Residential developers to face tough times

Experts are divided over the extent to which the asset class will be punished, but agree that painful times are ahead.

Those most at risk include private residential property developers, who cannot source credit from increasingly risk-averse banks and who are out of the equity market.

Public companies with a large exposure to the residential segment of the market include Stockland, Australand, FKP, AVJennings and Lend Lease. Not surprisingly, these property groups and others have been hit hard, with Australand shares down 75% for the year to date and AVJennings stock down 58.85%.

Yesterday property group and fund manager Valad Property Group scrapped its earnings guidance for 2008-09 and cancelled its planned first-half distribution payout because of unstable market conditions. Other companies have written down the value of existing or planned properties by hundreds of millions of dollars.

The growing concern for investors, as well as property owners, is that as property values slide, other assets will be dragged down as individuals and companies that have borrowed heavily try to claw back funds by panic selling.

"Australia now faces a recession, and as I said at the beginning of the year, house prices will fall very significantly," said Jonathan Pain, of HFA Asset Management. "Yes, Asia will help soften the blow, but it won't prevent a decline in economic activity, which will be driven by a continuing fall in discretionary spending as house prices decline and banks cut back on lending.

"We have some of the most expensive housing, relative to incomes, in the world and we have massive levels of household debt."

Sydney economist Steve Keen believes Australia faces a savage correction in house prices, and Morgan Stanley analyst Gerard Minack has predicted house prices could fall 30% or more by 2010.

However, ANZ senior economist Paul Braddick said drastic price falls were unlikely "unless the economy collapses completely".

"There is such a critical shortage of housing, it places a floor under house prices," he said.

"Sentiment could be weak enough that we could see some marginal falls over the next three to six months. But we don't think they will be significant or sustained - particularly with the sort of interest rate cuts that we're seeing and strong household income growth next year."

AV Jennings chief executive Louis Milkovits said the only way new house prices could fall was if land prices fell.

"Builders report a net margin of only about 4%," he said. "The average block of land costs about $200,000 and construction costs are about the same. If you don't get the sort of price that you're getting now then you can't be in business." The latest leading housing indicators suggest the housing building industry has already dived. In August, new home building approvals fell 3.7% to 12,095, the weakest figure in seven years. New home loans and sales of new, detached houses also fell in August for the seventh month in a row.

Mr Milkovits said he did not expect building levels to fall any further due to interest rate cuts and an ongoing shortage of supply.

"Normally an interest rate reduction of the size we saw in the last week would lead to a surge in activity," he said. "But I think at the moment, people are terribly confused. Once they can absorb all the information on the global credit crisis, and the security of their jobs and income, they will return to the market and activity will improve." HIA chief economist Harley Dale also said a recovery could be months away.

"We think there will be a moderate recovery in new home building in the 2009-10 financial year," he said. "In the meantime, the risk of business failure is increasing. Small and medium-sized builders in a range of situations across Australia could face trouble."

Mr Harley said that despite the prospect of further interest rate cuts, builders would struggle to refinance.

"If there's not as much money around to lend, then the net effect is still negative," he said. "It will be more difficult over the next six to 12 months for developers to get projects up and running. It won't be because projects aren't viable . it will be because there's potentially less credit available."