July 2015 – Is there a property bubble?
Is there a property bubble?
There has been considerable media about a potential property bubble in Australia. My view is that such media attention is based on a generalisation. We need to bear in mind:
- The property market (like all markets) goes in cycles;
- The Australian property market is not homogeneous. Different regions are in varying sectors of the cycle;
- Some regions are more susceptible to “boom and bust”, while others enjoy a more continuous and stable growth; and
- Sensationalism sells newspapers.
I do not propose to fall into the trap, and endeavor to discuss the property market in a generalist manner. Rather, I will focus on the GPS market. This market is defined by the “two hour rule” from our offices in Brisbane. In more recent times, this has contracted to 10kms from the Brisbane GPO with a “compelling reason” required to be demonstrated for us to venture back out to our traditional two hour drive boundary.
I have not seen evidence of a property bubble in the GPS market. Price growth has been moderate. Sales rates continue to be sound. The median price is lagging well behind all other capitals besides Adelaide and Hobart. If Sydney and Melbourne prices fell back to Brisbane levels, there would be a lot of newspapers sold.
The underlying strategy of GPS was crystalised in my mind during a phone call with a long-standing Investor in the darkest and most uncertain days of the Global Financial Crisis (GFC). I initially thought that the Investor had called me for reassurance. It was the opposite. He was calling to tell me the strategy if the world’s economy truly went pear-shaped. It went as follows:
- Finish all projects. We will get slaughtered if we attempt to sell partly-finished product. We have the monies and there are plenty of builders available as nobody else will still be building.
- We become a quasi-property fund and rent out all the completed product. The property market will come back. Historically, the rental market does not do as badly in such times of economic stress as people still need somewhere to live. Furthermore, there will not be much new product coming on to the market.
- Do not worry if the distribution rate drops to around 4% as supported by a deflated rental market. At 4% in such economic times, it will be one of the best performing assets in any of our Investors’ portfolios. When the property market does come back, then we claim the lost interest back under the mortgage as the interest is able to be compounded.
- If you come through such a period of economic upheaval, paying 4% interest along the way, having minimal capital losses, and an effective interest rate of 8%+ for the duration, you will be a hero.
This strategy continues. If you look at the typical product which is financed by GPS, it is generally quite vanilla and capable of sustaining a rental market. I do not see that there is a property bubble in the GPS market. If I am wrong, then we have a backup plan.
Is there a glut of product in the pipeline?
There is also media attention about a potential glut of apartment product in the pipeline which will lead to a crash in property prices as a consequence of an over-supply of new product.
My general view is that the government did learn lessons from the period of excessive lending which lead to the GFC. The government and its agencies, such as the Reserve Bank of Australia and APRA, continue to put a series of controls in place to reduce the pipeline of new developments by limiting finance.
While I do not profess to understand the finer workings of such complex strategy by the government and its agencies, I do see the various controls in play which include:
- The market is not being overrun by foreign banks who are lending so as to get monies out the door and establish market share;
- The Australian dollar continues to be under pressure to fall in value which makes Australian securities less favorable;
- Banks are under pressure to capitalize. We are now up to Basel IV; and
- Ratios of capital for development loans for banks is on the increase.
In my little world I am seeing:
- The banks are being quite conservative and not writing a large volume of business;
- I would rate their volumes as generally being “business as usual” for the Big 4 and reduced volumes for the regionals;
- There is very little competition from private funders such as GPS. As noted in previous articles, we have set what we believe to be an optimal size of funds under management. Once reached, we propose to then keep pace with inflation; and
- Vendors of development sites continue to over-value their properties making many approved developments unviable. Personally, I am presently at one of my all-time highs for rejection of applications for finance.
Overall, while there may be a large number of projects in the pipeline, the market will rationalize the flow-rate. This is a form of natural attrition.