Facing up to the new credit squeeze

Challenges will emerge in our property markets as overseas buyers face new barriers to purchasing apartments.

Summary: The mining slowdown has in part been cushioned by Australia’s construction sector and the flow of funds into our major housing markets from Chinese investors purchasing new apartments. However, there are trends that could spell a slowdown on the horizon: for instance, we are seeing a two-tier market where, because overseas investors can only purchase new property, they are buying off the plan at and a higher price than local investors are willing to pay when that same property comes onto the market. The increased difficulty of getting funds out of China means a greater reliance on Australian banks to fund property purchases – and if our banks’ loan books extend beyond APRA’s requirements, banks will have to raise more capital.

Key take out: I believe if these trends play out, there will be trouble – it’s important for Eureka readers to be across the situation and think about their exposure to bank shares.

Key beneficiaries: General investors. Category: Property.

Over the 10 years I have been writing weekly to the readers of Eureka Report and I have regularly attached a caveat to commentaries – the strong rise in Australian housing prices and bank shares depends on the continuation of Chinese and Asian investment. And that obviously applied mostly to Sydney and Melbourne apartments and selected suburbs where the major buyers are from Asia.

And so, today as I return to the subject, I know many readers will say that I have cried wolf in the past. (Others will say we need a fall so our children and grand children can afford to buy a dwelling).

But this week I found myself in the presence of important apartment operators in both Melbourne and Sydney (one was so concerned he called me) and they both gave me a different version of the same story.

I am sure that the people I am talking to also speak to stock market investors and their sentiments are no doubt part of the reason for our bank shares falling sharply. The Melbourne and Sydney situations are both different and the same. I am going to start with Melbourne because it has taken a bigger than normal share of Asian investment and Asian developers have been much more prominent in Melbourne than in Sydney, which is still dominated by Harry Triguboff’s Meriton.

Melbourne - a two tier market?

The Melbourne developer I spoke to has just completed towers, which he mainly sold off the plan to Asian investors. So far they are honouring their agreement to buy apartments, but what makes him nervous is that he is facing a two-tier market. Investors from Asia are not allowed to buy second hand apartments. They must buy new ones. And so a new apartment that Chinese or local investors purchase for theoretically, say, $700,000 must be sold to a local if it comes onto the market. And the locals are only prepared to pay in the vicinity in $500,000 to $550,000 for a second hand apartment. This is a very dangerous situation, because Chinese investors in this situation know they are facing an immediate paper loss greater than their 10 per cent deposit.

Figure 1. Median property prices, 2 bedroom units in Melbourne - 2006 to 2015.

Source: realestate.com.au,

For the most part, investors of this type are focused on the long-term and are very often prepared to leave the apartments vacant so the price differential doesn’t become top of mind. Nevertheless, Chinese are astute business people and they are aware that at least on paper there is a loss on every apartment they buy. Of course, the banks have suddenly become aware that if they are funding an apartment priced at, say, $700,000, the actual market value is substantially less so the value which they use for loan security is even lower. That means that if a Chinese investor needs to tap the Australian banking market, it becomes very difficult to gain substantial funding. I will return to this issue later. So far the situation is holding but the constant talk of an Australian property crash increases the nervousness of Chinese investors in a two-tier property market. The Chinese developers are still buyers of land in Melbourne and have bid the prices up to a point where my local developer is saying is that it is not worth the risk of taking on new apartment developments – what land he has left he is thinking of selling to Chinese investors.

Here comes the credit squeeze

And then we come to Sydney, where Harry Triguboff’s Meriton dominates the market.

Figure 2. Median property price, 2 bedroom units in Sydney, 2007-2015.

Source: realestate.com.au

Triguboff refuses to sell apartments to overseas investors unless they occupy them or rent them out. The secondary market does not carry anything like the discounts that are appearing in Melbourne and overseas investors are getting a yield on their money because the rental market is strong. But there are still problems: Up until about six months ago, Chinese apartment buyers were able to extract the money out of China and did not need to rely on the local banking system. They signed up to buy a vast number of apartments on ten per cent deposit when money was available from China. Even so, for a long time many Chinese and Asian investors have used the Australian banking system borrowing about 70 per cent of the value of the properties. Accordingly the Australian banks have a big stake in the market.

But now it is much more difficult to get money out of China, so more and more of those who bought apartments on ten per cent deposit are looking to Australian banks to provide the funding complete the deals. And here is where the rubber hits the road. The Australian banks have been told by the banking regulator APRA that they are not allowed to let investor loans rise by more than around six per cent. If they grow by a higher amount, APRA says it will force them to raise more capital. It is a very effective credit squeeze. If the Chinese banks were lending in the way they did previously, it wouldn’t have a big effect on the market. But given money is now harder to take out of China, people are getting twitchy. And it is made worst by the fact that ASIC is questioning the quality of bank loans both in the residential and the industrial sectors. The danger is that the regulators have their own agendas, which are related to bank gearing and are totally divorced to what is happening in the market place.

If they continue to put a credit squeeze on the lending to overseas buyers then we will see more than a token fall in the price of apartments and the fall will spread to the total bank lending book. And once that starts to happen then all the wonderful plans of the New South Wales government to sell land to Chinese developers to fund its revenue will suddenly dry up. Building activity will be curtailed. And remember it is the building of apartments and the avalanche of Chinese capital to fund those apartments that has been a big factor enabling Australia to get through the mining investment slump.

Turn it off and we will be in trouble and so will any government in power at that time. I think once the real situation is understood by the regulators and the governments, the right decisions will be made, but there is now a lot of nervousness out there in the market place. I know Eureka readers are heavily into bank shares because of the income and my hope is that we will ride through this problem. But given my conversations with developers you need to be alerted to what is happening. If you feel you need to trim your exposure then do so.

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