have responded by channelling more than A$600 million into US housing in 2010. The question is, are the opportunities worth it?
From an arm’s length perspective, the position of the US housing market looks dire on a number of fronts – particularly for owner-occupiers. Prices continue to stagnate, pressured by a bulging inventory of unsalable properties, and there’s a consensus view that this will flatten any recovery in the broader market until 2013. Job seekers remain challenged and labour force participation has declined. Employment figures are said to have risen; but without a robust improvement in the US labour market, any rebound in house prices is likely to be constrained in the medium term.
The recovery faces strong headwinds from not only the underlying market drivers but from regulatory and political reform. In February 2011 the US Government released a white paper outlining potential market reform options that could have widespread and long-lasting effects on the US housing market. US regulators are now questioning the American holy grail of home ownership. Even the US Treasury Secretary commented recently that,“while we believe that all Americans should have access to affordable, quality housing, our goal is not for every American to become a homeowner”.
This represents a seismic shift from more than a decade of government policies that encouraged all Americans to buy their own home. With the benefit of 20/20 rear vision, this undoubtedly helped pave the way to the current situation. As this is an issue that’s unlikely to be resolved before the next presidential election in 2012, the longer-term effects are as yet unclear. Whatever transpires, however, regulatory reforms will play a significant part in how the housing recovery plays out. In addition, the implications of shadow inventory are particularly vexing. Shadow inventory – made up of housing under delinquent loans, foreclosures and stock owned by banks – was estimated at 2.9 million homes in 2010. While the number of foreclosures being reported has slowed in the 12 months to March 2011, it appears that some of this is attributable to lenders scaling back repossessions amid regulatory scrutiny as doubts emerge about the legality of some bank foreclosures.
There’s an argument that a slowdown in processing foreclosure activity has skewed the data and that once the pipeline opens up again, foreclosures will spike once more. Some commentators in the US have put this figure as high as another three million foreclosures in the next 12 months. As such, the spectre of a double-dip in housing remains alive and well. Economist Robert Shiller, co-founder of the S&P/Case-Shiller Home Price Index, commented last month that further declines of 10 per cent to 20 per cent in the next five years wouldn’t surprise him at all. While this is obviously a broad-brush view, it highlights the risks still hanging over the market. While the data on the whole is ugly, windows of opportunity are now open for those looking to take advantage of the rental market. Com- pared to the lacklustre rental yields that have plagued Australian residential property for years, the prospect of double-digit returns is obviously enticing. With borrowers slow to resume purchases, due primarily to constrained credit (despite low interest rates), the rental market has been buoyed.
Dangers remain, however. With a national vacancy rate of around 13 per cent, would-be renters have a lot of choices. Extreme care needs to be taken then that the areas being targeted for investment, as well as the individual assets, are fundamentally strong enough to minimise vacancy periods. Given the constrained outlook for capital values, net yields should be calculated on a risk-adjusted basis to determine their worth. Returns in the market will be most sensitive to vacancy rates; and given that this will be the driver of the bulk of returns – unless a very long-term view is taken – a realistic assessment of this sensitivity is crucial.
To date, most of the focus on investment in US housing has been through direct investment. The current convergence of factors has whipped up appetites. There is currently a plethora of websites devoted to Australian companies providing people with the means to buy US housing assets directly. Despite an abundance of opportunities, Zenith would not advocate investing directly unless you have the ability to physically inspect the asset, have a sophisticated understanding of the American housing market and can access reliable, skilled agents and property managers.
So with the risks weighed against direct investors, unless they have sufficient time and knowledge, what is left for those Australian investors who still wish to pursue the American dream? The answer may be a managed fund. There have been several of these appearing in recent months, spanning both the listed and unlisted varieties, and available to both wholesale and retail investors. The burning question is, how are such funds likely to fare?
