Asset bubbles are called bubbles for a couple of reasons. First, the tend to keep growing larger until randomly and without warning they burst, causing an almighty shock. Second, anything inside the bubble has a warped sense of reality. What seems normal in a bubble seems patently absurd outside of it.

A perfect example of this is the views of so-called property experts. Often, these experts, who are liberally quoted by gullible journalists, are self-interested players whose views are clearly clouded by their own book. No better example than Australia’s leading financial rag, the Financial Review, which today featured an article on the growing profitability of Melbourne apartment builder Central Equity.

As it did in the early 2000s, Central Equity again is playing a key role in Melbourne’s property boom, developing several new sites around the CBD, including its Mainpoint tower in Southbank, adjacent to the Melbourne CBD. According to Scott Elliot in the AFR:

Central Equity’s latest Southbank tower, Mainpoint, will include 350 apartments over its 43 storeys … Mainpoint’s one-bedroom apartments will start at $489,000 — translating into a cheap $7950 per square metre, according to Oliver Hume Real Estate. [My emphasis]

The business providing the expert opinion that the new dwellings are “cheap” is Oliver Hume. Oliver Hume’s website describes it as a company that “specialises in the sale and marketing of medium- and high-density developments across the inner and middle ring of Melbourne”.

However, rather than analysing whether the claims were genuine, it seems that the AFR didn’t bother to work out whether a price of $7950 would actually be cheap.

For an apartment to be cheap, that means that its price is below its intrinsic value — that is, the present value of all future cash flows. It is pretty straight forward to work out the income on a Southbank apartment — there are literally hundreds for rent within a few hundred metres of the new Mainpoint development. Generally, prices for a one-bedroom property are $400-$500 per week, but most tend to be in the low $400s per week and are about 60 square metres in size. That means the gross yield on such a property is about $22,000 annually. After adjusting for expenses such as management fees, body corporate fees, rates and depreciation, the net yield is probably closer to $15,000 per year (or probably a bit less), or $250 per square metre.

So that means, the so-called cheap property (according to Oliver Hume) is providing its owner with a net yield before tax of about 3%. Bear in mind, prices range from $7950 per square metre, so in most cases, the yield is actually less than 3%.

So are these properties cheap?

The only conceivable way that they could be deemed a shrewd acquisition is if the rental yields were to increase substantially within a few years of purchase. That is highly unlikely though. For a start, the key driver of rental demand (immigration and temporary students) is actually alling. Second, as Oliver Hume itself noted to the Financial Review, there are “eight high-rise apartment projects with a total of 3623 apartments in the pipeline for Southbank”.  So with demand dropping and supply increasing, the chances of any substantial rent increases in the near future appear remote.

Is a 3% yield on a relatively risky asset (when you can get 6.5% in bank account) a cheap investment?

Depends who you ask.

Peter Fray

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