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April 26, 2023 by ash

Don’t be distracted by the RBA when it comes to residential property: Chris Bedingfield

House prices and interest rates are hot topics but it’s not the complete residential property story according to Quay’s Chris Bedingfield.

If falling Australian house prices are keeping you up at night, you might be surprised to hear it described as the investment pick to hold for the next five years. Chris Bedingfield, Principal and Portfolio Manager at Quay Global Investors stands by this though. It’s a call he’s made for some time.

He argues that the supply and demand dynamics, that is population growth and an undersupply of housing (just look at the rental crisis), along with the rising construction costs are likely to see housing prices eventually return. At least back to the level of replacement costs. As a result of this, he sees RBA decisions as simply being a distraction from the bigger picture.

“Even if you get an after-tax return on your principal place of residence of 3% pa or 3.5% pa, you will do better than what global equities has done over the last 20 years on an after-tax basis. You don’t need much of a good return to justify it,” Bedingfield says.

In this edition of Expert Insights, Bedingfield discusses why Australian housing is still a good long-term investment, his views on central bank activity and his tips for those looking to buy or sell in this market.

Edited transcript:

In the past, you’ve selected residential property as your investment pick to hold for the next five years. Is this still the case?

There’s two markets in residential property at the moment. You’ve got the rental market and the buyer’s market. The buyer’s market is affected by credit availability, cost of funding, sentiment and fear of missing out in the short-to-medium term. 

That can lead to false signals. When the market is going up, you might think the market is undersupplied. When it’s falling, you think it’s oversupplied, but it’s not really, it’s just the sentiment.

Where you can really get a good idea of the strength of the underlying market is the rental market. And we know the rental market is extremely tight in this country right now. We don’t have enough houses available for lease. I think the last number I saw was around 30,000 dwellings out of 10.5 million. That’s not a lot. And there’s talk now that population is going to increase over the next 12 months by 400,000 people.

Now, if you need more houses to be built at some point in the future, which you obviously do given those dynamics, prices have to get back to replacement costs. Otherwise, builders and developers just won’t show up. They’re not going to build it. 

We can either get prices back up to replacement costs the easy way or the hard way. The hard way is keep interest rates high and just let those rents grind higher and higher until the maths works again. Or we cut interest rates and get a development cycle.

I want to be really clear on this, I’m talking about your principal place of residence as opposed to an investment. I think if you’re a long-term owner of residential property and you think about those dynamics, the market is pricing at a discount, we’re seeing housing starts collapsing, the population is growing so prices have to get back to replacement costs to get the development cycle working again.

As long as it is sensibly financed and it’s your principal place of residence, I think it’s one of the better places to have your capital. The reason I say principal place of residence is that it is tax-free. It’s one of the last tax-free things you’ll have.

Even if you get an after-tax return on your principal place of residence of 3% pa or 3.5% pa, you will do better than what global equities has done over the last 20 years on an after-tax basis. You don’t need much of a good return to justify it. 

I still stand by it. I think I would never talk anyone out of buying their own home if they can because of those dynamics.

How do you see Central Bank activity playing out in residential property markets this year in terms of Australian property prices?

In the way the central bank thinks of how monetary policy works, the transmission mechanism is almost always through the housing market. What they’re trying to achieve is a deceleration of people spending. So mortgage holders will have less money to spend. And they’re also looking for a decline in construction activity. They’ve already achieved the second part of that, we’ve seen construction activity fall. Where the waters get a bit muddied is that in Australia and the rest of the world, rising interest rates make mortgage holders pay more. But people with money in the bank will have higher returns and can spend more as well, particularly retirees.

It’s kind of a wash when you think about the system because there’s as many liabilities as there are financial assets in the system. That’s why banks balance sheets balance. You’re getting this very muddied economic scenario where the central bank’s been raising interest rates but the economy’s been incredibly resilient outside of the construction sector. 

The thing about interest rates is that they may work but they’re non-linear in the way they work and the shocks can come very, very quickly. You don’t get this gradual slowing that the RBA is looking for because you have an interest income channel working against an interest expense channel. So it’s very hard to predict what they’re going to do.

Fortunately for us, we don’t think about it too much. We just fundamentally believe that if you can buy a building at a 20% discount to the cost to build and the development cycle is going to work again, we’re the first ones to make money before that development cycle occurs and interest rates can do whatever. There’s been plenty of occasions where interest rates have been going up and property does extremely well. My hair is of the colour that would probably suggest I’ve been around for a little while.

I remember in the late 80s, interest rates doubled and Sydney property prices went up 50% during that same timeframe. We saw Australian house prices boom between 2000 and 2007. Interest rates were going up at that time as well. That is likely to occur again at some point in the future. 

I think getting caught up on central bank policy is more of a distraction than anything else. If you can buy something below the cost to build and it’s worth building again at some point in the future, your only enemy is time. You just have to wait and that cycle will give you a return.

To what extent do you see the rollover of fixed rate loans affecting the market?

I’m looking forward to seeing how this plays out. 

It’s a very easy story to say, “wait till this debt rolls. It’s going to be awful and everyone’s going to get this big shot.” The other part of me thinks Australians are pretty smart people. You go home, you watch the TV, interest rates are going up, read the paper, interest rates are going up. You would think that most people would’ve managed their affairs by this stage. They would either be selling or thinking of selling or have sold, or their incomes have risen to the extent or their circumstances have changed to the extent that they feel like they can ride through it.

So there’s two sides to this. Are Australians, particularly those who bought in the last 2.5 years, politely unaware of what interest rates have been doing for the past 12 months? This is Australia, it’s like the Melbourne Cup. Interest rates are big topics. 

I think people are going to be surprised how resilient the market is when these rates reset. But to be honest, I’m looking forward to seeing how it plays out because I’m not 100% sure which way it’s going to go.

What are your tips for those buying or selling Australian residential property this year?

When you buy a principal place of residence, you own it until you don’t need it anymore. Don’t get caught up on the last transaction or comparable sales because you’re probably going to be buying too high at the top of the cycle. Then when markets are nice and cheap, you’re going to be scared off because prices are falling. You’re going to be running away when at the time, you could be buying at less than the cost to build.

Do your numbers, look at how much brand-new apartments are selling for versus existing and look at the macro environment as well. We know that housing starts are falling. That’s telling you everything you need to know. Developers are look at the feasibility today and they can’t make it work. That should give you a bit of confidence no matter which sector you’re looking at.