Is now the time to invest in property?

2023 is a “landlords’ market” with asking rents reaching record highs across the country during the March quarter, a new report has found.

This, at a time when supply is dwindling – investors are sitting on the sidelines as interest rates rise, and new home approvals have been trending lower for months as soaring construction costs spook buyers and wreak havoc on the building industry.

The RBA’s financial stability review – released Thursday – estimates the construction sector accounted for around 30% of company insolvencies over the past year. Nearly one in every three.

Yet rental demand is strong, and there’s no sign of that changing any time soon as an influx of overseas migrants, students and temporary visa holders hit our shores.

Updated government forecasts released this week project 650,000 migrants will arrive over the next two financial years. Add that to the thousands of births in that period and Australia’s population will increase by 900,000 by 2025.

Limited supply, booming demand. The result: higher rents, and higher property values.

After declining for almost a year as rapidly rising interest rates took the heat out of the pandemic-driven boom – there are signs we may have reached a turning point.

Corelogic’s home price index rose 0.6% nationally in March, driven by Sydney and Melbourne, up 1.4% and 0.6% respectively.

CoreLogic research director Tim Lawless put the rise down to a combination of low advertised stock levels, tight rental conditions and additional demand from overseas migration.

“Although interest rates are high and there is an expectation the economy will slow through the year, it’s clear other factors are now placing upwards pressure on home prices,” Lawless says.

“With rental markets this tight, it’s likely we are seeing some spill over from renting into purchasing, although, with mortgage rates so high, not everyone who wants to buy will be able to qualify for a loan.”

With the RBA this week keeping interest rates on hold for the first time since May 2022, that could give buyers the confidence to jump back into the market.

So, is it time to invest in property? And what are the best ways to do so?

In this article we’ll explore the opportunities in direct real estate and in listed property assets, like REITs and ETFs.

Investing in housing directly

Domain’s quarterly rental report found asking rents are at historical highs across the combined capitals and regions.

House rents have risen by $135 a week (or 31.4%) and unit rents by $140 (or 34.1%) nationally since the pandemic low.

Averages don’t tell the full story. In some capital city suburbs, rents have soared by more than 50% in just a year.

But investors have been sitting on the sidelines. They’re not necessarily selling in droves, but they’re rushing to buy either. At least, not according to the latest lending figures from the Australian Bureau of Statistics, which shows the number of new investor housing loans (excluding refinancing) has been trending down for months, to be back to where they were in early 2021.

If demand isn’t keeping up with supply, why would investors be sitting out the market?

On average, Corelogic’s head of residential research Eliza Owen says mortgage payments for new investment mortgages have risen faster than rents.

“Having high rent that exceeds mortgage costs is not the only reason investors take interest in property,” Owen says.

“Negative gearing exists to help investors purchase real estate and provide rental housing when operational costs of the property exceed rental income.”

But in return, investors expect capital gains.

“In the current environment opportunities for capital gains have been diminished by factors such as high interest rates and low consumer confidence. By the end of February 2023, Australian dwellings had seen a record fall of 9.1%.”

CBD markets are in hot demand with renters given many workers are returning to the office, and migrants typically settle in the capital cities when they first arrive. But data from PropTrack, REA Group’s data arm, shows intense competition is also forcing many further out from city centres.

It found, on average, more than 100 potential renters per available rental listing in some of the most popular suburbs, often within a one-hour commuting distance from a city centre. The data captured highly engaged renters, which are defined as someone who takes several high-value actions on a listing, like saving a property or booking an inspection.

Investing in listed property

Like the value of physical property, the share prices of listed property trusts have taken a hit over the past year.

Real estate investment trusts, or REITs, are companies that develop or buy portfolios of properties, such as office buildings, shopping centres, hotels, and residential houses and apartments. The properties generate income from rent and capital growth, and the REITs that hold these assets typically carry a lot of debt.

The Morningstar quarterly outlook report, released Thursday and available in full to Investor subscribers here, shows real estate is the most undervalued sector on the ASX amid concerns the global banking system could squeeze REITs on both sides: by their tenants and their lenders.

But Morningstar equity analyst Alex Prineas says Australian firms are better positioned than their global peers, and risks are generally more than priced in.

“Despite intensifying pressure on commercial property prices and net tangible assets, or NTAs, we think REIT security prices already factor this in,” Prineas says

“Local REITs also have long leases (typically three to six years) to solid tenants to support income, and little need to tap debt markets in the next 18 months.”

Undervalued property stocks

Despite construction firms accounting for almost one in three business insolvencies, Prineas says Morningstar’s top pick in the real estate sector is property developer Mirvac (MGR).

That’s because we’re heading for a housing shortfall, and 5-star Mirvac is a major player with a strong balance sheet and a solid reputation, meaning it’s set to benefit as competitors with weak balance sheets exit the market and buyers seek out reliable builders with a proven track record when buying off-the-plan.

Construction behind 30% of insolvencies

It also has a large residential land bank, which was built up between 2011 and 2015, and then again during the property downturn following the financial services Royal Commission.

“Mirvac is one of our top ideas in the REIT space at the moment with rival developers dropping like flies. Given the brewing housing shortage Mirvac looks very well placed,” Prineas says.

"We think Mirvac's integrated model, where the firm can undertake design, construction and development in-house is an advantage over operators who specialise in development, but do not have end-to-end construction capabilities.”

Mirvac shares trade at a 25% below net tangible assets (NTAs) – which is the value of a REIT's assets minus its liabilities.

“This seems too pessimistic given the NTA excludes substantial intangible value, including Mirvac's funds management and development arms. These represent only 12% of Mirvac's invested capital, but contributed about 40% of Mirvac's EBIT in fiscal 2022,” he says.

“The residential development business is one of Australia’s largest, at a time when weak construction rivals are exiting the sector.

“Government policy looks likely to usher in record levels of migration, driving population growth. This should intensify the undersupply of housing, especially in capital city urban locations where Mirvac is focused.”

Mirvac also owns a portfolio of office and retail properties. Prineas says despite intensifying pressure on commercial property prices and net tangible assets, REIT security prices already factor this in.

“REITs with substantial intangible businesses not captured in the NTA look particularly undervalued, including Dexus (DXS), GPT (GPT), and Mirvac.”

The RBA’s financial stability review says Australian REITs – which directly own around 10% of office space and 60% of retail properties – are generally ‘well placed’ to weather a decline in rental income and valuations because they have strong balance sheets.

“In general, A-REITs are not highly leveraged, although their leverage will increase if declining valuations lead to mark-downs of the book value of their properties,” the report says.

Property ETF

For investors who want exposure to the property sector without having to choose a specific stock, the Vanguard Australian Property ETF (VAP) is Morningstar's top pick for passive exposure to the local REIT market.

VAP tracks the price return of the S&P/ASX 300 A-REIT Index, and like most Vanguard ETFs, comes with an ultra-low management fee of 0.23%.

It earns a Gold medallist rating from our analysts.

Hear more about VAP in this recent episode of Investing Compass.