An Australian Property Bust or Boom?

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In yesterday’s Daily Reckoning I pointed out how Sydney apartments were selling like hotcakes — at least they were on the weekend — despite warnings from the RBA that looming oversupply is a major risk to financial stability.

Last week, the RBA released its Financial Stability Report, devoting a section to the banking sector’s exposure to the inner city apartment market.

The RBA’s concern revolves around the fact that, over the next two years, inner city apartments will grow by 16,000 in Melbourne, 12,000 in Brisbane and 10,000 in Sydney.

The banks have exposure to both the developers and the individuals taking out the mortgage, so I can see why the RBA is concerned about potential oversupply.

But the RBA doesn’t have good form on reading the housing market, so we should question their claims. For example, here’s what the RBA said when it last lowered rates in August (with my emphasis):

Supervisory measures have strengthened lending standards in the housing market. Separately, a number of lenders are also taking a more cautious attitude to lending in certain segments. The most recent information suggests that dwelling prices have been rising only moderately over the course of this year, with considerable supply of apartments scheduled to come on stream over the next couple of years, particularly in the eastern capital cities. Growth in lending for housing purposes has slowed a little this year. All this suggests that the likelihood of lower interest rates exacerbating risks in the housing market has diminished.

The last few interest rate cuts were a futile attempt to weaken the currency. That’s why the RBA felt the need to say that risks to the housing market, brought about by lower interest rates, had diminished.

What rubbish! The housing market has enjoyed another leg higher over the past few months, thanks to those interest rate cuts.

But the RBA has an ally over at The Australian. Robert Gottliebsen is handwringing over the apartment glut, too, and thinks it could well turn into a disaster for the Aussie economy.

Gottliebsen’s argument centres around the fact that there has been a regulatory clampdown on lending to foreign investors, specifically Chinese investors. This will apparently create huge risks for developers and banks when it comes time to settle and stump up the cash, because investors won’t have the money ready.

Indeed over the weekend it came to my attention that in Melbourne one developer had more than 5000 apartments due for settlement before June 30 covering inner and outer Melbourne.

In Sydney the largest developer Harry Triguboff is experiencing a 50 per cent non-settlement rate among Chinese buyers.

That sounds like two developers rang Gottliebsen to tell him about their problems.

Should we be worried about businesses that don’t diversify their client base? It’s not unusual for developers to overextend towards the top of a building cycle, so why is Gottliebsen so hysterical about the impact of Chinese buyers being denied finance?

Beats me…

If what he says turns out to be true, it’s disturbing that part of Australia’s economic model now relies on building and selling apartments to foreign investors, who may or may not rent the apartments out for their intended use.

Not a bad export market, but a completely useless one if we look beyond a few years.

Yet Gottliebsen thinks it’s an imminent disaster, and he somehow works Crown Casino’s recent woes into the equation:

If that [non-settlements] happens in Melbourne (and it could be greater) the developer I was looking at is in danger. There are many similar situations in Brisbane and Melbourne. Moreover a sense of foreboding came over the market at the weekend with the arrest of Crown executives, who could face 10 years in jail. No one knows what that will do to Chinese demand.

Is he suggesting that a crackdown on casino operators means even less laundered money flowing into Australian property? And this is a bad thing?

Just how desperate has the Aussie economy become that we need laundered money to prop up apartment construction?

What Gottliebsen and many others are forgetting is Australia’s economic growth secret: its population Ponzi scheme.

Economic growth comes from population and productivity growth. Generating productivity growth is hard, so we’ve ditched that strategy in favour of population growth. That’s easy.

From 2013 to 2016, Australia’s population increased by nearly one million. Around half of this increase was due to immigration; the large majority of immigrants move to Sydney, Melbourne or Brisbane. Hence the building boom on the east coast.

Given the state of the world, and Australia’s relatively safe position in it, this population growth probably isn’t going to end anytime soon. Which means the oversupply of apartments will be absorbed.

Yes, there will be problems, but not enough to cause the economy to implode.

The biggest risk for Australia and the global economy is the flow-on effect from increasing bond yields. Will the rising cost of money put an end to our property bubble and building boom?

It’s too early to tell, of course. But the wind is certainly coming out of ‘defensive yield’ stocks. Each day, I check which stocks are making (roughly) two-month highs and two-month lows. It gives me an idea as to where the strength is, both in the market and in the economy.

Yesterday, 10 property trusts showed up on the ‘new low’ list. That’s a bearish sign. It tells you that money is flowing out of this sector. But that’s not necessarily a sign of Gottliebsen-type doom. It’s a valuation adjustment based on a recent change in bond yields.

Remember this chart I showed you last week? It’s a composite Australian Government Bond price index. As yields rise, prices fall. Stocks like property trusts trade as quasi-like bonds; hence they fall when bond prices drop.


Source: Optuma
[Click to enlarge]

Until this rising cost of money flows through to the banking sector and the price of mortgages, I doubt the adjustment you’re seeing now will have any effect on the housing bubble.

An important impact on Australia’s cost of money comes from Europe. Part of the reason for the increase in yields in Australia (along with expected Fed tightening) is the prospect of the European Central Bank (ECB) winding down its own QE program.

With the ECB meeting later this week, we’ll soon see whether this trend to higher yields gets a kick along…or some much needed respite.

Cheers,

Greg Canavan,
For The Daily Reckoning

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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