Scott Picken, CEO of International Property Solutions (IPS) believes a paradigm shift is occurring: 8 years ago, people would only invest in property in their own neighbourhood. Now, investors are starting to seek the best investments globally. IPS was created 5 years ago to facilitate international investments and provide an end-to-end solution to ensure that investors can invest with confidence!

Monday, April 19, 2010

Low risks make it a great time to invest in property in Australia

* ECONOMIST: Frank Gelber
* From: The Australian
* April 15, 2010 12:00AM

DO I sound bullish about property to you? If not, you're missing the point. To me, this is an extraordinary time for property investment.

Most of the risk has gone. Non-residential prices have fallen dramatically. They're below replacement cost. Development has stalled. Demand is returning. And we can't build until rents rise.

Risk hasn't been this low, or investment decisions more clear cut, for 15 years. Certainly, across cities and sectors, prospects aren't uniform. But by and large, we're looking at strong positive returns over the next five years, with some internal rates of return above 20 per cent.

The key is risk. Some think high return means high risk. Too many people look at risk as statistical without trying to understand where it comes from. For them, risk is variation, everything that they're not sure of.

We can do better than that. We can specify sources of risk associated with specific events.

Let's focus on three specific cyclical property risks: overbuilding and its consequences, excessive gearing and overvaluation.

First, overbuilding. Before the global financial crisis hit, I was worried about overbuilding during the boom leading to oversupply and significant falls in rents and prices, a classic boom/bust cycle. Buoyed by the inflow of funds, building was rising to unsustainable levels. As it turned out, the GFC did us a favour, curtailing construction early, before we oversupplied markets.

The initial setback to development came from the funding squeeze. Now, the problem is making financial feasibilities work. Commercial and industrial commencements have halved in real terms since the peak and are struggling. During the boom the risk of overbuilding was high. Now, it has evaporated and there is the prospect of a shortage.

Second, gearing. This is not only an individual property investor risk but can also create market risk. The financial engineering boom put enormous pressure on corporate Australia to gear up. And the Real Estate Investment Trust sector, with relatively stable cash flows, was a prime candidate.

It was hard to resist. And the REITs didn't, gearing up from 14 to 40 per cent in the blink of an eye, with some more classic financially engineered operations heading above 90 per cent.

Gearing compounds returns in the good times, but multiplies losses when returns don't cover interest. Of course, the GFC triggered falls in property prices which, with gearing, compounded the fall in net assets.

Initially, shell-shocked investors did nothing. The REITs, without equity injections, were forced to try to sell assets. But, with few investors, markets didn't clear and prices fell. Only later were the less affected REITs able to raise equity, mainly through new rights issues, gradually reducing gearing to levels that are allowing them to resume normal operations and think about development and investment.

The third risk is overvaluation.

Increased gearing in the boom, plus additional equity, hugely boosted investable funds, all chasing a limited amount of property. Yields got away from us. Weight of money caused yield compression and caused prices to overshoot.

The risk was that yields would correct, that prices would fall. And they have. The risk of further price falls is low.

Contrary to the present heightened perception of risk, all three types of risk have receded. We're too cautious.

To me, it's safe to invest.

I worry more when I can't understand value. My benchmark is replacement cost -- we can't stay below it for long when we need to develop. This stage of the cycle presents an undervalued market with emerging demand and little new supply.

At BIS Shrapnel we're looking at internal rates of return in some sectors up to 20 per cent. Most risks are on the upside. What would you do? I know what I'll do.

Frank Gelber is chief economist for BIS Shrapnel

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