Why the Fundamentals Don’t Matter With Australian Property

model of a house and key ring

Yesterday, the Aussie stock market jumped 0.56%. It ignored sharp falls in US stocks on Friday, a weaker iron ore price and poor data out of china.

Yay for last week’s interest rate cut!

Expect more of the same today. US stocks jumped overnight, and the oil price continued its ascent. The economy continues to look dicey, but interest rate juice overpowers all.

One sector you’d think would be celebrating wildly would be property. But it’s not quite so clear cut.

A couple of articles that I came across yesterday suggest there is still a bit of fear out there in the property sector.

Top of the list comes from Business Spectator’s Robert Gottliebsen, who has taken to writing articles about property of late, seemingly after having a coffee with property developer Harry Triguboff. I assume Harry’s buying…

Over the past month or so, nearly all the articles have been about the decline in Chinese bidding for Aussie property. Which may be disastrous for an apartment developer like Triguboff, but not so much for the economy as a whole.

Still, Gottliebsen doesn’t think so:

Chinese buying of apartments was one of the biggest forces that enabled Australia to avoid going into recession following the dramatic decline in mining investment.

If the current dramatic decline in Chinese apartment buying continues, in the absence of some other offsetting factor, it could easily lead to a recession in Australia.

That’s quite a claim. I’d say the RBA’s huge 2011–13 interest rate cuts, which fired up local demand for debt, consumption and residential construction, were more than enough to keep our heads above water.

It just so happens that, around the same time, China’s Xi Jinping was trying to clamp down on corruption — and slow a property boom — which sent a torrent of panicked Chinese capital not only into Australia but to all corners of the world.

And because the Chinese can’t own land in China (they buy long term leases from the government), they do the smart thing and shift their capital to countries with secure property rights.

Australia is an obvious choice. But according to Gottliebsen, our banks don’t ask the right questions. Seriously…

The Chinese have been wonderful borrowers but the questions we ask on the bank lending forms do not correspond with the way they make their money, so, in the past, many bank loan executives have encouraged them to answer questions about their income sources with what are at best half-truths.

Hmmm, ‘half truths’ you say?

The Weekend Financial Review says it’s ‘no truths’:

AFR Weekend has obtained a copy of a recent loan application in Chinese and English that bilingual lending experts said was a “ludicrously obvious forgery” for a $960,000 loan to purchase a $1.06 million Sydney apartment.

Nervous lenders are stopping lending to overseas’ borrowers because of growing evidence that thousands of similar loan applications are being processed, or could have been approved and processed.

Look, there is a lot of genuine foreign capital coming into Australia. Selling property to foreigners (of which the most visible lately have been the Chinese) is a long running business model for Australia.

But when the sale is the result of fraud, it begins to get the public worked up AND makes the banks nervous (after they’ve done it without question for a few years).

Actually, you could argue that the banks didn’t care. It’s only now they see the loans paid off in record time (which means little money made on the deal) that they see the risk and reward equation as not in their favour.

Anyway, now that bank regulator APRA and the banks are cutting back on lending to Chinese buyers, concerns are rising about the ongoing strength of the property market.

Cue the next article, again from the Financial Review, quoting a report from value investor Roger Montgomery:

A key signal for whether Australia is about to experience its own property market collapse lies in the spike of house constructions, says value investor Roger Montgomery, adding if the United States is anything to go by, we’re in serious trouble.

After crunching the numbers, Mr Montgomery says the estimated 18 months local overhang is more than the 12 months oversupply the US had prior to the popping of its housing market bubble.

I know Roger. He’s a good bloke. He knows more about company analysis and valuation than most fund managers in the country. But I wouldn’t take advice from him (being a value manager) on Aussie property.

Capital city property hasn’t been good value for more than a decade. But that doesn’t mean it’s about to crash.

While Roger knows stocks inside out, my mate and editor of Cycles, Trends and Forecasts, Phil Anderson, is probably the most knowledge person in Australia when it comes to property.

I’m not just saying that. When Phil first began publishing his material with us a few years ago, I was a bit of a sceptic.

But I read his stuff…all his reports, his book (which I highly recommend) and his theory of the economic rent. Or rather, his revival of 19th century economist David Ricardo’s theory.

It’s spot on. Here’s what Phil had to say about the ‘fundamentals’ in his latest report for Cycles, Trends and Forecasts:

Unlike property prices, rents are tied to wages. You can’t borrow money to rent a house or a unit.

If housing values were determined by underlying ‘fundamentals’, then the price of a property and its rental income should track each other quite closely.

But they don’t.

Our housing market is based on anything but fundamentals. Its primary motivator is speculation on the free lunch of capital gains (better termed ‘land price’ gains).

As land prices inflate, rents get squashed, and yields inevitably fall.

In other words, Phil knows that not only are land prices high in Australia, but that they’re out of whack with the fundamentals. But he also knows that it doesn’t really matter. Australian economics and politics are driven by continued house price gains…and you can stick your fundamentals where the ‘sun don’t shine’.

Phil reckons this will continue playing out according to the cycle, which still has a few more years to run before we enter the mid-cycle slowdown. If you want to fund out more, click here.


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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