Australia's evolving property puzzle

General consensus has long held the Australian property market is set for a larger downturn. Recent data indicates the opposite could be the case.

For years consensus has expected the Australian property market to follow the US (and Spanish etc) market into a downward valuation spiral. This consensus view weighed heavily on more than just property. Australian commercial banks, loaded to the gunnels with Australian housing exposure via their mortgage lending, have until recently been marked down. Sometimes savagely.

But then something strange happened. If this week’s positive data on Australian home prices from the Australian Bureau of Statistics and Rismark is any guide, Australian house prices are in the process of bottoming out, as the following chart shows.


NZ house prices are at record highs

Nor is this latest Australian data an isolated data point. According to the Real Estate Institute of New Zealand, the New Zealand national median price rose 3.3 per cent year-on-year in June to a new record high of $NZ372,000.

With its currency pegged to the US dollar, Hong Kong enjoys the US interest rate regime. This is probably the major reason why their Centa-City Leading Index shows home values have jumped more than 80 per cent since the start of 2009. In the year to March, they rose 5.4 per cent.

In Singapore Gina Rinehart reportedly spent about $44 million buying two units, off the plan, in the Seven Palms Sentosa Cove condominium project. She will join fellow rich lister Nathan Tinkler at Sentosa. As we shall see, premium property in particular has hardly missed a beat since the GFC started.

North America

Property is even stirring in North America. After a traumatic five years, 30-year fixed price mortgages of under 3.4 per cent are starting to impact. The broader US housing market is turning. Consider the following chart of the top 20 US home markets. It shows a bottoming process with an ever so hopeful hint of an upturn.


Luxury homes in particular are on the march. In the Hamptons on Long Island, transaction volumes rose nearly 10 per cent in the June quarter. This represented the highest level of activity in over five years! In New York, a good quality apartment can still put you back $US100 million, give or take. Mind you, this two storey penthouse is still off the plan.

Artist's impression:
Source: Extell Development

Good view or not, it sounds pretty frothy to me.

In Canada it’s as if the GFC never happened. According to the Canadian Real Estate Association, home prices climbed 34 per cent since January 2009, as the following chart highlights.



In the midst of the euro meltdown, housing bubbles can be found across northern Europe from Norway to Switzerland. Norway’s debt-free government, 2.7 per cent unemployment and 1.5 per cent official interest rates are particularly attractive. Switzerland enjoys similar fundamentals.

Even in London, premium property is up. According to Knight Frank, house and apartment values costing an average of £3.7 million climbed 10.7 per cent in May from a year earlier. No doubt the fault of all those Russian oligarchs and continental squillionaires looking for hidey holes.

Savills reports luxury property globally is rising at a fairly rapid clip, as shown in their following chart. High-end property rose in most major cities across the globe in the six months to December 2011. Sydney was one notable exception.

Source: Savills

Staring into the abyss

"When you stare into the abyss, the abyss stares back at you.” – Friedrich Nietzsche

The obvious question to ask is: Why are these hard assets rising? Consider the abyss the world’s central banks faced in 2007. Before the panic, global assets equalled, let’s pick a number – $100 trillion. Global liabilities equalled, lets say $80 trillion. The difference represents the world’s pre-GFC wealth, i.e. $20 trillion. Trillions is a pretty nonsensical number for most of us to grasp, so let's keep it real simple. In 2007 the world owned about $100 in assets less about $80 liabilities giving net worth around $20.

Suddenly stupidity (sub prime) and later fraud (Madoff, Stanford, Libor) is uncovered. In the space of a few days to weeks, asset values drop by say 35-50 per cent. At that point the world’s global balance sheet looks like this. Assets - between $50-65. But liabilities stuck at $80. As my daughter would say – "busted”!

This is the global balance sheet the world’s central banks faced during the height of the GFC. Even worse, a move to liquidate assets in a fire sale to satisfy creditors, would create a domino effect of asset sales and cascading asset values to; well pick another number – way lower than anyone wanted to think about. The Stone Age would beckon. So, what to do?

Our generation, perhaps more than any other in history, has a phenomenal capacity to operate in a virtual world. And in finance, fiat currencies backed by nothing more than "trust me” ("yea right”), give enormous capacity to operate virtually. Under a George Costanza type principal of "you're only busted if you recognise the loss”, the first stage in the GFC recovery was for central banks globally to, well, just ignore the losses. Operate virtually, as if nothing happened.

Stage two is a little trickier. Reducing liabilities is impossible without triggering a default. So if liabilities can’t be changed, the only other alternative is to reflate asset values back to 2007 levels. Hmmm.

Enter quantitative easing

At heart the world’s central bank’s quantitative easing programs are about reflating asset values back to something like the value of liabilities. Hopefully more. The following chart from Deutsche Bank shows how central bank’s tripled the size of their balance sheets post GFC. They did this by creating money (fiat currency) and going on a buying spree – mostly government bonds but also mortgages.
Quantitative easing stabilised asset prices. It enabled the world to avoid a return to the Stone Age. However to date only modest "asset reflation” success has been achieved as evidenced by the above property anecdotes.

Equities and precious metals

"Bull markets are born on pessimism, grow on scepticism, mature on optimism, and die on euphoria.” – John Templeton

But I think that might be starting to change. Equities are also stirring. July’s 4.3 per cent rise in the Australian market was its third strongest rise in 19 months! In the US the Dow has risen every month this year except May. It is currently less than 3 per cent below its one year high.

Although commodities have been under pressure, all precious metals are up 1-4 four per cent year to date. Much maligned gold is up 4 per cent. The following chart shows the correlation between the gold price and central bank assets. The more quantitative easing, the higher the gold price, and vice versa.


"Don’t fight the Fed”

The view that real asset prices are starting to bounce is the complete opposite of current consensus, which seeks safety in bonds and other 'defensive' assets. In many countries of northern Europe (eg Denmark, Germany), demand for safety is such that governments no longer have to pay to borrow. Investors pay governments to look after their savings. In so doing they are guaranteeing themselves a loss. That just doesn’t make any financial sense.

Meanwhile in Australia, property prices are certainly not in the fast lane because the Reserve Bank of Australia continues to comatose the Australian east coast economy. The RBA’s high interest rate regime is killing Australian manufacturing and tourism. And is not that helpful to retail either. All three industries are huge employers.

But commodity prices are falling. For example, iron ore is below $US120 a tonne or down a third in a year. This will see the RBA come under increasing pressure to lower Australian interest rates to levels more commensurate with other western countries. It might take a while, but look to property markets in the US, UK, Canada and New Zealand for a lead on the medium term direction in Australian property – i.e. up.

Perhaps quantitative easing and record low global interest rates, which have gone negative in a swathe of countries across northern Europe, are starting to impact after all.

Mike Mangan is the chief executive of 2MG Asset Management.


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