There were quite a few comments on my last piece that I thought were worth fleshing out a bit.
If you missed it, the argument in a nut shell is that self-managed super funds (SMSFs) are now sitting on a massive pile of cash (bigger than Westpac). They have a fairly small exposure to residential property, and surveys suggest they’d like to increase it. If they did, and took advantage of rules that allow them to leverage, we could see a huge surge into property.
First of all, thanks to Greg M for picking up on a mistake. I said that SMSFs could leverage against assets. As he correctly points out they can’t. SMSFs are allowed to borrow to invest, though the exact rules have changed a few times in recent years.
My reading is that it works the same for SMSF as it does for you and I, with certain deposit and loan to valuation ratios enforced by the banks. This means that SMSFs can leverage, but only off cash holdings.
I got a bit lazy with the distinction between cash and assets there. But it doesn’t change the numbers at all. SMSFs have more than enough cash to cover the kinds of property exposure they’d reportedly like, so those quick back-of-the-envelope calculations I did still hold water.
But thanks Greg for keeping me on my toes. It’s good to know my readers won’t let me get away with intellectual sloppiness.
Second, Amanda was wondering that if there was a demand for 700,000 properties from SMSFs, who would fill them? As she rightly says, “they have to fill those houses with tenants to see a return on investment… 700,000 or so more tenants need to be found in a very short time…”
The answer to Amanda’s question is exactly the dynamic that is going to drive prices higher.
If SMSF demand suddenly caused an increase in supply of 700,000 homes, then that’s right, there would be a glut of rental properties, and rental and property prices would fall.
But that’s never going to happen.
It’s funny. I write around 1,000 words per article and some people get a fixation on one single point like the 700,000 homes. The reason I mention it is to highlight how much money is in SMSF’s and what potentially is possible.
Here’s the reality…
As I said, we build about 70,000 homes a year at the moment, so unless we really start cranking up production, it would take ten years to build that many homes.
And as Amanda says, SMSFs are going to want to see a return on their investment. So the most likely scenario is that the SMSFs will just go after existing properties that are tenanted already.
That means they’re going to start competing for the existing investment properties already out there. Maybe some will build off the plan, but typically investors favour established dwellings.
But there’s only a limited number of those. So that means that all this extra demand is just going to jack up the price.
Remember it’s 700,000 properties at current price levels. As the price level goes up, SMSFs will need fewer actual homes to get the exposure they want. Some other investors will cash-out or get squeezed out of the market, and at some point, the market will find a new equilibrium.
I don’t know exactly what that end point would look like, but the only guarantee in that scenario is that prices will be a heck of a lot higher.
My mate John Fitzgerald pointed me to some back-of-the-envelope calculations he did. Now John is worth squillions, and has over 5,000 property transactions to his name. When he talks, I listen.
John agrees with the basic maths I’ve got. But he compares the SMSF appetite to the value of sales. He says that in Australia we sell around $190 billion in residential property each year.
With gearing, he reckons 30 percent of SMSFs alone could buy every residential property sold in Australia, for the next three years!
As he says, almost 3,000 SMSFs are being set up every month! In his mind, it’s a total game changer.
He reckons this is one of the factors that helps explain one of the property market puzzles of recent times. We’ve seen prices, particularly in Sydney growing strongly (if we annualised September’s growth we get something close to 30 percent!).
But credit is only growing at 4.7 percent. How can that be? How can we have a boom without credit growth? That’s never happened before.
He reckons the answer is that there are new buyers in the market that we’ve never seen before. One is SMSFs.
The other is the Chinese.
And he reckons it’s taken the market by surprise, because 6 years ago, neither buyer existed.
As he says, “I look at China and you can take my numbers on SMSF and quadruple them and still not come near the capacity there. John McGrath told me that one of his Sydney auctions in September had 16 registered bidders – all Chinese origin and all cash buyers.”
“The top two house sales in Australia this year were for $52m and $33m, both to the Chinese and both in cash.”
I’ve been saying this for a while too. I don’t think most people realise the kind of wealth machine that China has become.
Before the GFC, to make the top 50 wealthiest list in China you needed $6 million. Today, you need $3 billion. These days, they’re creating 25 billionaires per month!
China’s top 20 percent had $1.4 trillion in bank savings last year. John notes that just 13 percent of that would buy every house in Australia, in one year.
Thanks John. That’s some serious food for thought.
(And I think this probably answer’s Tom’s question from the last post, right?)
We’ve got a cyclical upswing combining with a massive paradigm shift in the make up of the market, with the twin giants of China and the SMSFs letting their presence be felt.
It’s going to be HUGE!
And thanks everyone for the comments. I don’t often have time to respond but I do follow them closely, and I’m always impressed and humbled by the intelligence and knowledge that’s on display.
As I said, it definitely keeps me on my toes. I can’t slack off with you lot around!
June Jones says
As usual, great informstion. Thank you Mark.
Marat says
Oh well, those are interesting times we live in.
Simon says
There is a fly in the ointment here and that is national and international debt, the real inflation no one talks about, the gearing that is a high as 2007 and the instability in many countries. No one in these article talks about the truth of what is probably going to happen and that is wars and default. Many reason for these comments look beyond main stream media news, beyond a good content for discussion that is mainly aimed at selling you something, look and open your eyes, if you can’t see what is going on, if you really can’t see how bad things are likely to get then I rest my case. It is not all doom or gloom but it is not a bed of roses with real estate and the BS we get fed by certain people with an angle and a spin. Real estate agents also talking up a super great book,,,,why? sure they are not biased in way shape or form of course not, they have you the buyer/renter’s best interest at heart. In a nut shell grab a pick rock of salt because the hype of a good book is stinking the air a little these days.
Taylor says
Real estate agencies do well in good and bad times – in the former, people want to buy and sell, in the latter, people have to sell…
Ken says
I think the fly in the ointment better rest his case. Ken.
Holy Moly!!! says
“Before the GFC, to make the top 50 wealthiest list in China you needed $6 million. Today, you need $3 billion. These days, they’re creating 25 billionaires per month!
China’s top 20 percent had $1.4 trillion in bank savings last year. John notes that just 13 percent of that would buy every house in Australia, in one year.”
FAAARRKKKKK!!!!
Simon says
Hey Guys here you go, have a read on this link and check the report out it may give you some food for thought. As for those who are optimistic about property based on foreigners buying up your houses at any bid and pushing prices to a bubble, well good luck with that idea.
http://pro.portphillippublishing.com.au/p09siswarning/ESISPA67/?email=omac-ok%40hotmail.com&a=20&o=1081&s=1432&u=324545&l=81531&r=MC&g=0&h=true
jessica says
The price of anything has a limit due to its relative value; whenever that price exceeds beyond its real value , we know something fishy occuring. this has happened so often in human history.
Ken. says
If the Chinese want to buy a house in Australia, let them pay what they want. Just as we can’t all afford to buy Buckingham Palace, why shouldn’t the Queen or any other person with the money, be able to buy it. Nobody gives a rat’s arse if you or I can’t afford it. Any property is worth what someone is prepared to pay for it. Take paintings for example, I wouldn’t give you the time of day for one. Jealousy is a curse and rottenness to the bones. Cheers, Ken.
Simon says
It’s obvious that my comments fly way over some people’s heads, never mind what will be will be and you don’t know what you don’t know…
natalie says
We have a SMSF that purchased a property outright back in 2005 it has not gone up at all since then its still worth what we paid for it. I have had it on the market to sell for years and no nibbles. What would be your advice to grow this fund?
Simon says
If it is a property that you can rent then at least get a yield on it for a couple of years if not more, and if you have no debt on it then, at least you can save the rental income, write of depreciated fixture and fittings against the tax and sell the property in 3 to 5 years perhaps at a 5% below market value. It all depends on your circumstances financially. Also look at any government spend that may be coming in the area over the coming years, infrastructure etc, then if it sounds like it is worth keeping until then, do so.
I find it strange that you have had no growth for 8 years and no one wants to put an offer?
Good luck!
Ken says
Natalie, I wasn’t aware that smsf existed 8 years ago. Could you tell me what state, town, suburb it is in. Did you buy it for a retirement or investment. It would be beneficial if you could mention a price also. Some times this explains why it hasn’t gone up in value. Most of Knowledge Source’s students have been advised where to buy and where not to buy. Thanks, Ken.
Bob Adermann says
$1.4-trillion in Chinese bank accounts and probably twice that in unlaundered money stuffed away in Chinese mattresses. Here’s what a $trillion looks like: http://bigw.wordpress.com/2009/03/15/118/
Tom says
Jon,
Because of the more advantageous depreciation allowances on new buildings, it would be logical for normal portfolio investments to be new or ‘Off The Plan’. This helps offset the Tax paid on salary and other income. However an SMSF may not need these Tax deductions, so established buildings would probably be OK.
Tom