Australian Property Fear: Overhyped

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Today’s Profit Watch takes a detour from our normal terrain to a landscape just as choppy and dangerous: The property market.

We need to keep a tab on what’s happening here — even if you only play in shares.

You’ll see why after today’s missive.

Here’s what caught my eye: Melbourne rents are rising, and quite strongly.

The Saturday Age ran an article on this. It’s based on a quarterly report from its Domain real estate brand.

Rents in some Melbourne suburbs are up by double digits.

It makes for an interesting insight…

Here’s why I bring it up.

We’ve all heard the extreme property bears many times.

Now, it’s true the housing market has cooled.

I’ve said before that the regulatory restrictions around bank credit are behind this.

Credit creation drives the economy, and the asset markets.  

When a bank makes a loan, it’s not using deposits or previous savings. It creates the money out of nothing.

The more this happens for property transactions, the more real estate prices will inflate.

It’s one reason why Australian property trades far above rational values based off income flows.

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The majority of people simply don’t buy real estate for the income.

They’re chasing the capital gain. And they use a lot of borrowed money created from the banking system to do it.

Whatever rental flow comes in is usually used to defray the holding cost of the loan.

Key point:

The only genuine restrictions on this bank credit creation process are:

  1. Banks’ ability to find borrowers
  2. Their confidence they’ll get the money back

Here’s the key insight: This bank credit creation can become totally divorced from the real economy.

The history of major property busts shows this pretty clearly.

Eventually, borrowers take on way more debt than the economy can handle, based off genuine income.  

This game can last a long time…until eventually rising interest rates come along to expose the shaky foundations of the whole thing.

However, rents have their own story to tell…

What rising rent suggests about the economy

You see, rents are not divorced from the real economy. In fact, it’s the complete opposite, because rents are tied to wages.

Rising rents in residential Melbourne suggest a few things to me. One is that a major property collapse is unlikely.

Population growth and strong employment are (presumably) driving this trend. Higher income from a property enhances its capital value. This bolsters the market against a major collapse.  

A second point is that the economy might be chugging along a bit better than people give it credit for…and landlords are responding to this. 

Now, granted, Melbourne is one city across Australia. But only Sydney and Darwin saw median rents drop over the last year. That would suggest support across the economy, broadly speaking.

This is not to say it’s all hunky dory out there…

Construction data, especially around apartments, is weak. 

Some developers could find themselves in trouble shortly. We’ll have to wait and see on that…and who has financed them.

But there’s something else to note around all this property collapse talk too…

When the powers that be fiddle…

Politicians can change rules to suit themselves.

For example, The Age reported after Christmas that the Victorian Planning Minister is looking to change strict planning controls around skyscrapers in the CBD.

Certain height restrictions could be about to get the flick. That can take up land values again. The higher a building can go, the more valuable the land underneath.

Hmm. There are other tweaks happening.

Already, bank regulator APRA is scrapping the interest-only restriction and the RBA is letting the banks know not to go too tight.

Suffice to say, I’m not yet convinced Aussie property is the massive bubble waiting for a pin like so many think it is.

Even Perth — in the doghouse for so long — is showing signs of life. The reviving mining industry is feeding back into the real estate market over there.

The point for today is not to say you should rush out and buy property, or real estate related stocks.

It’s only to say that the wildly pessimistic forecasts around Australian property appear off base to me…unless some other major development comes along.

Just consider the recent decline in the Aussie dollar. It’s making real estate in Australia cheaper for international buyers.

All this is important. One of the lessons I’ve learned over the years is that if you’re in the stock market, you need to make an effort to understand real estate too. 

Both markets influence the other, but real estate is by far the largest asset class, and crucial to the health of the banking system.

If the property market begins to stabilise around these levels, it’s much more likely that the share market will bounce back this year.

One way to gauge this probability is to keep an eye on bank stocks. If they can hold or rally from here, the market would be suggesting the worst of the property falls are behind us. 

If not, then we might need to start worrying.

Cheers,

Callum Newman Signature

Callum Newman,
Editor, Profit Watch

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