Knowledge Source

Your freedom to create wealth...

You are here: Home / Archives for Property Investing

The boom hidden within a boom

by

The second instalment in ‘Ten Reasons Why the Boom has Ten Years to Run’ is something I call “The Densification Dividend”.

Think about this for a sec.

Imagine a suburb with one house. The house is valued at $1m. The median house price for that suburb is, obviously, $1m.

Now imagine some one comes along, subdivides the house and builds another house on the back block. Both houses are now valued at $600,000.

But now what’s the new median price of this suburb?

$600,000.

So the suburb has seen the median price fall from $1m to $600K. That’s a 40% fall. (Steve Keen is finally right. I had to construct a theoretical universe for it to happen, but a win’s a win.)

But do you see what’s happened here? Home-owners (only one of them) have seen the value of their property holdings increase 20%. But the median house price has actually fallen 40%.

Whooo-oooo.

Prices are down. Equity’s up. This is the Twilight Zone.

Someone once said that statistics are like a bikini. What they reveal is exciting, but what they conceal is vital.

We never hear the footnotes that go with property statics when people are talking about them in the papers or on the news. But no statistic is perfect. They’re an abstraction of reality. They’re not reality itself.

And that’s definitely true of median house prices. They’re good for giving you an indication of trends, particularly over short to medium time frames.

But they’re no good at capturing structural changes in the market – in this case, a move to higher-density living.

Now, what does this mean for us?

Well, pretty much across all the capital cities, there is a relentless drive right now towards higher density housing. Housing is being structurally reconstituted.

For a long time we’ve had a reputation in Australia for large homes on sprawling quarter acre blocks. We built as if we had an abundance of land and endless plains to share. (Where did they get that idea?)

However, the size of new homes actually peaked in 2009 at an average of 222sq metres.

And since the GFC it’s been falling. The average new home now stands at 192sqm, making it smaller than in 2001.

Partly that’s about the wave of apartment building we’ve seen in recent years, but detached house sizes are falling too – from 249sqm in 2009 to 223sqm today.

And our sprawling back yards are going the way of the Hills Hoist. The average lot size of vacant lots in the capitals has fallen from around 700 sqm in 1996, to about 450sqm today.

But none of this will be any news to investors.

Sub-division deals or townhouse developments can be some of most profitable deals going. They’re some of the sweetest fruit on the property tree, and the easy ones do seem like they’re getting harder to come by.

And the trend towards smaller houses and smaller lots seems locked in. It’s not going anywhere. For land in particular, it’s One Direction only.

(That was for you Niall. If you’re reading.)

And then there were some really interesting stats in the latest census results. The one that really jumped out at me was the surge in townhouse developments.

We here are lot about apartments but really, the biggest news in property is the emergence of the townhouse.

Between 2006 and 2016, the number of townhouses in Australia increased a massive 61%! Compare that with 14% for high-rises, and 11% for detached houses.

Now think about what that means.

Statistically speaking, higher density housing is putting downward pressure on median prices. Townhouses are cheaper than the houses they replace, even though there’s more of them per block.

So if we imagine an inner-city suburb where prices are growing at say 10% a year, those equity gains aren’t equally distributed.

Recent generations of home buyers – say someone who bought a new townhouse – they’re seeing house prices increase by 10%.

But older generations of buyers, say those who bought the original quarter acre blocks, they’re seeing that 10%, plus a whole lot more – the value of being potentially able to subdivide and develop.

And so there’s a boom within a boom – the older generations of buyers get two booms for their buck.

And the longer you’ve been in the market, the bigger you “densification dividend” tends to be.

But that’s the thing. Time makes “old buyers” of everyone eventually. As the relentless densification of our suburbs marches on, eventually everyone finds themselves the beneficiaries of a densification dividend.

I mean, Brisbane is a classic example. There’s a whole bunch of high-rises going up, but mostly they’re not replacing detached houses. Mostly they’re replacing those old 6-packs you see about the place.

So even if you bought a unit in one of those 6-packs 20 years ago – even if you bought something that you thought never would be – you’re still eligible for the densification dividend today.

But it isn’t something that is captured by statistics about median prices.

And if you look at the planning strategies for all the capitals cities, increasing densification is a cornerstone of all of them.

That means that any buyer in the next 10-20 years is going to be eligible for a densification dividend eventually.

Even if it doesn’t show up in the suburb-level stats.

This is what I mean when I say its the hidden boom within a boom.

It’s also one of the reasons why I’m more interested in land prices than house prices, but everyone talks about house prices so what are you going to do.

And it’s one more reason why this current boom has at least 10 years to run. This is number two. If you missed number 1, you can read it here.

So remember it. Densification dividend. I just made the term up, but I reckon you’ll be hearing more about it soon.

Have you see a densification dividend on any of your properties?

We’re already in a rate hike cycle… so what?

by

When people say they’re worried about rate hikes, I say rates are already rising, and it hasn’t hurt anyone yet…

Last week I gave you the first reason why I thought this bull run had at least another ten years to run. Read it here.

I haven’t had time to pull the other points together, but I just wanted to clear something up.

Some people thought it was strange that I was talking about structurally lower interest rates when their banked had just jacked UP their rates – especially on interest-only investor loans.

So I just wanted to explain what I mean.

First when I’m talking about duration and the bond market and so on, they’re not seeing the interest rates increases that we’re seeing.

As far as they’re concerned, rates are still at rock bottom.

All the rate hikes that we’ve seen and that people are talking about are what we call “out-of-cycle”. (Forgive me if I’m going over old ground here).

That is, they’ve got nothing to do with the RBA’s regular monthly cycle of official interest rates. (Monetary Policy: Now with Wings)

It’s got to do with other stuff.

Right now that other stuff has to do with two things. The first is a new set of standards in global banking, called Basel 5.0 or something like that. Basel is the city in Switzerland where the Bank of International Settlements is located. The Bank of International Settlements is the public relations wing of the Intergalactic Order of Templar Knights and Space Lizards.

(No, seriously. Google it.)

The short of it is that the new Basel rules mean that banks have to be a little less slap happy with their loan to equity ratios, and at the coal face, that means higher rates for people like you and me.

(Curse you space lizards!)

The other place this stuff is coming from is our own APRA. APRA – the Association of Performance and Recording Artists – has seen a steady mission creep in recent years towards oversight of the financial sector. Now they’re worried that banks are a little too exposed to the mortgage market – especially investors and interest-only loans.

To put a lid on things, they’ve introduced speed limits – restrictions on how quickly banks can grow their investor and interest-only mortgage books.

At the coal face, that means higher rates for people like you and me.

(Curse you Molly Meldrum!)

You can get a sense of the first effect here. This chart shows the growing disconnect between official interest rates and the standard variable rate.

The gap opened up in the GFC, and has since got steadily wider and wider. Today, we’re looking at a gap of around 3.5 percentage points.

This chart just tracks the difference:

That’s pretty substantial. I mean, imagine what your interest rates would be if there hadn’t been this decoupling.

Banks would be practically giving you money.

So that’s one.

To get a feel of the second, this chart here overlays rates for investor and interest-only mortgages on the chart above.

You can see that the recent pick up has been driven by the premium that interest-only investor mortgages are attracting…

… just as Molly Meldrum intended.

And if you compare current rate settings with where we were at a year ago, you can see that owner-occupiers have seen a pivot – P&I rates are cheaper, while IO are more expensive.

But there’s no dodging it for investors. Investor loan rates are up about 0.3 perceantage points for P&I, and up a whopping 0.8 pp for IO.

That’s a pretty thorough disincentive. Many mortgage brokers are saying there’s no point even going for IO loans any more.

Anyway, long story short, interest rates are up. Not in the general economy, just in the mortgage market.

That means two things to me.

The first is that since interest rates in the general economy haven’t budged, the duration effects I was talking about in my last blog are still in full effect.

The second thing is that when chicken-littles are freaking about Molly Meldrum’s do-youself-a-favour rate hikes, I’m a bit like, whatever.

We are 350 basis points – or 14 rate hikes – into the current rate hike cycle. The rate hike cycle is almost 10 years old. It hasn’t trashed the economy yet. It’s not about to do it soon.

The Australian property market is one tough nut. A slight upward drift in book rates facing investors isn’t about to derail the whole show. Not by a long shot.

And that’s because interest rates are just one part of the story. I can think of at least 9 other factors driving prices higher…

But I haven’t got time for it this week.

Maybe next week.

Anyone out there copping some over-sized rate hikes?

Ten reasons why this boom has ten years to run

by

Ok, I only had space for one this time, but it’s a big one. The rest to follow…

So I was telling my friend about a deal I was getting into and he was like, “Hey? Are you buying?!?”

And I’m like, “Yeah, of course I am.”

And he said, “Oh, I was just reading some of your blogs. I thought you were a bit bearish on the market at the moment.”

This surprised me. And so I looked back at some of the blogs I’ve written recently – apartment gluts in Brisbane, flammable towers in Melbourne – and I realised that it maybe had been a little gloomy lately.

But I wasn’t meaning to take a position. I just kind of follow my nose to whatever story is breaking and what’s capturing my attention.

And if you had to take a reading on my position, it’d still be bullish. Even uber-bullish. But that’s mostly because I’m looking at some long run trends. These trends either tend to be boring, or slow-burning, or both.

They don’t make for interesting blogs.

So just to be clear, let me lay out why I’m buying right now, and why I’m buying for my unborn grand-children.

I’ll try keep it simple, but forgive me if we get a little techy.

1. Duration
Duration is a financial concept used in measuring a bond’s value. It’s a way of working changes in interest rates into a bond’s price.

Long story short, the structural decline in interest rates has seen bond prices soar.

Property is the ultimate duration asset. While a bond matures at some point in time, property (like me) never matures. It keeps on generating income from here until infinity.

So how do you value an infinite income stream?

There’s nothing in financial markets like it. They don’t really know how to deal with it.

But what I can tell you is that a lot depends on where you think interest rates are going. If you think interest rates are going to “normalise” – pop back up to their long run average of about 7% or something, then you’re not going to put a lot of value on an asset that delivers an infinite income stream of 3-4%.

But what if you think rates are going to remain low? What if you think they might go even lower?

Suddenly an infinite income stream at 3-4% starts to look pretty attractive.

We’re now almost 10 years on from the GFC. For the first 5 years, most people thought central banks would normalise rates fairly quickly.

But this didn’t happen. Rates remained low, and any attempts even to raise them a little caused massive tantrums in the market.

And so now, slowly and surely, people are getting used to a low interest rate future. Look at 20-year government bonds – they’re offering about 3-4%. That’s where expectations are.

And so as more and more people come round to the idea that interest rates aren’t just magically going to normalise, the more demand there is for property. Not just from mum and dad buyers, but from institutional investors.

After the GFC, in America, we saw a tonne of institutional money head into residential property. Guys like BlackRock became landlords. We’d never seen that before.

And so as more people come round, and as demand goes higher, obviously prices go higher as well.

But do you see what’s happening here? The only driver of higher prices in this model is people’s expectations about future interest rates, and the slowly gathering consensus about our low-interest rate future.

And this is the thing. This process isn’t over yet. There are still people who think that rates will normalise. They believe the Fed and the RBA when they say they intend to lift rates as soon as they can.

(I think they’re dreaming. I think we’ve seen a structural and permanent shift towards lower rates through the saturation of the investment market (we’re not in the high-growth 60s anymore) and continual cost pressures from the production power-houses in Asia.

Technology is winning the race now. It is pushing costs down faster than demand can grow. Prices can only go one way from here. And interest rates will go with them.)

So there are interest rates hawks still holding out for higher rates. But every year rates hold around record lows, the number of hawks falls, and our demand herd grows.

Eventually everyone will come round, and this demand stimulus will have run its course, but the question is, how long will it take?

There’s no real way to know. My guess is that maybe we’re at 50/50 in the market, hawks to doves. Maybe a little more biased our way. Maybe 60/40.

My best guess is that it will take another 7-10 for all the interest rate hawks to come round.

That means 7-10 more years of growing demand – and growing demand from guys like BlackRock with very, very deep pockets.

So the boom has at least 7 years to run on this model.

But this is just one factor. I’ve got 9 more!

—

But I’ve run out of space for this blog. I’ll write more about the other 9 later. There’s a bit to it so I’ll have to find time.

What do people think? I know people value my opinion. Maybe I could make it subscriber only, just to give you guys access to it, and give you an edge over the herd. I don’t know if I just want to be throwing it up on the internet for everyone to read…

Would you want access to a Jon Giaan sealed section? Interested in your thoughts.

Do you see rates on hold? Where do you see the market balance at? 50/50? Or something else?

NO B.S. FRIDAY: How to win a room

by

A trip to the local council reminded me of some basic persuasion techniques.

So this week I went along with a friend to his council’s community access session.

He wouldn’t appreciate me going in to all the specifics here, but basically, he needed to go and lobby the councillors directly to get them to delay considering his D.A.

He had gotten word that his D.A was going to get knocked back, because he had these koala friendly trees on his property that he wasn’t aware of when he first put his DA together.

“Koalas?” I said. “Don’t you live alongside and freeway?

“Yep, and there’s pitbulls to the north and 3 cockerspaniels to the south. We haven’t seen a koala in over 20 years.”

But that’s the way DAs work. You’ve just got to jump through the hoops.

Anyway, I went along with him – mostly for moral support – but also because I’ve been through this process more than a few times, and maybe I’d be able to answer any questions he couldn’t.

Anyway, we get there, and there’s two hours allocated to community access, and there’s about 40 people on the list to speak.

Oh my god. I’m looking around the room and already I’m sizing people up. There’s the ex-councilors who are very long in the tooth now, but miss the days when they had something meaningful to do.

Then there’s the obvious cranks. (Why do crazy guys always have crazy hair? Is it part of the job description?) They’ve obviously been working very hard on their presentations because they haven’t found the time to shave or find clean pants.

And then there’s a mish-mash of local business owners and residents, coming along for the first time, and generally looking like they’re out of their depth.

And then there’s the councillors themselves, gritting their teeth and bracing themselves for the onslaught that was obviously about to hit them.

And it was seriously on like donkey-kong once it started.

Crazy pants guy is first cab off the rank and he’s speaking to the plans for a new waste-water treatment. Well he wastes no time going straight to “dereliction of duty”, “abuse of trust” and “legacy of lies and deceits”.

And I couldn’t even tell if he was for or against what was on the table.

Next there was a local cafe owner who had been asked to move his tables of the public side-walk. From what I gathered the previous owner had told him that he was allowed to have tables on the sidewalk, but that just wasn’t the case. But now, this was council’s responsibility and if they were forcing him to move, then he was going straight to the land and environment court.

The there was an ex-councilor. I have no idea what he was talking about. He was reading a prepared statement off a piece of paper, and it was full of technical terms about this that and the other.

In fact, come to think about it, pretty much everyone was reading off a prepared statement.

Now I’m watching the councillors, and they genuinely looking like they’re doing their best to keep up, but it’s obviously wearing on them. Within an hour they’ve been called everything from incompetent to corrupt, and that’s just from the presentations you could actually follow.

They were getting that glazed look in their eye.

I lean over and ask my mate what he was planning to stay.

He shows me the statement he’s prepared. It’s two full A4 pages of size 12 font.

“What? You’re going to say all that? In 5 minutes?”

“Yeah, I’ll read quickly.”

I’m like, “Mate, no way. I’m telling you that’s not going to work. Do you mind if I speak for you?”

He was reluctant but he comes round.

So when our time comes I get up and take the mic, and I look the councillors in the eye and say:

“Look, we’re just here to ask for a delay on the decision for the development application relating to such and such a property.”

“We’ve been working closely with the council planners, and that’s been great, they’re all very professional, but it’s come to our attention that there are some issues with koala habitat that we weren’t aware of when we first put the DA together, so we’d just like a little extra time to make sure we’re doing everything right.

So yeah, if you could delay the decision on such and such a property, we’d really appreciate that.

Thanks very much.”

And then I sat down.

At that point, I had every councillors eyes on me. I had their attention.

Mostly I think they were amazed that someone had only used 40 seconds of their allocated 5 minutes. An hour and a half in to community access that would have felt like a gift from God.

But I was speaking to them as people. I was conversational, I was “off-script”. That made my message easy to hear.

(I actually can’t think of a situation where you’re better off reading a prepared statement… maybe in court. Or maybe when you’re fronting the media to explain why you’re entire first division side has failed their drug test. But generally, that paper locks you up, it makes you sound like a robot, and it makes your message very difficult to receive.)

The other thing I did is I brought myself inside the tent. I didn’t set it up as some sort of adversarial show-down. This comes from face to face marketing. If you have to argue the merits of your product, if you’re in an argument with your customer, you’ve lost the sale.

So I made it very clear that we were happy, we were friendly. We just wanted this little procedural thing to move things along. Easy easy.

Seriously, if you start off with, “I’d like to remind councillors of the oath they took when they took office, which they seem to have forgotten….” how far are you really going to get?

If you cast someone as the enemy, then they’re never going to agree to what you’re saying, no matter what it is.

I would have thought all this was obvious, but after this week’s meeting, I had to wonder.

Oh, and the other technique there is top and tailing. I said up front what we wanted, so everything that followed had a context. And I ended with it so it was left there in their minds.

Anyway, long story short, we got what we wanted. I don’t know how much help I actually was – it was a pretty reasonable request to begin with – but I’m fairly sure my mate’s 2 page epic wouldn’t have helped things.

And I just thought I’d share this. I thought these techniques of persuasion were pretty obvious, but after listening to a dozen accusation-filled rants, I did start to wonder.

Rule 1 – get on the right side of the fence.

Sometimes it’s as easy as being the only friendly (and sane) voice in a room.

Any tips for dealing with council? Or being more persuasive?

Damn! I was right… and that makes me so mad 😡

by

It’s perverse, but this disaster could create a mini-boom in property.

Almost two years ago to the day I warned about how many tower buildings across Australia are using highly flammable cladding and are simply disasters waiting to happen. As I said then:

“Building standards a not being followed, and a major incident is inevitable. Here’s hoping nobody dies.”

Well, people have died. The Greenfell tower disaster in London claimed more than 50 lives and piped dramatic images into homes across the country.

This should be the wake up call we need. I hope it’s the wake up call we need.

I wonder if people realise how close to home the Greenfell disaster is.

As the Brisbane Times reports:

“The London tower devastated by a vicious building fire may have been installed with flammable cladding during a recent renovation.

Online records indicate contractor Harley Facades Limited installed “over-cladding with ACM cassette rainscreen” at Grenfell Tower.

ACM stands for aluminium composite material, which is the same combustible product blamed for fuelling nearly a dozen major high-rise fires globally in the past decade, including in Melbourne in 2014…”

That incident in Melbourne they’re referring to was the fire at the Lacrosse Building. A single cigarette left burning on a balcony started a fire that leapt 13 stories in 13 minutes.

All the fire safety measures in the world – sprinkler systems and all that – they won’t save you when the fire is coming from the outside in. This is an entirely new kind of threat and one we’re not prepared for.

It’s hard to finger exactly where this is coming from. Engineers Australia reckons that the codes aren’t being followed, or enforced. “No one is inspecting this stuff.”

The Master Builders Association on the other hand says it’s not so much about the builders, as it is about dodgy, counterfeit building materials coming into the country – things arriving that are stamped with a certain fire rating, but that simply aren’t.

What a mess.

The thing that’s really scary though is that we’re not just talking about the odd high-rise here and there. We’re talking about a systemic problem that potentially affects thousands of buildings across the country.

Australian Society of Building Consultants NSW president Chris Dyce reckons there are 2700 buildings just in Sydney that use this aluminium composite cladding. Half of the high-rises build in Melbourne over the past ten years are non-compliant.

Engineers Australia reckons 85% of Sydney’s recent apartment stock is defective!

Even if it’s only half as bad as they reckon, it’s still a terrifying prospect.

Because that’s the nature of risk that I don’t think people get.

If you have one dodgy building, then the risk of a single disaster is the risk of one person being careless with one cigarette.

But when you’re talking about 1000s of buildings and thousands of people and thousands of cigarettes, then the risk of a single disaster multiplies exponentially.

That’s why Engineers Australia reckons a major fire in Sydney is “inevitable”.

As I said, Greenfell was a tragedy. Let’s hope it’s the wake up call we need.

But now let’s step back a bit and think about what this means for the market.

I’m not one to profit from other people’s misery, but I have been known to profit from other people’s incompetence.

So we can pretty safely say that at some point or another, all of these defects – or at least the most dangerous ones – will have to be fixed.

The best-case scenario is that the remediation happens now and we get on the front foot with it.

The worst case scenario is that we need our own Greenfell to spur people into action.

But either way, it’s going to happen at some point.

Individually, as buyers, I think this creates a new risk that we need to cover ourselves against. It’s quite likely that individual unit holders will have to come up with the money for remediation. You might be able to pass it on the builder if they were dodgy (and you can pin it to them!), but if they were following standards (which themselves weren’t tight enough) you might be left holding the baby.

And we’re talking serious coin. Imagine stripping the cladding off a 24 storey building and putting new cladding on. That’s big bucks.

And if it’s not clear whether it’s the code, or the builders, or the materials manufacturers that’s the problem, it can be hard to defend yourself against.

I wonder if you might be able to get insurance cover..?  A little extra in your premium to protect yourself against forced remediation costs. I’m not sure. Anyone got any ideas on that?

Whatever the case, as buyers in high-rises, an extra degree of caution wouldn’t go astray.

The other point I’d make is that if the government announces that all 2700 buildings in Sydney need to be remediated, all at once, then that’s going to spark an incredible building boom.

There’ll be incredible competition for builders and for new materials. That will affect the remediation costs as well as the costs facing new stock coming to market.

It will push the cost of new housing through the roof. And since existing housing keys of the price of new housing, the price of existing housing will surge as well.

And given Sydney is already struggling with a shortage dynamic, and needs to be bringing stock to market flat-chat just to keep pace with demand, this will create the conditions for a mini-boom.

I know, the modern economy is perverse like that. A cocktail of incompetence and corruption can be just what you need to see a boom in prices. Hate the game and all that…

And if you really want to double down on this dynamic, look at quality stock in areas where there are a lot of these buildings. Some of these buildings could become uninhabitable through the remediation. That might create a massive spike in rental prices in the immediate area as those displaced people look for a home.

I’m thinking quality town-houses in quality locations are set to do well.

Anyway, that’s what I see as the market impact, but let’s not loose sight of the fact that we’re talking about people’s lives here.

Here’s praying for a casualty free fix.

Any people in the insurance biz got any insight on this? Can you see any opportunities opening up?

Banks vs. Perth Property (a clash to keep an eye on)

by

The banks are quietly rotating their books. Who wins, who loses?

Let’s stop and think about the APRA restrictions again.

Now we know that APRA have gone hard on the banks about the pace of growth in investor loans, and in interest-only loans in particular.

So far it seems the banks are playing ball. We’ve seen all financial institutions increase mortgage rates, though there has been some pivoting away from investors and interest only toward owner-occupiers in the pricing.

Ask any mortgage broker and they’ll tell you it’s a much tougher credit environment, especially for investors.

Now let’s think about this from the bank’s perspective.

You’re in a competitive industry. Until recently the name of the game was market share – you were growing your mortgage book as fast as profit margins would allow.

But then along comes APRA and totally flips it on its head. You don’t get to say how fast your mortgage book is growing any more – at least to investors. APRA says investor loans can’t be growing at more than 10% a year.

They also put limits on investor only loans, saying they can’t be more than 30% of issuance.

Suddenly an industry that was spread out over a range of growth rates is pulled into a very tight pack. Every bank will want their investor mortgage book growing at 9.99%. They’ll all want 29.99% of their loans to be interest only.

Suddenly they’re marching in lock step.

So maybe you compete on price, but the pricing space was competitive already, so there’s not much you can do there, and you’re funding costs are largely determined overseas so it’s out of your hands.

So what do you focus on to get a competitive advantage? How can you separate yourself from the pack?

Loan quality.

Not all loans are the same. Some borrowers are riskier prospects than others.

So say you’re a bank growing very close to your 10% speed limit. You’ve got one more loan you can make before you’re maxed out. You have two choices in front of you. Which one do you go with?

The one that’s lower risk.

The aim of your game, if you’re growing as fast as you can already, is to start rotating your book into a higher quality portfolio.

That might mean choosing higher quality applicants over less quality ones.

But it may also mean going back through your book and weeding out lower quality ones to make room for higher quality ones.

And that might mean that interest-only investors, when it comes time to roll their loan over, might be facing a very tough time of it. The banks will be looking at them and saying, if I cut this borrower loose, will I be able to replace them with a better one?

I might be able to cut them loose and pick up a higher quality borrower, thereby saying under APRA’s speed limit, but improving the quality of my book.

Now that probably means passing a stricter eye over an individual borrowers circumstances, but knowing what we know about the banks’ business models, it probably also means differential preferencing for different geographies.

Banks might be saying, other things being equal, we’d like to replace Perth borrowers with Sydney borrowers…

… for example.

We are seeing some signs of this. Mortgage brokers in Perth are saying things are pretty tough right now, and APRA’s measures are a ‘sledgehammer’. From mortgage broker mag, The Adviser:

“The Australian Prudential Regulation Authority (APRA) has been castigated by brokers for its nationwide “sledgehammer” crackdown on interest-only loans, which have been labelled as “myopic” and “devastating” for regional Australia. 

Damian Collins, managing director of Momentum Wealth in Perth, told The Adviser that APRA’s moves to limit the flow of new interest-only loans were based on a “sledgehammer” approach that neglected to consider the impact on areas outside of Sydney and Melbourne.  

… Mr Collins said: “We got told in WA [in April], that for investor refinances, [lenders] are not doing them… so, you can tell APRA is definitely putting the pressure on the banks to manage their loan book growth, which is strange because in WA there aren't a lot of investors doing anything at the moment.

“So, I guess [APRA] aren’t really looking at it state by state, they're just looking at it as a global pull and finding any way they can to make changes.”

The Momentum Wealth MD went on to say that some of his clients in WA had previously been able to borrow around $2 million and, within a couple of months of the macroprudential measures being announced, that figure dropped down to $700,000.

Mr Collins lamented that the regulator had not taken a state-by-state approach.

“It's like taking a sledgehammer to the problem and certainly has affected investors across the country… You'd think [APRA] would be able to do it better, but they haven't,” he added.

Touching on the crackdown on interest-only loans in particular, Mr Collins said that the penalties now made this type of loan practically redundant for investors. According to the Momentum Wealth managing director, the repayments on some interest-only loans are the same now as P&I.

He said: “It's at the stage now where, for a lot of our investor clients, we're saying: ‘Get a P&I loan, it’s just not worth paying that premium for paying interest-only.’”


Looks like a pretty serious wind-back in Perth. But I actually reckon it’s worse than what this bloke is saying.

It is not that Perth is getting hit with the same stick as Sydney and Melbourne. It’s that APRA gave the banks the stick and the freedom to hit whoever they wanted.

For the sake of loan quality, they decided to hit Perth – hard.

That has the potential to create a self-fulfilling prophesy in some of these markets that are struggling.

I’m still watching Perth. I think there will be some bargains to be had. But I also don’t think its time to jump in just yet. Give it a few more months and see how the APRA restrictions and this loan-quality business play out.

Too soon for Perth?

Trump, property and how to suck at propaganda

by

Three property experts fail to get there message right, while Trump is out on his own.

So a bit of a mixed bag this week. The things that stuck out for me this week weren’t so much in the data, but in the stories people are telling.

Propaganda is a fine art, even in property, and here are three complete fails and one total home run.

The first is from Real Estate legend John McGrath:

Have you noticed that the speculation has started? The property market is “grinding to a halt”. The boom is over. The banks have lent too much. The bubble is going to burst…

The key is not to panic…

… The two most likely eventualities are as follows:

  1. The pace of growth in property prices will slow down but not stop. Property prices will keep growing but at a lesser rate per year.
  2. We have a minor correction, where the market will do as it has done before and give back about half of the prior year’s growth, so that would be around 5%…

… If you are in the market to buy, don’t put it off because you think prices will plunge – it never happens that way. Take a sensible measured approach, set a budget and buy the right property for you.

If you are thinking of selling, now’s the time. It feels to me like we’re at, or close, to the peak of this cycle, so if you want to fully capitalise on this boom, now is the time to sell.

Ok, so in short, don’t believe the hype. The market is not going to crash, and now is the perfect time to buy, and the perfect time to sell.

Only a real estate agent could pull that off with a straight face. I’d agree that the negative press is overblown (again!), but I’m not convinced I see prices falling or even stalling.

This “peak of the cycle” business is classic real estate fodder. What better way to convince people to sell than tell them that the market has peaked?

But you also need buyers, who will just sit on the sidelines if prices are falling, and so we have the logical double-twist with half-pike that says prices will fall, but only a little, creating the perfect time to buy, the perfect time to sell, and the perfect time to pay a real estate agent a nice fat commission.

Pull the other one John.

The second fail is from Macquarie Bank. They reckon the Bank Levy will have a “disproportionate and unintended consequences” on their operations and they may have to move offshore.

I think the “I’m taking my bat and ball and going home” argument can pack some weight if you’re a well-loved Aussie icon, like Holden or Vegemite. But who is going to cry for Macquarie?

All it says it that your only interest in Australia and Australians is purely financial, and you’ve got a bit of a glass jaw.

Don’t let the door hit you on the arse on the way out.

The third fail was from the apartment lobby, through Sue Jong, chief operations officer of Chinese real estate portal Juwai. They were complaining about the recent changes in NSW that slugged foreign investors with extra fees. She said:

“This policy could decrease foreign investment in NSW new property by as much as 15 per cent.

With every misguided new policy proposal, foreign investment will decrease along with new housing construction, housing affordability and construction employment.

For every unit a foreign buyer purchases, they enable developers to build four more homes for first-time buyers and investors.”

I’m not sure about that last stat. Sounds a little suss to me. But one thing I could tell you is that if I owned a highrise apartment in Sydney, I’d be praying for a 15% fall in foreign demand, since, by law, that demand must go into new dwellings.

And adding more dwellings to an already oversupplied market can only lead to more downward pressure on prices.

I think there is real anger in the community about the way some shoddy highrises have been thrown together, have flooded the market, and have neglected the needs of locals just to serve foreign investors.

In most people’s minds, Ms Jong just said the government’s policy was a good idea.

Fail.

Lastly, and just because I couldn’t resist having a go at it, was Trump’s ‘Covfefe’ gaffe.

In case you missed it, apparently, Donald Trump forgot to lock his phone, and arse-tweeted the free-world.

The internet, of course, went into melt-down.

The narrative, of course, is that Trump is unhinged and unpredictable, and can’t manage basic things, like his phone.

But am I the only one who thinks it was deliberate?

The tweet was left up for hours, even though the White House would have known within minutes what had happened.

And what does it say about Trump? It says Trump isn’t filtering himself. He’s not passing his messages threw focus groups, before spewing up the most banal version possible to the listening public.

For Trump’s base, he’s just reinforcing the message that he’s “authentic” and “not a politician.” They go nuts for that stuff.

And what was the complete sentence there? “Despite all the negative press…” That will mean different things depending on who you are. If you’re part of his base, he’s talking about a vindictive press that’s out to slander the President. If you’re not, then it has been a pretty gruesome month in the news.

So no matter who you are, here’s a funny word to break things up a bit: covfefe.

It’s genius right?

If only he’d use his talents for good, not evil.

What do you make of it?

Warning: Depreciation that costs you money?

by

A Labor-lite budget gave us negative gearing lite, but the depreciation changes might be about to cost you money.

One of the most-interesting but least-talked about things to come out of the budget is the change to depreciation in negative gearing.

Most of the media seemed to have missed it. I kind of missed it too. I thought it was just some small-fry changes aimed at heading off any pressure to seriously reform negative gearing.

But now I’m not so sure.

And the truth is that if these changes are implemented full-stick, it could cost you thousands of dollars every year and/or make it harder to on-sell your property.

In case you missed it, the proposed change will limit plant and equipment depreciation deductions to only those expenses directly incurred by investors.

Basically, if you didn’t write the cheque yourself, you don’t get to depreciate it.

This has the potential to shave several thousand dollars a year off a property’s cash-flow stream.

Consider the following three examples (and I tip my hat here to Louis Christopher at SQM Research, who’s done some great work helping us get a grip on the changes):

On-selling a New Build

Say you purchase a unit off the plan. There’s significant plant and equipment depreciation benefits that come with newly-built dwellings. We could easily be talking about five or six thousand dollars in the first year on a median priced unit in most cities. It tapers away after that, but even 6 or 7 years down the track we could still be talking about a couple of thousand a year.

Over the life of the property, we’re talking about something like twenty grand.

But under these changes, now, when you sell the property, the incoming buyer no longer has access to that depreciation stream. It’s gone.

And say you’re circumstances change, and you have to sell after only one or two years. The incoming buyer has no capacity to claim a depreciation deduction, not just in the year they buy, but in all future years.

They could lose up to twenty grand’s worth of value.

Hard to say how much that will hurt you sale price, but it’s certainly not going to help.

One thing that’s not clear is what happens if you flip the property before completion. Have you paid for the plant and equipment, or has the new buyer? The government needs to clarify this one.

All New Builds?

The above example assumes that the first buyer is the one paying for the plant and equipment. However, in the strictest sense of the word, the developer is the one who pays for it. In that sense, only the developer has a right to claim depreciation.

This would be a pretty hardcore interpretation of the change – basically purchasers of off-the-plan developments wouldn’t be able to access any depreciation benefits.

Most people think that this isn’t what the government intends, but now that the media has moved on, they might be able to slip it through. We’ll have to see.

It also creates a bit of a grey area. If I do like a one into four townhouse build, and then sell each one individually, what do I need to do to make sure that the new purchaser is the one paying for the plant and equipment in the eyes of the law?

The Fresh Reno

Lastly, say I buy a nice little doer-upper and spend $200K on plant and equipment. If I now sell the property to you, even if the paint is still drying, you cannot depreciate any of the plant and equipment.

No need to get any clarification here. This is exactly what the government has in mind.

The Timing

There’s a bit of ambiguity here that needs to be clarified. That clarification will happen when the budget passes through parliament over the next couple of months.

However these changes are time-stamped with the budget on May 9. That means that these changes will affect any property bought and sold today, even though we still don’t quite know what the full ramifications are.

That’s not ideal. Realistically, if you’re buying, you’re going to have to assume the worst – even though the worst is pretty hard-core for off-the-plans.

If you’re selling, you’ll need to find a buyer that isn’t assuming the worst to get a premium price for your property.

The Up-shot

At the end of the day, investors have just lost a benefit that was worth potentially several thousand dollars a year.

As I said, that’s not going to help prices.

Louis Christopher reckons it will help cool investor demand in the short term. It will be interesting to see. Most investors I know are pretty savvy with their depreciation schedules, and factor it in to their offer prices – but I tend to move in a savvy crowd.

Will your average mum and dad investors care? They should, but will they?

This also gives us a look at negative-gearing lite. Labor wanted to end negative gearing. This is a small, partial step. If it doesn’t move the dial, it will open the way for further reforms.

If it does crimp investor demand and the market softens, the government will be vindicated in their softly softly approach. It will be interesting to see.

So yeah, still waiting for a few details, but something to be on top of here.

Will this affect you and your strategies?

What game theory says banks will do next…

by

Are the banks going to blow the whole thing up? Do they even have a choice?

I was talking about this Bank Levy business with a good friend of mine. He’s a smart man – has a PhD in mathematics and game theory. His take on the whole bank levy thing has really got me thinking… and a little bit scared.

On the face of it, I like the levy. The too-big-to-fail banks enjoy an implicit government guarantee. That means that if sh!t hits, the fan, the government (i.e taxpayers) has their back.

The markets recognise this situation, and so are willing to lend them money more cheaply. As a result, Aussie banks are some of the most profitable in the world:

Killing it.

Christopher Joye at the AFR reckons the government guarantee saves them about 0.18bps on their funding costs. So a levy that slaps them with 0.06% on their liabilities, only claws about a third of it back.

So it’s only fair. And it many ways it helps level the playing field with smaller banks who don’t have a government guarantee.

But as my friend pointed out, the problem is that this isn’t directly tied to their funding guarantee. It’s just a levy. Just a tax. Just because ScoMo said so.

And this makes it dangerous. The UK introduced a bank levy a few years back, and guess what happened? Since then they’ve jacked it up 9 times.

9 times! And why wouldn’t they? It raises a lot of revenue, and everyone hates the banks. It’s like free money. Whee.

And since our Bank Levy isn’t tied to anything either, what do you think the chances are that it will stay at just 0.06bps?

Would sod-all be a fair estimate? (That’s what my mate reckons it is.)

So think about this from the bank’s perspective for a sec. This is not just a one off cost that they somehow have to manage. Who knows where it’s going to end up?

Letting the government tax you now is like letting Dracula set up a catheter in your jugular and trusting him to only take as much as he needs.

(Just a couple of drops to tide me over to pay day…)

So there’s a lot more at stake here than the initial estimate of $1.5bn a year. It’s a liability that could quickly grow to $3bn or $6bn or $12bn!

So the stakes are high – much higher than I thought.

The question now is how are than banks going to play it?

So far, their response has been fairly predictable. And that’s because somehow the government did a good job of keeping it secret. The banks genuinely seemed to be caught off-guard.

And so their response has been pretty lame. It’s “tax by stealth”. It’s going to be passed on to consumers, or maybe shareholders. Jobs are at risk. It’s “playing fast and loose”. It’s poorly thought out and light on detail.

The banks seemed to be throwing up a bunch of muck and seeing what stuck. But all it did was just create noise, and by the time the banks had figured out their story, the front pages had moved on.

The PR battle has been fought and won.

And this is what makes me nervous. If the PR battle is won, what happens next? If you back a grizzly bear into a corner, what happens next?

As my mate says, the banks can’t afford to roll over on this one. If they cop it sweet, and spread the cost out across their consumers, shareholders and staff, all it says to the government is that cookie jar is open.

Next time you need the money, just dip in here first.

My mate says that the banks have to go hard and they have to go now. They don’t have a choice. Even if they lose this particular battle, they have to leave the government with enough scars to make any future government think twice about tapping the Bank Levy cookie jar.

If they don’t it will cost them another $6bn… at least!

So how would they do that?

Well, what does a banking sector on the offensive look like?

I don’t know what you reckon (I’m genuinely curious, let me know your thoughts), but I think whatever counter-offensive we see, it’s going to involve rate hikes.

A lot of rate hikes.

My friend reckons the dominant strategy for the banks is to hike rates so hard that they almost put the economy on the floor. … almost.

And I think they could do that. They could say, we’ve got the bank levy to deal with. We’ve also got APRA on our backs about shoring up our capital bases. Fine. You want us to be “unquestionably strong”? Here it is.

100 bps.

Bam.

(I’m in a pretty sweet position but even I would notice a full extra percent on my interest payments.)

And if they really wanted to stick the knife in, they could focus hikes on investors (since negative gearing would mean the government would actually get less revenue) while giving first home-buyers a discount to try and sway public sentiment.

They could also go hard on foreigners purchasing apartments to try and push the (already-shaky) apartment segment over.

100bps, overnight, would hurt. A lot. It could be enough to break sentiment in the property market and in the broader economy altogether.

It could be enough to bring on a recession, which would be enough to ensure the government was turfed from office.

And that, maybe, would make any future government think twice about tapping the cookie jar.

And ScoMo says he’ll be watching the banks closely, but it doesn’t matter. Even if the ACCC forced them to reverse course at some point down the track, you only need high rates for a short time to snap the neck of sentiment. A month would probably do it.

If my mate is right, it’s a dangerous situation because the banks’ strongest play seems to be to take the economy to the brink of collapse, if not over it altogether.

It’s killing me imagining what’s going on behind the scenes right now. It’s going to make a fantastic book one day.

If we make it through.

What do you think? Is my friend making a mountain of a mole-hill?

WTF? Labor kills my property wealth!

by

Labor has unleashed a wrecking ball aimed squarely at the property market…

Suddenly it’s on like Donkey-Kong.

Labor has opened the broadside guns on property. Seems like every day we’re seeing another big policy announcement aimed at ‘housing affordability’.

And we’re not talking chump change anymore. Most affordability policies in recent memory have been as fulfilling and nutritious as licking an envelope.

But not this time. Labor has let loose a massive wrecking ball, and it’s heading straight for the property market.

1. Negative Gearing? Gone.

CRAASH!

2. Foreign Buying? Big fines for that.

SMAAASH!

3. SMSF leverage into property? Banned.

BAAZOINGO!

4. Vacant properties? Taxed!

BAM!

That’s a big-hitting policy line up. Any one on its own might be risky. But all of them together?

Flippin look out!

No government in recent memory, maybe in the history of the world, has ever taken such an aggressive affordability package to the people. No political party has come out gunning for property in such a Rambo-esque way.

Hold on to your hats folks.

But are things really as bad as they seem?

I’m not so sure.

Partly that’s because I’m not inclined to take politicians at face-value – EVER. So when Labor says they care about housing affordability, I tend to be a little sceptical.

I also can’t imagine that any political party would want to be in the driver’s seat if the property market crashed. Can you imagine? They’d get beaten over the head with it for decades.

And that’s particularly true for Labor. The general perception is that Labor is less strong on the economy. (I don’t think that’s necessarily true. I think they tend to be about equally useless.)

But presiding over a property market crash would certainly cement that perception for Labor. They’d struggle with it for decades.

And if the market did tank, I don’t think “But we fixed affordability for you. You should be thanking us!” is really going to fly with the electorate.

(Voters tend to be ungrateful like that.)

So there’s really nothing to be gained by being the party that brought down the housing market. Nothing at all.

So my assumption would be that Labor is looking for something that sounds big and impressive, while carefully avoiding doing anything that might influence the market in a meaningful way. (You’ll be surprised how far this rule of thumb will get you in assessing political risk.)

I call it the Sounds Good, Mostly Useless hypothesis. Let’s test it out.

1. Vacant Property Tax
The Victorian government just introduced something like this, and Labor wants to take it national.

The trouble with this is how you measure it. Some people have used water-usage to identify empty homes – but if the government tried that, it’d be pretty easy to game – just set a timer on the tap in the kitchen.

The Victorian system is self-reporting. (Good luck with that!)

It also sounds like the taxes are pretty small change. I’ve heard someone say that to a Chinese buyer, a new apartment is worth 20% more than a “used” one. So unless you’re talking about something that gives 20% a nudge (they’re not), I don’t see it moving the dial all that much.

Assessment: Sounds good, mostly useless.

2. More Fines for Foreign Buyers
Labor wants to double the screening fees on foreign investment and double the fines imposed on foreign investors who illegally purchase residential property.

The fees themselves are pretty small, so doubling a piffle is a pifflepiffle. Just a cost of doing business.

Doubling the fines is also a good idea, but Australia’s enforcement of the rules is pretty piss-weak, even after we beefed up the regime a year or so ago.

Look at the numbers. Since the new regime kicked in, the ATO has issued 388 fines worth more than $2m. That sounds impressive, until you realise it’s only about $5,000 on average.

Again, for foreign investors, it’s just a small cost of doing business.

Assessment: Sounds good, mostly useless.

3. Ban on SMSF leverage
Like a lot of Labor’s policies, this one has good intellectual cover, and one was on the key recommendations of the Murray Inquiry into the financial sector a few years ago.

SMSF leverage into property has been growing rapidly since it started in the latter years of the Howard government, and SMSFs looked set to become a major player in the market.

But it’s been growing rapidly from zero, and hasn’t had time to get all that far.

In my world, I know a lot of people using SMSFs to buy property, so it’s easy to forget that SMSF buying is still tiny – just 0.18% of the market. Getting rid of it is hardly going to move mountains.

This is still a pretty serious move, but it’s more about removing a source of future demand, rather than existing demand.

Assessment: Sounds good, mostly useless.

4. Ban on Negative Gearing
This is also a pretty radical reshaping of the market, but the thing to remember is that the change is grand-fathered. That is, if you had a negatively geared property before Labor brings their changes in, you get to keep negatively gearing it and claiming your deductions.

So again, this is about shaping future demand, rather than the market today. And even in theory, it’s not clear where the adjustment will be made. It could be in the relationship between rents and prices, it could be in the way people structure their finance (most people who negatively gear are wealthy enough to get creative with their financing).

The market will evolve, but it is certainly not clear to me that it’s going to have a big, or even noticeable impact on prices in the short term.

Assessment: Sounds good, mostly useless.

So look, while it all might sound a bit scary, I think most of Labor’s policy is in line with the Sounds Good, Mostly Useless theory of political science.

And that’s not an accident. You can be certain that Labor is being very careful about tipping the apple-cart, while very carefully choosing messaging that maximises voter-impact.

That’s politics for you.

But from where I sit, I don’t see any skies falling in.

What do you think? Mostly useless?