Data shows that SMSF demand for property is booming. The RBA is worried it might make the cycle worse, but I argue that SMSFs will actually make the market more predictable… and safer.
I’ve been arguing for some time there are two massive factors that make this property cycle different to any one that’s come before.
That’s the surge in Chinese buying and the weight of SMSF buying waiting in the wings.
And it’s these two factors that make it such an interesting market right now. We’ve got these two super-factors overlayed over the top of a long-due cyclical recovery.
And it’s these factors – both weighing very heavily on the demand side – that means we could see incredible price growth in this cycle.
About a year ago, I did some rough back-of-the-envelope calculations, and showed that we could see SMSFs adding $160-$350 billion worth of demand to the market. At current prices, that’s several years worth of supply.
If it all came at once, it’d be a massive price shock to the market. You think property in Sydney is expensive now. Just wait.
Some people thought I was over-playing my hand. But the news from the front is that SMSfs are on the move.
A recent report in the Sydney Morning Herald said that “there has been a five fold increase in borrowing to fund a $40 billion splurge on property.”
In the four years to the end of the 2012/13 financial year, SMSF investment in residential property has increased from $37 billion to $88 billion. In terms of portfolio share, residential property is up 80%!
SMSFs are piling in. And keep in mind that though this the latest data we’ve got, it’s pretty old news now. It only up to June 2013, just one month past the bottom of the cycle.
Since then, the property boom has found its legs. There’s a good chance that our SMSFs positions are actually much larger than this.
So we’re probably already a third of the way towards the lower bound in my calculations.
But the SMH is also reporting that SMSFs are leveraging themselves into property, which is what opens up the upside potential in my estimates.
Apparently, limited recourse lending arrangements have increased 460%!
So SMSFs have pulled out all stops and are really ramping it up.
As I’ve said, the impact on the market could be massive!
So massive in fact that’s it’s got the RBA looking a little tetchy.
In their submission to the current Financial System Inquiry (haven’t heard of it? I know right? Facebook has been unusually quiet about it) the RBA lets us know that they’ve got their eye on it.
In their words: “Property investment by SMSFs is a new source of demand that could potentially exacerbate the property cycle.”
But they shouldn’t be so nervous.
While they see the writing on the wall in terms of the massive injection of demand that’s coming our way, I think it’s wrong to think that it’s just going to feed into cyclical dynamics.
What they’re saying is that the swings in the cycle could become more pronounced. The boom will be bigger, but the consolidation phase could be steeper… and more painful.
I don’t think that’s actually the case. What I think we’ll actually see is a level shift in prices as new demand is absorbed by the system, followed by a more stable and dependable cycle after that.
Why more stable? Well, think about the kind of thing that could rock the property market from here. What might pull the rug out from under property and cause a sudden correction?
Almost the only conceivable cause that I can see is some kind of major international economic shock. Maybe the US government defaults on its debt. Maybe another European economy craps its pants.
This could hurt Australia. And if people start losing their jobs, mortgages become more difficult to service, and we could see a fall in demand feed through into a fall in prices.
This is pretty much what happened with the US property bust. A few banks went belly up, people started defaulting on their homes (which brought an excess supply to the market), and prices fell sharply.
But the important thing to note here is that the key agents in the price erosion were regular working families in the suburbs, who had taken on stretch, ‘aspirational’ mortgages.
It wasn’t the investor class. SMSFs, with large, mature diversified portfolios would be much better placed to ride out the ups and downs of the market than young suburban families.
So to the extent that the balance of the market shifts more towards SMSF investors, this should make demand and the market more stable.
The other thing to remember is that the share market remains fragile – in the US more so than here. So any economic shock large enough to rock the housing market is going to hit the share market too.
Again, this is what we saw in the US.
So before house prices take a hit, shares are going to go into free-fall.
So what’s a SMSF going to do? Bail out of property and buy into a plummeting share-market?
Forget it. They’ll know that property is always a good long-run bet. They’ll just sit tight and ride it out.
So SMSF demand is likely to be the most stable demand segment in the market. And that means that the more SMSFs we have in the market, the more stable it’s going to be.
We’re not looking at a super-cycle as much as a level-shift in prices.
Good time to get on board.