Investment Enews
DECEMBER 2016
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It is hard to believe that we are already approaching the end of 2016. And what a year it has been. We’ve seen the people of the United Kingdom vote to leave the European Union (watch this space…). We’ve seen the people of the United States defy the pollsters and pundits to elect Donald Trump as President (watch this space…). We’ve seen the Western Bulldogs (AFL) and Cronulla Sharks (NRL) complete fairy tale-like wins in their respective competition’s premiership. And – most amazing of all – we’ve managed to retain the same prime minister for the whole year (although we might be counting our eggs before they hatch on that one…)

To wrap up this… exciting… year, this Investment Enews will take a look at the current state of the Australian property market and our prospects as a nation for the years ahead.

Australian Property and the Prophets of Doom

It will surprise no one to learn that 2016 saw expert predictions of an imminent housing collapse. After all, such forecasts have become the 21st century’s never-fail headline grabber. The amusing “Chart of Shame” below shows just how common – and how misguided – these claims have been over the last fifteen years or so.

That is, of course, not to say that we’re perennially bullish on the Australian property market. After all, the property market is a market and – as with all markets – property prices can fall as well as rise. Indeed, history tells us that most – if not all - markets experience corrections at times. However, the poor predictive track record of the ‘prophets of doom’ suggests that we should be wary of making investment decisions in reliance on them.

So what does the housing market in Australia look like at the moment? Here are four key graphs showing important truths about the current Australian housing market.

Four key Charts About House Prices

First, when considered in aggregate, housing prices in Australia are high. As the adjacent graph from SQM Research shows (see Louis Christopher’s Housing Boom and Bust Report 2017 here), Australia’s house prices have historically been closely related to the size of the national economy. Since the turn of the century, however, that relationship has been more tenuous. In recent years, a gap has developed. Proponents of ‘mean reversion’ theory would argue that this gap will eventually close, either via a relative acceleration of GDP growth or a contraction or extended slow-down in house price growth. Whilst having some intuitive sense, prospective purchasers should be wary of placing too great a reliance on this type of comparison. It is based on historical observations. There is no iron-clad rule that the relationship between housing and nominal GDP can never change and there is certainly no iron-clad rule that the relationship must “revert” within a particular time period.

Next, and as we never stop saying, it must also be remembered that there is no such thing as “the Australian housing market”. Australia is a vast continent with a relatively small population. Each region has its own economic drivers and the story of house price growth has varied dramatically from region to region.

Since 2012, Australia ex Sydney and Melbourne has experienced a notably flat property market. Adelaide, Brisbane and regional areas have seen very low positive growth over a period of more than a decade. Perth (plus mining-related areas and the Northern Territory) have seen prices decline materially in the last few years as the mining boom has subsided. Sydney and Melbourne, on the other hand, have experienced very strong house price growth, driven by strong local economies, low interest rates and population growth.

On the other hand, whilst we’ve seen that housing prices are high when compared to nominal GDP, on an affordability (interest payments) basis they are very much within normal ranges. Extraordinarily low interest rate settings have compensated for the very strong average house price growth and have kept household interest payments well within the normal range as a proportion of income. Indeed, housing is currently about as affordable as it has been at any time over the last decade. Even on a generational time-frame, housing affordability is within normal ranges. Of course, this measure does not take into account the difficulties many first home buyers have in saving a deposit, but it does provide a significant part of the explanation as to how house prices could have risen so strongly in some markets.

Finally, there is the foreign purchaser effect on house prices. Last financial year the value of foreign investment approvals for Australian residential real estate surged 75% to a record $65 billion. That is a small fraction of the $7 trillion Australian residential property market, especially when you take into account the one-in-three conversion rate between FIRB approval and actual investment as estimated by observers such as UBS. However, foreign purchasers of residential real estate are limited to new stock and so make up a significant proportion – perhaps as much as 25% - of new developments. Critically, currency plays a big part in these transactions and the weakening of the Australian dollar (AUD) over the last few years has had a significant impact in keeping house prices relatively low for foreign purchasers.

When you net off these and other factors, we can see that, whilst house prices in Sydney and Melbourne are high against historical points of comparison, there are some very rational reasons for this. Our basic assessment of the Australian housing market remains unchanged. Year to year corrections are possible in any market, including housing. In particular, some areas remain exposed, such as the those still correcting after the end of the mining boom and localised areas facing demand/supply imbalances. At an aggregate level, however, there is very little prospect of a serious and sustained ‘bursting’ of property prices generally in the absence of any unforeseen economic shocks.

Will we see an Oversupply of Housing?

The possibility of an imminent oversupply of housing – particularly apartments in Melbourne, Sydney and Brisbane – is a topic that has attracted a lot of attention in recent times. Economics 101 teaches us that housing prices are determined by the interplay of demand and supply. Some have queried whether the Eastern seaboard capitals are building excessive numbers of new apartments. If they have been, prices are likely to drop.

The difficulty with this discussion is that the key relevant numbers are so difficult to determine with any precision. Noted property analyst and researcher, Louis Christopher has done some heavy lifting in this space to manage some of this uncertainty. Based on his analysis of ABS private sector housing approvals and certain necessary simplifying assumptions as to likely dwelling supply and demand, Christopher has projected the following net dwelling supply outcome for Australia’s three largest cities.

As you can see, Christopher projects a significant surplus for Brisbane, with a smaller (proportionate) surplus for Sydney and almost equilibrium for Melbourne. However, as we have pointed out previously, building completions do not occur in a vacuum. For a variety of reasons, including regulatory action and concerns about a possible supply surplus, many traditional sources of finance for these developments have dried up. Indeed, some recent work by property advisory firm, Urbis showed that the projected new apartment supply to be launched in Brisbane between October 2016 and June 2017 has dropped (in just a quarter) from 4,856 apartments to 3,600 apartments.

Clearly, developers and lenders are responding to the well-publicised concerns about possible oversupply and are responding accordingly. So, whilst excess supply and price corrections may occur in some geographically concentrated markets, a broader supply excess looks highly unlikely.

Are There Reasons for Optimism About 2017?

Finally, given the apparently intractable bias of our media to the negative, we conclude our final Investment Enews for 2017 by reminding ourselves that we have a lot to be thankful for. From the distance of almost a full decade since the onset of the global financial crisis, it is clear that Australia’s economy has performed as well or better than anyone could have hoped or expected. This chart shows how the economies of most of the world’s developed nations have performed since the final quarter of 2007. As you can see, the outcomes have been dramatically different for each nation. Japan has barely grown at all, turning the so-called “lost decade” of the 1990s into a full generation of virtually zero economic growth. The Eurozone as a whole has done little better and the UK – whilst performing a little better – has still only seen around 8% growth IN TOTAL across the period. Even the US is still only around 10% larger than it was almost a decade ago. By contrast, Australia’s economy has grown almost 25% over the period. Commentators frequently focus on the fact that this is ‘below trend’, but in the context of the stagnation across the world, this is a very powerful result.

The reasons for this performance will always be debated. Some will point to our good fortune in being a close trading partner of the world’s growth engines in Asia. Others will single out the benefits of an open economy with a strong migration program that continually refreshes our workforce with new skills and outlooks. Yet others will talk about strong economic institutions and policy settings.

Whatever the reasons, we should never overlook the fact that Australia’s economic performance over the last generation has been the envy of the developed world. And there is a lot more to come.

The chart (right) shows what the metro system of a large city in a developed nation (Tokyo) looks like. Compare that to the metro systems in some comparable cities in our largest trading partner, China. Whilst China has come an extraordinarily long way in a short period of time, it is clear that there is still a massive amount of substantial infrastructure and other work to be done. All of this presents an incredible opportunity for Australia. This opportunity extends beyond the mining sector to include opportunities in advanced manufacturing, project management, professional services and business services.

As long we do not take this opportunity for granted, the long-term outlook for Australia at the end of 2016 is as rosy as it has ever been.

To all of you, our loyal readers of Investment Enews, our business partners and our investors, the staff at La Trobe Financial wish you a very merry Christmas and a safe and prosperous New Year.

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La Trobe Financial Asset Management Limited ABN: 27 007 332 363 and AFSL No: 222213 is the issuer and manager of the La Trobe Australian Credit Fund. It is important for you to read the Product Disclosure Statement for the Fund before you make any investment decision. The PDS is available on our website www.latrobefinancial.com or by calling 1800 818 818. You should consider carefully whether or not investing in the Fund is appropriate for you.

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La Trobe Financial is one of Australia's leading independent credit specialist Fund Managers. Its business includes residential mortgages, commercial mortgages, and investment services operating one of Australia's largest Credit Funds under AFSL 222213. It employs over 180 staff and has managed over AUD$12 Billion covering over 100,000 investment grade assets since inception in 1952.

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La Trobe Financial Services Pty Limited - Australian Credit Licence Number: 392385
La Trobe Financial Asset Management Limited - Australian Credit Licence Number: 222213

This publication does not constitute financial advice and should not be relied upon as such. It is intended only to provide a summary and general overview on matters of interest and it is not intended to be comprehensive. You should seek your own financial or other professional advice before acting or relying on any of the content.