Last week I attended an investment management conference in Melbourne. The day was lined up with asset managers providing the attendees with their point of view on markets – including the stock market, bond market, and of course, the property market. Most, if not all of the firms presenting were either equity or bond managers. I don’t believe there was a property manager presenting on the day. Yet, most managers spent a bit of time discussing the property market, and the gloomy outlook for this sector. The large debts, the level of construction, foreign buyers, I could go on.
That evening I also attended a property development forum, presented by two specialist groups, who talked about the current situation in the property market, providing a different point of view from the asset managers earlier on in the day. I guess this is what makes the market, right? One persons view compared to another.
Here’s where I think the property market is at.
We’ve been hearing the same call for years – the Australian property market is a speculative bubble…blah blah blah.
Sure, property prices aren’t cheap. In fact, they’re sitting a little above their long-term trend according to AMP.
All the reasons the equity and bond guys were giving at my presentation are well known. Ballooning debt levels, prices to income and rent ratios are high, and there are far too many cranes in Melbourne’s skyline (and yes, there is an index for this).
Unfortunately, in both my experience and readings, things are little more complex than this.
1. Ballooning debt
Household debt has been skyrocketing since the GFC, and after the RBA began cutting rates in 2012 (I guess you could argue debt has been skyrocketing since 1991). Yet the amount of interest paid by households is back down to levels not seen since 2004. Notwithstanding, this is a problem. How will this debt be reduced? Inflation? Wage growth?
2. It’s a bubble
When people refer to the US property bubble, I ask them which city they’re referring to. Yes, the US had a property meltdown, however not all cities we’re wiped out. New York fell 24.45%, Dallas down 7.53%, and Boston fell 16.38%. In fact, it wasn’t even the cities that had the largest growth pre-GFC that fell the most (refer LA and San Francisco). On average, prices in major cities fell around by one third of their value.
Similarly, when people talk to me about the Australian property bubble, I ask them which city/ies they’re referring to. In Australia, it’s largely been a story of Sydney and Melbourne.
This hasn’t always been the case (see chart below). Perth property prices we’re going bananas during the mining boom, yet they’ve been lagging ever since. Most cities circle around the national average, some over-performing, and some under-performing. Lack of affordability eventually encourages investment into other cities, as we’ve seen recently into Queensland and Tasmania.
3. We’re building too many dwellings stupid
It’s everyone’s greatest fear (or possibly greatest desire – a claim to fame perhaps?). The miraculous oversupply of property, more specifically in apartments. It’s expected that Victoria will be home to about 8 million people by 2050. And these people will want somewhere to live, surely. Based on these numbers, it may come as a surprise to most people, but we’re just now starting to build enough property to help support our growing population. Sure, we’re going to see periods of oversupply and periods of under-supply, which in turn will result in periods of price growth and periods of price declines. This is not unusual, the free market has been valuing assets this way for centuries.
Over the last 7 years, Victoria’s population has been growing well above the national average.
This is supporting vacancy rates remaining low. In Melbourne and Sydney, we’re seeing below average vacancy rates:
You think it’s bad now? Over the next 20 years, population growth is expected to surge. Here’s where they’ll grow the fastest:
These people are going to want somewhere to live. Here is where we’re going to see the largest growth in dwellings:
If you think there is a lot of development activity in the City of Melbourne, you haven’t seen anything yet. The city you and I know today, will not be around in the next 10-20 years. Here’s a great interactive site the City of Melbourne have up, and you can see what is constructed, what has commenced, and what has been applied for.
4. The banks are a proxy for the residential property market
Then why are you investing in the stock mister equity guy?
At the end of the day, it’s going to take one of two factors to bust (temporarily) this housing market – a rapid rise in rates, or a rise in unemployment. The consensus goes something like this…rates are rising, which will lead to higher unemployment, which will lead to loan defaults, which will lead to property price declines, which will lead to a banking collapse. Sounds reasonable. Luckily for us, this actually happened, so we can see what impact is actually had. Western Australia – mining boom collapse. Trade fell 25%, unemployment up to 6.50%, property prices fell 12%. Do you know what impact this had on Westpac’s lending losses – they doubled…from 0.02% to 0.04%. If this scenario we’re replicated across the nation, bank profits would be cut by 0.60% (farrelly’s). Not really the Armageddon scenario that’s being painted.
5. Tighter lending standards will stop the price rises
It’s no secret, lending is tightening. This has created an opportunity for private/non-bank lenders to enter the market. The banks shouldn’t be expected to cater for every transaction that occurs. I was recently told by someone that Westpac (if WBC can do it, I’m sure most of not all lenders can) are now able to tell how much exposure they have to a single building even each purchaser took out their loan from a different Westpac branch/office. This enables the bank to limit their lending to one particular building/construction.
My expectation is that we’ll see in Australia what we’ve been seeing in the UK and US. That is, non-bank lenders growing as a proportion of all lending.
Currently you could lend senior money out and receive 10-12% pa. I do wonder though, what impact this will have on bank profits.
We have an under-supply problem. Our population is growing at a rapid pace. We’re seeing them from all around the world, and they want somewhere to live. Here is the state of Victoria’s population and household projections to 2051. This report is used by decision makers in government to plan for our future. I suggest it’s something worth reviewing if you’re looking to invest in property. You should also check out the government’s online planning maps. Again, this may be useful if you’re looking to invest in property for the long-term.
Sure, the market isn’t cheap – this isn’t something new. The property market grows at above average rates, and is then followed by growth at below average rates. When rates eventually rise, my expectation is that we’ll see a decline in prices. Those that have over leveraged themselves will be forced to put the for sale sign out the front. The fact that most people have, and will continue to want to buy, live, and invest in property, will naturally create a safety net. Property prices can float sideways for long periods of time. They don’t always need to boom or bust, the outcome is not always binary.
As long as the music keeps playing (demand), we’ll all keep dancing. Australia does not have a property bubble.