If you want to profit from property, don't get into development
Property prices across Australia have exploded this year. The median Sydney price, in particular, increased 22% over the past 12 months and now tops $1 million. It’s a wonder that even the locals can afford to live there.
But this situation is more unusual than it seems. More than 70% of the increase in borrowing for housing has been by investors, which now account for more than 40% of the market. Compare this to the USA, where at the height of its property bubble in 2007 investors still only accounted for less than 20%.
What’s more, over 90% of borrowing has been for the purchase of established properties, rather than new home starts. This has served primarily to push up the price of existing homes, with supply being unable to keep up with demand.
No one should be better positioned to take advantage of a hot housing market than property developers AVJennings (ASX:AVJ) and Devine (ASX:DVN). Both hold enormous land-banks of undeveloped lots in several high growth regions such as north Melbourne and south-west Sydney.
It’s such a shame they just never seem to make money.
For the better part of a decade, management have pointed to their big land pipelines and said great profits are just around the corner. Write-downs, they would have you believe, are just inconvenient anomalies. But AVJennings and Devine only achieved returns on equity of 7.1% and 1.5% respectively over the past year and that says it all, especially given the booming market.
These companies aren’t bad builders, they’re just playing an intensely competitive game by targeting large subdivisions in quickly growing suburban areas.
Most Australian governments are notorious for drip-feeding new land to the market and this makes for ferocious competition at auctions. Overpaying for land has led to very sizeable write-downs over the last few years – more than $155m between them – so you shouldn’t take these companies' net tangible assets (NTA) at face value.
Until there’s a change in the Australian competitive landscape or approval process we find it hard to imagine AVJennings and Devine rolling in profits any time soon. In any case, if you own the banks or a home, you probably have more than enough exposure to Australian property for one portfolio. If housing does well, you will too.
Frequently Asked Questions about this Article…
Property prices in Australia have surged due to a significant increase in borrowing for housing, primarily driven by investors who now make up over 40% of the market. This demand has pushed up prices, especially for established properties, as supply struggles to keep pace.
In Australia, investors account for more than 40% of the property market, whereas during the USA's property bubble in 2007, investors made up less than 20%. This highlights a much higher level of investor activity in the Australian market.
Despite holding large land-banks in high-growth areas, AVJennings and Devine face intense competition and high land costs, leading to significant write-downs. Their returns on equity have been low, at 7.1% and 1.5% respectively, due to these challenges.
Investing in property development companies like AVJennings and Devine carries risks due to the competitive nature of the market and the tendency for governments to release land slowly. This can lead to overpaying for land and subsequent write-downs, impacting profitability.
Everyday investors might want to be cautious with property development stocks like AVJennings and Devine, as these companies face significant challenges in turning a profit. If you already own a home or bank stocks, you likely have sufficient exposure to the property market.
Australian governments are known for releasing new land to the market slowly, which intensifies competition among developers and can lead to higher land costs and write-downs, affecting the profitability of companies like AVJennings and Devine.
While AVJennings and Devine hold large land-banks in growth areas, the competitive market and high land costs have hindered their ability to capitalize on these assets, resulting in low returns on equity and significant write-downs.
Investors should consider the high level of investor activity, the competitive landscape for developers, and the impact of government land release policies. Owning a home or bank stocks may already provide sufficient exposure to the property market.
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