‘It’s About the Land, Stupid’


Here’s something the perpetual property bears leave out of the discussion with their doom and gloom: Industrial rents are just fine, thank you very much.

Look no further than Goodman Group [ASX:GMG]. This logistics behemoth came out yesterday and reaffirmed its full year guidance in a trading update. You can put that success down to the booming ecommerce sector.

Goodman is an international business. But even its Australian division shows a 97% occupancy rate. It doesn’t seem too worried about the future, either.

This is perfectly consistent with what is happening all over the world. The Economist reports this week that five REITs servicing the tech industry in America have doubled their value from five years ago.

More broadly, the US REIT industry has made compound returns near 20% for the last three years.

It’s not just about storing all those books and clothes and food we all order online. There’s massive space required for data centres and telecommunications infrastructure.

I keep making the case for a rising ASX based off strong miners and cost-cutting banks. The REIT sector could help give a lift too.

Property trusts make up around 8% of the ASX. Investment bank JP Morgan makes the case in today’s Australian Financial Review that the sector could rise somewhere between 15-30%.

How so? It’s to do with interest rates, mostly. REITS are currently benchmarked against a bond rate of 3.5%. That’s despite the fact that long-term Aussie government bonds are now well under 2%.

The reason the difference is still there is because the market hasn’t yet assumed that bond yields will stay this low for the foreseeable future.

However, experience overseas suggests bond yields are more likely to stay lower for longer. Look at bond markets in Japan and Europe.

We’ll keep an eye on this. But it does show the current difficulty in property is heavily skewed to the residential sector.

Politics will turn the credit cycle

Why? Credit restrictions, mostly. It’s not the usual suspects — rising interest rates and unemployment.

But the wheels are turning here. We already know that first homebuyers will get a boost, no matter which party wins the federal election.

Now the property industry is lobbying the RBA and APRA to loosen the credit spigot, according to The Australian.

No doubt the powers that be will have a wary eye on the crumbling figures for building approvals. They’re down 23% this year.

The industry pressure to ease the borrowing requirements is going to become intense.

That’s unless Australia goes full bore on some form of nationalised housing scheme. Don’t put it out of the bounds of possibility.

There’s a very interesting piece in today’s Australian Financial Review on the US firms Fannie Mae and Freddie Mac. It’s unlikely you’re familiar with these.

However, they play a crucial role in the American housing market. They buy loans from banks and then securitise them to sell to investors.

The catch for the American taxpayer is that they also absorb a lot of credit risk. This can go very bad…as 2008 showed. But it wouldn’t surprise me in the slightest to see something like this show up here.

The banks would love it. One of the things that stops them from generating even more housing loans is the amount of capital they need to set aside for each loan.

An Aussie institution like Freddie Mac, as I understand it, would allow them to create a lot more new loans. That’s because as soon as a loan is removed from a bank balance sheet, so is the required capital charge set aside for it too. That frees the bank up to create another loan to replace the one sold off.

That’s not all. Look at what’s happening in America right now. The Wall Street Journal reported two days ago that Freddie Mac and Fannie Mae are packaging up bonds where the borrowers are already geared to the hilt.

It’s the same old story as every property cycle. The only way to keep the game going is to let in more marginal borrowers. It takes many different forms: Lower lending standards, shared equity schemes, stamp duty reductions, blah blah blah.

The only thing never addressed is the fundamental issue: The cost of land.

Don’t be fooled by this idiocy

There’s a comment in today’s AFR that is a perfect example of this. One commentator is asked to opine on how we go about solving the riddle of Australian housing. He points to this dastardly issue of poor supply…

It drives me crazy that we address far too little attention to dealing with the supply side like restrictive zoning and high cost of imported lumber and the high cost of imported cement and concrete products.

This is, by far, one of the most idiotic things I have read in ages. Two things refute this garbage. I mean, really, imported concrete?

I have a book on my desk right now called Breaking Point: The Future of Australian Cities. The author is a man called Peter Seamer. He was the CEO of the Victorian Planning Authority for 10 years. I think it’s okay to assume he knows a bit about the issue.

He shows quite clearly that the cost of land has inflated way beyond the cost of construction materials since 1973. Or as he puts it: ‘…the increase is mostly due to a shortage of land in locations where people want to live.

What he should have said, actually, is available land. Here’s why. Every year, a group called Prosper Australia releases its Speculative Vacancies report in Melbourne. I suggest you read it. Google it. It’s free.

Rather than use the property industry’s vacancy statistics, they test the market using water use. If a property is using minimal water, they assume it to be empty.

Their data indicates that it’s possible that 16% of rental properties could be empty across Melbourne. It depends on how you tweak the data to get to a final figure. The point is the same regardless.

Land across Australia is used incredibly inefficiently. I only have to walk out the door to see this. Not far from my house is an old place that the owner doesn’t rent. He told me directly he doesn’t want to. The block is merely his ‘super fund’, which he plans to hold for 10 years.

It’s the rational thing to do with Australia’s idiotic tax system. The holding cost of the land is nowhere near the potential capital gain he’ll make. The block could host three units.

In the meantime, that land — close to the beach, road and rail transport — is held off market. This is part of the pressure behind Melbourne’s sprawl. The margin sets prices everywhere. David Ricardo proved that in 1810.

Suffice to say, Australia could have all the cheap lumber and concrete it liked, and house prices would rise regardless. It’s about the land, stupid.

Rising house prices are mostly due to rising land values. Economists call these economic rents. They’re the windfall you get from owning or controlling the title.

It’s the same in the mining sector. Any value above the cost of production is a rent captured via control of the relevant lease. Oil rents, for example, are very lucrative.

The Saudi cost of production is said to be US$5. The current price of Brent crude is around $70. That’s around US$60 per barrel in pure rent (profit) if we allow for some transportation and other costs.

Now you know why Saudi princes are so ridiculously rich! The higher oil goes, the more rent there is to capture. That’s why I suggest you back firms that control leases over areas with potential to capture these rents.

One my favourite oil stocks just came out today and said drilling has begun on its next target. Go here to jump on board before it’s too late. It could hit a big payday – within 50 days.

Best wishes,

Callum Newman Signature

Callum Newman,
Editor, Profit Watch