For the best browsing experience on this site, we recommend you upgrade your browser
AboutSubscribe Your Editors Contact Us RSS

How The Belief in Australian Property Will Go With the Generational Wind

Old structures creak in the wind. Leaves swirl about the streets as the gusts gather in intensity. There are a few spots of rain…but they’re hardly discernible.

People go about their business, unperturbed. They have faith in the structures. They’ve been there so long. They will always be there.

When it comes to matters financial, faith usually only lasts a generation. Very rarely does belief in financial matters endure. And when it does, it’s belief in a way of doing business.

We don’t accumulate knowledge and wisdom. In fact, we all start from the beginning. We mostly choose to ignore the lessons passed on from those who have made mistakes before us. We’d prefer to make them anew.

If there is one belief that has endured in Australia beyond a generation it is a belief in Australian property. At our inaugural investment conference last month keynote speaker Satyajit Das said he doesn’t get into conversations about property with Australians. It’s like debating the existence of God. The inference? Das is a property atheist.

We’ve been talking about the Australian property slowdown/bust for years now. So has our mate Kris Sayce over at Money Morning. You, dear reader, sometimes get annoyed when we’re not all singing from the same hymn sheet. One of us sees a long slowdown while another sees a quick-fire bust. You think we’re hedging our bets.

We just see a different route to the same destination. Whatever way it happens – via a bust or a drawn-out slowdown – hindsight will prove Aussie property vintage 2012 (and for many years previously) to be a bad investment.

Another gust of wind just blew in the gathering storm. Genworth Financial, a US-listed mortgage insurer, has abandoned plans to list its Australian division on the ASX. Genworth is Australia’s largest mortgage insurer. The US parent company hoped to raise $800 million by selling 40 per cent of the business to Aussie investors.

That no longer looks likely. As a result, Genworth’s US shares promptly fell 20 per cent. The decline doesn’t simply reflect the lost transfer of wealth from Aussie investors to the US parent. It also represents the fear of more losses to come.

For years the Aussie mortgage insurance business was a big cash generator for Genworth. According to Morgan Stanley analysts, over the past two years it generated average quarterly earnings of $50 million. However, in the first quarter of 2012 it expects to report a small loss.

That’s some turnaround. And US investors don’t like the fact they’re stuck with the business.

Genworth Financial Stock Price Plummets

Genworth Financial Stock Price Plummets

In a statement to the US stock exchange, Genworth said its decision to pull the proposed float was due to…

“…elevated loss experience in Australia as lenders accelerated the processing of later-stage delinquencies from prior years through to foreclosure and claim at a higher rate and severity than expected, particularly in coastal areas of Queensland that experienced natural catastrophes and regional economic slowdowns and among certain groups of small business owners and self-employed borrowers.”

That’s a long sentence. And a lot of information. Those who genuflect before sitting on the Australian property pew believe this is just a temporary slowdown. It’s mostly related to the Queensland floods…and the abysmal Gold Coast property market.

Others (your editor included) believe this is yet another sign that Australian residential property has entered into a long bear market.

According to today’s Financial Review, ‘Lenders use mortgage insurance where customers borrow 80 per cent or more of a property’s value, with Genworth covering any short fall between the loan value and the property sale price in the situation of a default.’

Given the lax lending standards in the run up to the credit crisis in 2008, a 20 per cent deposit seems quaint. The banks may have tightened their lending requirements after the GFC scare. But we would guess a large proportion of first time homeowners in the past five years or so would not have scraped together a deposit of more than 20 per cent.

So that means a lot of mortgage insurance. And now, with the China slowdown in the early stages, Australia’s subprime borrowers are getting into trouble.

Of course there is the tragedy of the floods to take into account. Queensland’s natural disasters last year took lives and turned many others upside down. When that happens and you have debt, it’s a vice-like grip that’s hard to wriggle free from.

But that can only be a small part of the problem. When you go from making roughly $50 million a quarter to incurring a loss, there’s something else going on. That something else is a silent sub-prime crisis. Busts and slowdowns ALWAYS start at the periphery…before moving to the core.

Regards,

Greg Canavan
for The Daily Reckoning Australia

From the Archives…

What the News on Bond Yields Say About the “Resolved” Eurozone Crisis
2012-04-13 – Eric Fry

The Art of Selling Stocks
2012-04-12 – Chris Mayer

Misguided Faith in an Economic Recovery
2012-04-11 – Joel Bowman

Beware the Big Government Debt Switcheroo
2012-04-10 – Dan Denning

The Discount Rate: Borrowers, Lenders and Bonds
2012-04-09 – Nick Hubble

Greg Canavan
Greg Canavan is a feature 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 Sound Money. Sound Investments, 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.

22 Comments

  1. Lachlan says:

    “We’ve been talking about the Australian property slowdown/bust for years now. So has our mate Kris Sayce over at Money Morning. You, dear reader, sometimes get annoyed when we’re not all singing from the same hymn sheet. One of us sees a long slowdown while another sees a quick-fire bust. You think we’re hedging our bets.”
    The property market here is a credit bubble which is somewhat different than China where savings have financed much of the price appreciation. I would argue its getting late in the day for a property crash in nominal terms and the credit bubble will be resolved largely through inflation when the US dollar is relieved of it’s reserve currency status. It could be argued that idea is overplayed. Maybe. It seems to me though that China is moving swiftly to make other arrangements.

  2. Biker says:

    GC: “…hindsight will prove Aussie property vintage 2012 (and for many years previously) to be a bad investment.”

    No, despite a few variations on a theme, you’re all singing from the same hymn book, Greg. You have to, if you’re to _sell your product._

    As you say: “If there is one belief that has endured in Australia beyond a generation it is a belief in Australian property.”

    This kind of belief (which you’ve aligned to religious fervour) gets in the way of your pitch. It _must_ be attacked. Scan DRA’s Real Estate threads and you’ll find your adherents echo your collective tendency to grasp at any little straw. In your example above, it’s the QLD floods.
    In theirs’, the most recent anecdotes point to a coal mine closure as the end-of-the-world as we know it.

    There are some interesting property developments recently, which will impact markets. As with any major shift, there will be winners and losers.
    Your claim that ‘property vintage 2012′ is a dud is a laughable generalisation typical of this continually amusing site!~

  3. X says:

    Still talking your book Biker? Well, here’s a little tune for you from the Rolling Stones.

    Time, is on my side, yes it is.
    Time, is on my side, yes it is.

    >> There are some interesting property developments recently, which will impact markets. As with any major shift, there will be winners and losers.

    WHAT!!! Losers ???? In PROPERTY???? That’s UNPOSSIBLE!!!!!

    You’re not the real Biker, someone is impersonating Biker. The real Biker would never say that there will be LOSERS in property!!

    Still, even if you are the real Biker making a small concession that the property market may have changed … just a little … with some “interesting developments”, you are STILL WRONG!

    It’s not that there WILL BE losers in the property markets, there already ARE losers in the property market. In fact, that market is full of losers. All of the WINNERS got out 5 years ago, and all that is left is losers.

    Carry on.

  4. Biker says:

    X (Stoned): “Time, is on my side, yes it is.
    Time, is on my side, yes it is.”

    Let’s look at Greg’s headline, X: “How the Belief in Property will GO With the Generational Wind”

    Yet his fifth paragraph commences with this little truism:

    “If there is one belief that has endured in Australia BEYOND a generation it is a belief in Australian property.”

    Time is on the side of the property investor who watches debt shrinking 30% every decade, due to inflation. Time is on the side of the same investor who raises the rent each time tenants vacate. Time is on the side of the investor whose properties are paid off rapidly through these two factors, as tenants pay off rentals with more dollars annually… while debt decreases.

    Yes, there _will_ be losers. Those who panic (believing this inter-generational BS) and _sell_ offer the astute real opportunities. Those who fail to own a home outright by the time they retire are losers-in-waiting. Those who fail to diversify* (and thus deny themselves flexibility) will always be losers.

    But the real losers are those economic refugees from effed economic zones who believe that the Australian property market will crash, giving them half-price homes! Time isn’t on their side. While ‘time will tell’ is their mantra, time has already told.

    * Put all their X in one basket, you might say… .

  5. Ned S says:

    “You’re not the real Biker, someone is impersonating Biker.”

    If that’s someone impersonating Biker, they are doing a jolly fine job of it … :)

  6. X says:

    >> Time is on the side of the property investor who watches debt shrinking 30% every decade, due to inflation.

    Here in essence, is the core of your philosophy: The future will be exactly the same as the past.

    But which past? The ‘Howard Years’ past, where an expansion of credit saw property prices outpace inflation and wages by almost double, or the other ‘recession we had to have’ past, in which property prices decreased in real terms, and interest rates hit 14% in response to the previous credit bubble?

    Inflation occurs, regardless of whether one is in debt or not. Houses are a ‘wasting asset’ which depreciate in value. Their rising price is due to a peculiar delusion which has been the ruin of many a society and Empire. The delusion persists, until it no longer does.

    Take the case of Damascus, the oldest permanently settled city in the world (approximately 4000 years). If Biker was a wise property investor living in downtown Damascus 3000 years ago, he would have seen a ‘bright future’ for property in Damascus, and purchased his first house for 100 shekels.

    Assuming a constant annual return of 7% on Damascus property, and constant rate of inflation of 4%, and assuming that there are 10 trillion shekels to the modern Dollar, then Biker family descendents are now sitting on a goldmine, with a property worth $3,248,434,509,344,208,874,926,734,002.

    Right Biker? I mean, the arithmetic is indisputable. Property ALWAYS goes up, ALWAYS outpaces inflation. Right? Right?

    Strangely though, a quick Google search of Damascus property finds prices at a substantial discount to their TRUE value of 3.2 trillion trillion dollars (plus change).

    What’s wrong with this picture? Why are houses in Damascus not worth 3.2 trillion trillion dollars? The answer is very simple. Eventually, reality collides with the delusion. This tends to happen on a fairly predictable time scale, roughly every 90 years for the last 4 centuries. (The cycle length has varied at different times in history.)

    If you buy property at the beginning of the cycle, you are sitting pretty, much like those who purchased property during the Great Depression. If you buy property at the end of the cycle, like Biker here and a great many other greater fools, you will be much like the people in Damascus, wondering what happened to the 3 trillion trillion dollars they were owed on their wasting assets.

    Why this meta-cycle occurs is the subject of intense debate. Some say it is a deliberate conspiracy by the owners of capital, others say it is behavioral, following the great cycles of human societies (or Empires). Regardless, if history is any guide, what happens now is a massive contraction in credit lending, and the collapse of economic activity that accompanies that. Or not, maybe it really is different this time, but personally I’m betting that it is not.

    >> But the real losers are those economic refugees from effed economic zones who believe that the Australian property market will crash, giving them half-price homes!

    That’s no way to talk about our Chinese customers!

    Or were you trying to have a dig at Stillgotshoeson with your usual ineptitude?

    Now, to your other claims.

    >> Time is on the side of the property investor who watches debt shrinking 30% every decade, due to inflation. Time is on the side of the same investor who raises the rent each time tenants vacate. Time is on the side of the investor whose properties are paid off rapidly through these two factors, as tenants pay off rentals with more dollars annually… while debt decreases.

    Only in a growth cycle. In a contraction, tenants can and do move into denser living arrangements, such as moving back with family or sharing space with friends. Meanwhile, the landlord has a illiquid asset that is decreasing in price, that costs money to maintain, with increasing property taxes from increasingly broke governments (whose income tax revenues are declining), added to which is increasing debt as the lender raises interest rates to get access to increasingly scarce capital.

    If you believe that you will never see a sharp contraction within your own or your children’s lifetime, then what you describe above is exactly the strategy that the financially naive should follow. The best time to buy property in the 20th Century was between the years 1932-1945. Each subsequent year following 1945 saw a marginal decrease in total return. The worst time to buy property was between the years 2004 to 2007, on the flip side, anyone whose grandparents or great grandparents purchased property during the Great Depression, 2004-2007 was without doubt THE best time to sell to realize those gains.

    >> X (Stoned)

    You wish. I guess being drunk most of your life causes you to project your lack of self discipline on others. Or maybe your just not a Rolling Stones fan.

  7. Biker says:

    Sharp contraction? We’re well-placed to take advantage of your property crash fantasy, son.

    Stillgotshoeson? You mean that Irish fella who cursed me with incurable diseases and a broken-neck bike accident on this very site? :D :D :D

    You’re a _desperate_ mob, you lot!~ ;)

  8. Biker says:

    Your comment is awaiting moderation. :) Not surprising!

    Sharp contraction? We’re well-placed to take advantage of your property crash fantasy, son.

    Stillgotshoeson? You mean that Irish fella who cursed me with incurable diseases and a broken-neck bike accident on this very site? :D :D :D

    You’re a _desperate_ mob, you lot!~ ;)

  9. X says:

    >> Sharp contraction? We’re well-placed to take advantage of your property crash fantasy, son.

    I’m not sure what you mean by that, but I suspect you don’t either. You didn’t type drunk again did you?

    Did you mean that you believe we are still in a growth cycle? That there will be no credit contraction? If so, then that is the point we disagree on. As long as the growth cycle resumes, your investment strategy is probably the best that someone with your financial knowledge can achieve. So, good luck with that!

    If on the other hand you are claiming that your investment strategy in property will survive a sharp credit contraction, then I am afraid I have bad news for you. You.are.wrong.

    >> You’re a _desperate_ mob, you lot!

    Why would I be desperate? All of my investments are liquid and convertible. My rent is 40% of what I would pay on a mortgage for the same area, the balance of which is going into a mix of yield and inflation hedge assets. I live like a King on my low low rental cost, while my colleagues spend 3 hours a day in a third-world tin-can (sometimes called a train) so they can pay more than twice as much for somewhere to live, for the dubious value of ‘equity’ in their liability.

    Given the increasing shrillness of the calls for rate cuts, FHOG extensions, tax breaks in the media, I think it might be the property industry that is _desperate_.

  10. Ned S says:

    “At our inaugural investment conference last month keynote speaker Satyajit Das said he doesn’t get into conversations about property with Australians. It’s like debating the existence of God. The inference? Das is a property atheist.”

    Interesting that Satyajit Das was a keynote speaker for DRA.

    Das is bearish alright (so am I – though maybe not as bearish as Das.) But I recall reading a general comment of his that went along the lines that when things turn turkey housing ‘typically’ drops something like 30% compared to 70% for stocks. (Don’t quote me on those figures and I considered suggesting he might have said 40% and 60% ???, but my best recollection is 30% and 70% so I’ll stick with that.) But either way he certainly seemed less bearish on housing generally than on stocks.

    His comment was made 18 months ago mabye?

    Anyway, for me the real biggy still is to avoid leverage unless one is REALLY sure they’ve found a bargain – Be it a stock or a property.

  11. X says:

    @Ned S

    The reason the *INITIAL* drop in price is greater in stocks than property is because of liquidity. Because property is illiquid, the transactions dry up almost instantaneously, but the stock market tends to overshoot on the sell side, and tends to ‘dead cat bounce’ at the bottom.

    Property debt tends to be periodic, either weekly, fortnightly or monthly payments, but equity leverage (through derivatives such as options,short selling or CFDs) is operated through a margin account, and the instant THAT goes into the red, the position is either closed out immediately, or the client receives the dreaded ‘margin call’. Because of this, a lot of positions are unwound very quickly, and you get a snowball effect.

    If you are leveraged in the stock market, you may get closed out or stopped out.Margin lending certainly burned a lot of people in the last crash though. If you are leveraged in property, you now own an illiquid asset and are on the hook for the principal as well.

    To cheaply limit your downside in stocks, you can buy deep-out-of-the-money PUTs on any stocks you own (at >95 delta if someone will sell them to you). The premium is small and at least your downside is limited. If the market carries on up, then they expire worthless.

    OR, you could do what Nassim Taleb does and buy NAKED deep-out-of-the-money PUTs, but you really need to know what you are doing for that kind of play. :)

    Unfortunately, there isn’t a really good hedge on the short side of residential property. There are some commercial REITs you can short as a proxy. I don’t know of any REIT foolish enough to buy residential property. If the drop is sharp, another play is to look for REIT stocks that are trading below their NAV. If they can survive the illiquid period on their cash flow (assuming there isn’t an equally sudden drop in occupancy), then they are trading at a discount to the underlying assets.

    If there is a crash, there will be bargains a-plenty, with willing sellers (both in property AND stocks). It’s not the interest rate so much as the principle you have to worry about. Except if you are already leveraged … then the interest rate should be your primary concern.

  12. Biker says:

    ‘X’: “If there is a crash, there will be bargains a-plenty, with willing sellers (both in property AND stocks).”

    Yes, I recall the last major ‘crash’ knocked shares for 55.4%… . ;)

    Seems DRA may have decided it’s somehow counter-productive blocking my stuff, Ned. Quite a few ‘lost posts’… but who’s counting?!~ :D

  13. X says:

    >> Seems DRA may have decided it’s somehow counter-productive blocking my stuff

    It’s an absolute mystery why they would ‘block your stuff’. Every post you dig yourself a deeper hole! I would have thought they would be encouraging you, not censoring you.

    >> Yes, I recall the last major ‘crash’ knocked shares for 55.4%..

    And then central banks began flooding the market with liquidity to save the housing sector, shares gained back nearly half of that drop within a year, we got 7% inflation for 5 years,and gold rose 70% per year for 3 years. Soon we will all be billionaires, but it will cost $100,000 for the weekly groceries.

  14. Ned S says:

    “Soon we will all be billionaires, but it will cost $100,000 for the weekly groceries.”

    Yep, life’s been a bit annoying since September 2008 – For me anyway. To the point I’ve even opted to start working again – I’d prefer part-time stuff. But full-time seems to be what’s being offered?

    Oh well, take the full-time stuff and see if it just mightn’t turn into part-time stuff further down the track maybe.

  15. Biker says:

    Billionaires? You’ll punt yerself into oblivion*, King X.
    How much are shares _still_ down, son?

    * Probably already have!~ :D

  16. Biker says:

    King X: “…we got 7% inflation for 5 years,and gold rose 70% per year for 3 years….”

    _I_ dig myself into a deeper hole each post? :D
    Did you graduate from primary school? ;)

  17. X says:

    >>King X: “…we got 7% inflation for 5 years,and gold rose 70% per year for 3 years….”

    >>_I_ dig myself into a deeper hole each post?
    >>Did you graduate from primary school?

    Which part are you disputing, the 7% inflation, or the 5 years?

  18. X says:

    >> Billionaires? You’ll punt yerself into oblivion*, King X.
    >> How much are shares _still_ down

    You think I am invested in shares? Not sure what gave you that impression … Or is it part of your fantasy on your brilliant investing that anyone not in property must be in shares, and therefore losing?

    You hear that whooshing sound above your head? That’s you completely missing the point of my comment on ‘billionaires’.

    >> , son?

    Oh, and by the way, I’m not young enough to be your ‘son’. I know you use the term deliberately to be condescending, but it really just makes you sound like an clueless idiot. Oh wait …

  19. X says:

    @Ned S

    There have been some changes to IR laws recently. IIRC it makes part-time a bad deal for companies, so they tend to wait until they have a full-time position and hire for that. Also, if you have any skills at all, they want to get as much of your time as possible, as it’s difficult to hire people who can do anything.

    Inflation bites, but we can expect a lot more of it. We can’t export it like the USians, so those on a fixed income can expect to take a hit. Precious metals are a good hedge, but are very volatile, so timing is difficult.

    Good luck!

  20. Chris in IT says:

    Biker,

    Long time no chat. Still winding people up I see :)

    Quick anecdote from Sydney. On chatting with a nice lady in Chatswood yesterday she noted that 85% of her household income went to paying her mortgage. This just stopped me mid sentence. “Pardon?”. Yes. 85%. I asked how she could even eat on 15% of her income.

    All investors are assuming that there will always be someone else to come along and pay more for their investment, exactly when they want to sell it. So far, that has been a good bet. This is helped by a good few factors, but principally there are a few things that are needed to increase the valuations a property investor needs to keep this thing going positively. Wages increasing faster than inflation, so greater ‘value’ can be acquired as per month debt payments. People need to be able to afford bigger payments to push up valuations. The other way is to reduce interest rates for the LONG term to create a new lower baseline expectation for interest rates.

    Here in Sydney however we’re still seeing crazy valuations at the same time as cracks appearing (as always). A neighbour just sold. She didn’t like the renters behind(who had mental issues and a gun). You may imagine that may be a hard sell. Not at all! Sold for $972,000. 3br, the property is about 6mx30m. That said, I see a lot of worry too. One sentiment I express and people tend to agree with is, ‘Do you feel good about committing to a near million dollar mortgage for 30 years in the current economic climate, or do you think.’. The changes in the world make ANY long term plan a problem, and for me, investments like property which you are not nimble(and you may need to be) are not a wise move.

    For me, a much better bet –long term- is agricultural land coupled by 999 silver. Explicitly, NOT gold due to the 1954 banking act (http://www.austlii.edu.au/au/legis/cth/consol_act/ba195972/s42.html ). Unless you get a licence to operate a jewellery shop in which case you are exempt.

  21. Chris in IT says:

    “Sharp contraction? We’re well-placed to take advantage of your property crash fantasy, son.”

    It has always made me wonder… As a retired guy in northern QLD in a semi rural area who’s primary investment strategy is to be a residential landlord what value you find in the primary output of this site. DR for the past decade has sold the idea of currency debasement (answer:gold, and they were right) and increasingly a shakey property market, which every other country has dropped except Australia and Canada, both countries you have links to (assuming your Son actually bought that land in B.C.). DR is a contrarian site, where IP is ‘traditional’ investment.

    I really don’t know why you bother? Did Somersoft kick you out or something? :P

  22. watcher7 says:

    House price change 1997-2008:

    Ireland 193%; Spain 184%; Australia 163%; Britain 150%; USA [Case-Shiller ten city index] 102%.

    * Joe Brennan, Irish Bank Evicts Pensioner After $155 Billion Losses, bloomberg.com, April 25, 2012:

    Home prices may drop as much as 70 percent from their 2007 peak, according to Dublin-based securities firm Davy. The central bank assumed prices would fall 55 percent to 60 percent when it tested the banks’ financial strength in March 2011.

    * Rick Ackerman, Interest Rates May Be Close to a Major Bottom, rickackerman.com, May 23, 2011:

    We have been predicting here for years that home values would ultimately decline by 70 percent and that the collapse in vacation properties would be even worse, hitting 90 percent. However, given the unprecedented weakness of these markets in the face of a failed multi-trillion dollar monetary stimulus and a dead-cat bounce in the stock market that has take more than two years to play out, one shudders to think about how quickly the final phase of the collapse would unfold were the flimsy support of artificially suppressed interest rates to be removed.

    Comment by Chris T:

    Rick’s numbers aren’t even that far off:

    Here in tony NJ (at least going by the property taxes), even AFTER all of the last three years, residential real-estate STILL costs more than 6x annual income or substantially more.

    Purely unsustainable, esp. when compared to the decades long factor operative until about 1980.

    With the ultimate 70% decline Rick mentions, that factor will be about 2.5 (assuming about 25-30% to date). Sure, incomes better not take a major hit (nominally speaking of course), but if they did, then we’d still go to the 2-3x factor level, just the 70% will have been too optimistic.

Leave a Comment