Something’s melting Down Under

“Don’t worry about the world ending today, it’s already tomorrow in Australia” ~ Charles Schulz

Australia is a beautiful country, blessed with abundant resources and natural wealth, and was once an important outpost of Imperialist Britain in the Far East a century ago during the Victorian Era – forging an identity for the basis of the Commonwealth we know today.

Hands-across-the-sea_w480

Due to its rather remote location (other than New Zealand) on the world map, Australia has often been a refuge and shelter from trouble, and this was seen across 2 horrible world wars and several geopolitical crises during and after the cold war. Unfortunately in this century, it has also become a place for speculative capital seeking refuge or returns in a global, highly-financialised and intertwined economy.

A sporadic, surreptitious worldwide financial bubble propped up by central banks globally (as explained in an earlier post) have led to the development of asset bubbles in many different areas of the global economy, and real estate is one prime beneficiary of unconventional monetary stimulus in developed markets over the past decade.

While Hong Kong, Singapore and recently London have already seen gradual price declines in commercial and residential real estate valuations for at least since 2013/2014, cities like New York, Tokyo, Vancouver, Melbourne (to a certain extent) and Sydney are still richly-valued and supported by hot money seeking higher returns in a miserably-low interest rate environment. However, things are changing.

Australia’s economy struggles to rid its reliance on commodities…

As China slows down and transits into a consumer-driven economy, Australia has been hit by the cyclical downturn in commodity prices over the past 4 years. The end of the mining boom in Perth have already led to a rise in unemployment and a slowing economy in Western Australia, depressing both commercial and residential real estate prices there. For some time now, Australian policy-makers have attempted to rebalance the continent’s economy away from resources, but political impasse have slowed the process. As a growth engine, domestic consumption as well as tourism is still insufficient to replace the mining boom, and slower GDP growth rates have resulted from 2013 to present.

The Reserve Bank of Australia (RBA) have eased monetary policy as a result in an attempt to stimulate the economy, lowering Australia’s benchmark interest rate from 4.0% in 2012 to the current 1.75% (a total of 225 bps). Affected by declining commodity prices and lower interest rates, the Australian Dollar (AUD) has steadily weakened against the currencies of its trading partners, affected by an unwinding of decade-long carry trades as well. While a weaker AUD lends support to exports growth, it also makes real estate to foreign investors look attractive.

AUD REER

However, the real estate cycle seems extended

As a whole real estate valuations have held up, but the cycle now seems extended, particularly in Victoria and New South Wales. While Brexit woes may actually attract more foreign capital into Australian real estate for some time, it may only further exacerbate the frothiness of the issue.

Commercial real estate

The government has been under pressure to stimulate economic conditions while simultaneously ensuring that residential property valuations do not overheat (lest the locals take to the streets with them pitchforks). While data shows that real estate prices in Western Australia and Northern Territory have seen disinflationary trends due to the end of the mining boom, house price inflation is also falling in Melbourne and Sydney since 3Q 2015. Policy-makers have also introduced cooling measures like stamp duties and tightening standards on mortgages for foreign home buyers in New South Wales and Victoria.

Both new home as well as existing home sales data across Australian cities have also started to see declines since the second half of 2015, and the Australian Bureau of Statistics have reported that growth in investor mortgages and overall mortgages have slowed the fastest since the second half of 2010, with speculative activity seeing some declines.

new home sales

More headwinds and risks ahead!

Should rebalancing efforts (transiting to a domestic, consumer-orientated services economy) take a longer time to materialise, Australia’s economy could continue to slow in a slow-mo fashion as global economic momentum post-Brexit seems to be decelerating. There now seems to be serious headwinds to both commercial and residential real estate valuations going forward, particularly in New South Wales and Victoria.

Additionally, due to the deflationary shock that a weaker Renminbi has on asset markets and global economic momentum (the Chinese being a major purchaser but having a lower purchasing power), a sharper-than-expected depreciation of the Renminbi against all currencies could be a catalyst, or even the coup de grace to a deflating real estate market in New South Wales and Victoria (see chart à la Bloomberg below).

chinese investment

Course of action:

A diligent investor could seek out highly leveraged and weak companies that rely on the real estate market in New South Wales/Victoria (think of mortgage providers and construction companies) and bet against them.

As for me, I’m preparing to short listed real estate companies via ETFs that track the sector. There are 3 in total, the SPDR S&P/ASX200 Listed Property Fund (SLF), the VanEck Vectors Australian Property ETF (MVA) and the Vanguard Australian Property Securities Index ETF (VAP). They seek to track indexes of publicly-traded Australian REITs – the S&P/ASX 200 A-REIT Index and the MVIS Australia A-REITs Index and the S&P/ASX 300 A-REIT Index respectively.

Dividend yields are north of 4%, and with yields of Australian government and corporate bonds falling, REITs look attractive on a relative basis, and real money may move in to harvest those yields in a post-Brexit investment environment. On the price charts, the index displays a bullish uptrend, and it is likely to continue for a while – until it couldn’t (real estate is highly cyclical and no force on earth can change that). Hoping that their drivers of income would hold up may be a fool’s hope at this juncture given the factors explained above. A break in prices is something to look out for.

A REIT index

*images taken from www.visitnsw.com and http://www.nma.gov.au/*


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