Commercial Property on the Ropes in a Consumer Economy

About the only good news from Friday's session on the ASX is that neither the All Ords or the ASX/200 closed on the lows. Both were down for the day. But by the end of trading both seemed to come to their senses, get up off the floor, and keep on keepin' on.

And the week starts off with a positive bit of news: Centro Properties may be saved by its bankers. Today's Age reports that its financial backers will throw Australia's second biggest retailer a lifeline. Good timing, too. Centro has $2.3 billion in debt it needs to roll over or pay off by the end of the day.

The group says its 770 shopping centres in the U.S., New Zealand, and Australia are doing just fine. It's the leverage behind its $22.6 billion managed funds portfolio that's killing it. Unable to refinance debts, it's worried about an asset fire sale.

The consumption boom and the property boom (both retail and commercial) have their origins in the larger credit boom. Here in Australia, the consumption boom is silently going bust. Or at least it's under a lot of strain, if you ask Gerry Harvey. You have to wonder how long Centro's good vibe is going to last.

You can check this sort of thing on cash flow statement and balance sheet, of course. If your business model is failing because you have too much debt or can't generate cash from operations to service debt and all your other expenses, there's no escaping it. The only question is whether you can sell enough of your assets to keep the business a going concern.

It will be interesting to watch commercial property in Australia in 2009. Will it go bust? And will it go bust before residential real estate? Naturally, most of the focus in the property market is on residential real estate.

Australia has resisted a major residential real estate bust so far. For one, you can't mail your keys in and walk away from your home here like you can do in America. Secondly, Australia has a higher percentage of variable rate mortgages that are linked to the RBA's cash rate (indirectly). With the RBA's rate cuts, mortgage costs have declined for many.

None of that has made residential property more affordable, mind you. When you measure it in median incomes, median house prices are anywhere from seven to ten times the median Aussie income. Ouch. But doesn't everything happen at the margin? And what does that even mean?

Well, it could mean, for example, that the loss of jobs in Australia's financial industry from the global credit crunch leads to lower housing prices in Sydney's trendy suburbs and then, the rest of Sydney. This is especially true in London, where the City provides (or used to) thousands of high incomes which were then leveraged into mortgages for even higher house prices.

That whole financial income-housing deleveraging is taking place now, too. You can't leverage a high income into a big mortgage if you don't have an income. This is sort of the opposite of what's happened in America, though. Here, you have a housing market under pressure from the high-end borrowers who've borrowed up to bid up house prices, whereas in America it was driven by the sub-prime buyers at the low end.

Either way, what happens when that aggregate buying power from the over-leveraged elite leaves the market? We have no idea what the answer is. Maybe the only good news is that a collapse in borrowing (and more selling) from the high-end of the market may bring down prices at the lower end too and finally make things a bit more affordable. But that's only if you can get a loan.

In any case, real estate values are generally local. But there are two key national characteristics to Australia's real estate market that make it susceptible to synchronised moves. First, the mortgage finance industry is global, not local.

Or more simply, the credit crunch put a lot of non-bank Aussie lenders out of business and consolidated the rest under normal bank umbrellas. When it comes to getting a mortgage, it doesn't really matter where you live in Australia. The banks are going to be tougher to do business with. The mortgage market is national.

The second aspect of the market that makes it more national is that so many Aussies live in the capital cities. This concentration of demand (also through immigration) generally supports prices. But it's what also makes them unaffordable. Even though different suburbs have different price trends based on particular characteristics, a fall in prices at the highest end suburbs could have a surprising effect in other places.

More predictions for 2009 tomorrow, by the way. Here's one to chew on: the collapse of the Mexican government as oil revenues plummet.

Can anyone make money making cars? Toyota says it lost $1.7 billion the last six months. Sales are collapsing. The strong yen didn't help either.

Now you see why the Japanese have chosen to keep their currency competitively weak over the last thirty years. It makes their products cheaper overseas. The unwinding of the dollar carry trade has seen a big rise in the yen, and bad news for Toyota. It's the company's biggest profit decline in eighteen years.

The global auto industry is begging for some creative destruction. You'd think the internal combustion engine was ready for a replacement that didn't burn hydrocarbons. But the world has nearly 100 years of capital investment sunk into a petroleum-based transportation and production system. It's not like changing the batteries in your torch.

But we reckon batteries will have something to do with the big change that's coming. If it comes in time. More on that tomorrow.

Dan Denning
for The Daily Reckoning Australia

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