Better residential development outlook good news for some A-REITS: Ken Atchison

Stockland and Mirvac are two of the largest Australian listed property companies with market capitalisation of $8.1 billion and $6.3 billion respectively. 

Both companies have suffered from losses through residential development exposure over the last 18 months. 

Small companies which specialise in residential property development include AV Jennings, Cedar Woods, FKP and Peet have also experienced difficult trading conditions and reported significant losses. 

Weak housing and apartments prices, rising construction costs, and low volumes of residential sales across Australia have contributed to the losses experienced.  

The chart below shows the movement in residential prices in Australian major cities over 10 years to March 31, 2013.

But signs of recovery have emerged.

Perth and Sydney residential markets showed greater resilience over the last three years than other states. The outlook for market in Sydney is positive, whilst Perth is stable. 

Sydney prices had been flat for most of the period since 2004 despite a persistent supply shortfall.  Indications of encouraging building approvals and home loan approvals have emerged in 2013.  Vacancy currently below 2% and improving employment will support demand. 

Perth is the centre of the strongest population growth in Australia.  Shortfall in supply persists despite the slowing activity in the resources sector.  New construction is emerging and is needed as the vacancy rate is low at 2.4%. 

In Melbourne the housing market is characterised by an oversupply of dwellings with significant construction of new dwellings since 2009/2010 and lagging infrastructure investments which will facilitate residential developments.  Strong price rises in 2010 have prompted the growth in supply. 

After strong interstate migration to Queensland from the southern states for a number of years immigration has slowed particularly as the Gold Coast market collapsed in the global financial crises.  Demand arising from improving employment prospects is now emerging. 

Whilst unemployment and interest rates remain low and population growth from overseas migration continues, fundamentals will improve for developers.  Affordability is assisted by the low mortgage interest rates after a 2% fall in official cash rates. 

In a strategic review conducted by the new CEO of Stockland, Mark Steinart, residential development will be smaller but remain a material part of the business.  It might contribute around 15% of earnings.  An improvement in the residential property outlook will assist Stockland. 

Mirvac similarly has reduced the significance of residential development for earnings as it grows the core real estate asset holdings.  Contribution from residential development of 24% of earnings is expected. 

Outlook for Stockland and Mirvac earnings will benefit from improving economic and property fundamentals which increases profitability for residential development.  The principal driver of return for both is from rent from core property holdings.  Variability of earnings will be greater than REITs that do not engage in development but less than companies that are solely residential property developers. 

Smaller specialist residential developers will benefit directly from emerging improvement in residential property development and are already experiencing some improvement in share prices.

Ken Atchison is managing director of Atchison Consultants.