Today’s Profit Watch is going to reveal a link between Mexican energy policy and the Australian housing market.
It’s only obvious if you understand the very basis of so much economic activity: Chasing something for nothing.
Let’s introduce you to Andres Manuel Lopez Obrador. He’s the newly elected Mexican President.
He’s trying to pressure foreign energy firms to produce Mexico’s hydrocarbon resources.
Obrador is a politician. He wants cash for all the projects he has in mind.
That’s harder to find in previous years because the current level of oil production in Mexico is low.
This is despite the fact that previous governments issued permits across the Gulf of Mexico and onshore.
Obrador is threatening to use the power of the state to enforce companies to get on with producing oil instead of ‘speculating’ with the contracts.
And fair enough. Oil is a national resource for the country.
However, it’s easy to imagine a scenario where, if a lease was acquired when oil was trading for US$40 a barrel, it will become much more valuable when oil goes to, say, US$60.
This move in oil can be monetised through selling the development rights of the lease to someone else at the higher valuation.
However, there is no guarantee there’s any oil coming out of the ground — or any revenue for the Mexican government.
We don’t need to concern ourselves further as far as Mexico goes.
But the case is a useful demonstration of the difference between value created through production and what appears to be happening in Mexico — value created via exchange.
We can see the same dynamic at play in Australian housing…
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Andrew Welsh is a Melbourne property developer.
An article in The Australian Financial Review cites him highlighting the land speculation around development lots on Melbourne’s fringe.
The game here is for a group of buyers to buy greenfield sites with a deposit down, but no other intention than on-selling before settlement.
This is no more than a greedy hand snatching at the land price increase.
And, it must be said, probably a very profitable move over the last few years. The cost of outer Melbourne land was up 40% in the year to March.
It’s when the cycle turns that this game gets exposed for the racket it is. It’s more than likely that many of these speculative buyers don’t have full financing in place.
Now defaults at settlement beckon. The market is retreating. Land prices are coming down and these speculators want out of the action. There are no greater fools around to sell to anymore.
It need not be this way…
Aussie housing slowdown — a good thing
This behaviour could be stopped in the same way Obrador is dealing with energy firms in Mexico. That is, by attaching some form of development obligation to any greenfield project.
That would mean only legitimate developers and builders entered the market for raw land.
The consequences of such a move delivers a wide range of benefits. There’d be less demand for speculative holdings. That would lower land prices and help deliver cheaper housing.
Capital would flow to genuine investment projects. It would also mean the financial system was at less risk of bad debts.
It’s highly likely that this cycle of defaults on Melbourne’s fringe — if it happens — is a bit of a boon for the very large developers.
Anyone with the financial muscle would love nothing more than to take good property off the hands of distressed sellers.
Only the very largest will have the cash and bank backing to buy up everything they can get their hands on.
But anyone with a big land bank will be well placed for the next upswing in the housing cycle. And yes — this will come at some point. Australia’s population may double in the next 35 years.
The mainstream media bleats as if the current housing slowdown is a bad thing. I don’t agree.
It only takes a moment’s reflection to realise that property booms cannot inflate forever.
Developers have to make a profit to want to build houses. Buyers can only pay so much before their financial resources are exhausted.
And a lot of financial instability can generate when real estate booms get of hand.
It’s one reason why the recent Aussie crackdown on investor and interest-only loans is a good thing — if you’re interested in a sustainable economy that prioritises and rewards genuine production and innovation instead of rent seeking.
As we can see from Mexico and Melbourne, it’s not always the former and too often the latter.