Special report: Brisbane property – good value or value trap?

In our last report on the Brisbane property market, released in March 2015, I argued that investment fundamentals and valuations in Brisbane property were sound relative to the other major capitals, but that the economic outlook was mixed, thus posing some risks to potential investors.

With Sydney’s and Melbourne’s housing markets continuing their bull runs and in clear bubble territory, we thought it was time to revisit the Brisbane housing market to see if now could be a good time to invest.

A decade of stagnation:

The below chart tracks detached house prices, as reported by the Australian Bureau of Statistics (ABS), to June 2017:

The June quarter price results for Brisbane showed the housing market growing at a subdued pace, with house prices up 3.9% over the financial year and 16.0% above the June 2010 peak.

Brisbane unit price growth has been more subdued, with values falling by 1.3% in the 2016-17 financial year, and up just 6.3% from the June 2010 peak:

When adjusted for inflation, Brisbane house price growth has been weak. In real terms, Brisbane house prices were still 0.7% below their March 2008 peak:

Brisbane units have performed more poorly, with values remaining 8.4% below their December 2007 peak after adjusting for inflation:

The recent under performance of Brisbane housing has seen its median house price relative to the other capital cities fall to the lowest level in more than 40-years, suggesting that Brisbane housing presents relatively good value:

The below charts show the differential against Sydney’s and Melbourne’s housing values, with both at record lows:

 

It is important to note, however, that the above charts do not necessarily infer that Brisbane housing is “cheap”, since it is our strong view that Australian housing as a whole is overvalued. Rather, what they illustrate is that Brisbane housing is “cheap” relative to the market as a whole (Sydney and Melbourne, in particular).

Price momentum remains weak:

The June quarter results from the ABS shows a market where price momentum is weak. As shown in the next chart, real inflation-adjusted house prices grew by just 2.0%, whereas real unit prices fell by 3.1%. Both have also displayed a downward trend, albeit only slight for houses:

Usually the single best short-term indicator for house prices is housing finance commitments, which have shown a strong historical correlation.  As shown below, the annual growth in real finance commitments was barely positive in June (+0.3%), which from past experience suggests that price growth will remain subdued:

Brisbane remains oversupplied, especially in apartments:

In my 2015 report on the Brisbane housing market, I argued that the supply situation was evenly poised, reflected in both construction levels relative to population growth and rental vacancies.

Today, the situation has eased significantly, as evident by relatively moderate (albeit strengthening) population growth meeting strong dwelling construction:

This month’s property data from the ABS includes a series showing the total number of dwellings in each state. Although this series only dates back to September 2011, it is arguably the best data to use when assessing actual dwelling supply, since unlike the ABS’ various quarterly housing construction data (shown directly above) it takes into account demolitions as well as new additions.

Below is a chart plotting annual population change in Queensland against annual net dwelling additions:

And below is a chart showing the number of new additions to Queensland’s population as a ratio to the number of net dwelling additions:

Clearly, the supply situation has eased greatly over the past five years from one of shortage to an undeniable surplus.

The uplift in dwelling construction has been driven primarily by a surge in high-rise apartment construction, as shown in the next chart. And while high-rise approvals are well past their peak, there still remains a large pipeline of apartments still to be completed across Brisbane.

Indeed, CoreLogic this month estimated that greater Brisbane unit supply would grow by 20% over the next two years, with 39,420 apartments and townhouses hitting the market, including 15,650 over the next 12 months alone.

Rental vacancies have also lifted considerably in Brisbane, sitting at a relatively high 3.2% in the three months to August 2017:

With the deluge of apartments still to hit Brisbane’s market over the next two years, the city’s vacancy rate is certain to remain elevated for an extended period.

Rental returns still relatively good:

Brisbane’s rental growth has underperformed the other capitals in recent years, with gross house rents rising by only 11% since September 2009, compared with 16% rental growth in the other capitals, and gross unit rents rising only 9% in Brisbane versus 19% in the other capitals (see below charts).

Nevertheless, Brisbane’s relatively weak house price growth has improved rental yields relative to the other capitals.

Brisbane’s median gross house rental yield of 4.5% is well above the other capitals (3.7%), as are gross unit rental yields – 4.9% in Brisbane versus 4.4% in the other capitals. This makes Brisbane housing a relatively attractive investment proposition from an income perspective (see below charts).

Economy recovering slowly from mining construction downturn:

In our 2015 Brisbane housing report, we noted how the state’s economy faced stiff headwinds as the huge liquified natural gas (LNG) projects in Gladstone were completed.

While these jobs were obviously not in Brisbane, we expected a significant knock-on effect to the Brisbane economy and housing market via: 1) the significant number of workers in engineering, mining services, and mining company head offices; and 2) fly-in-fly-out workers that lived in Brisbane.

We are pleased to report that this process of retrenchment is largely complete with Queensland’s mining capital expenditures (capex) having falling back to normal levels relative to state final demand (SFD):

Reflecting this turn of events, the growth in Queensland’s economy – as measured by SFD – has recovered to be tracking in-line with the national average:

Queensland’s labour market has also improved, although it remains weaker than the nation as a whole.

Full-time jobs growth in Queensland has recovered:

As have hours worked:

However, Queensland labour underutilisation – combining both unemployment and underemployment – remains elevated at 14.9%, having fallen only moderately from recent highs:

Queensland wages growth also remains weak, but has at least recovered slightly to be in-line with the national average:

Overall, Queensland’s (Brisbane’s) economy remains fairly soft. And the outlook suggests that there will not be an acceleration anytime soon.

While the LNG-led construction downturn has ended, Brisbane now faces a large apartment construction downturn over the next two years as the huge pipeline of apartments under construction are completed (see charts above).

The strength of the recovery will also hinge on what happens to the Australian dollar. If the Australian dollar depreciates, as we anticipate, this would likely spur the tourism industries of the nearby Gold and Sunshine Coasts, which would obviously have flow-on effects to Brisbane’s economy:

Bottom Line:

For residents of Sydney and Melbourne locked-out of the housing market or seeking to invest in property, Brisbane is a compelling option, provided you steer clear of the oversupplied apartment segment.

After a decade of stagnation, the typical Brisbane house is trading at less than half the cost one in Sydney, and less than two-thirds the cost of a typical Melbourne home – the best relative valuation in more than 40 years.

Reflecting this relative undervaluation, Brisbane houses also offer far better rental returns than the national average, despite sluggish rental growth, making them a safer bet from an income perspective.

Nevertheless, there are still some risks. Brisbane faces a deluge of supply over the next two years as roughly 40,000 new apartments and townhouses hit the city’s market, which should place additional downward pressure on price growth and rents.

Capital values would also likely take a hit in the event that housing nationally nosedives; although given its relative affordability, we expect Brisbane to offer much better downside protection than the Sydney and Melbourne markets.

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