COVID cash and a commercial crisis

An increase in migration after the lifting of COVID barriers has helped Australia dodge the worst effects of a residential property downturn caused by higher mortgage interest rates.

But it’s a different story in the commercial property market, where a crisis is brewing.

Less politically sensitive than residential property, the high-rise end of the commercial office market is where falling values could hurt a sector close to the wallets of most investors: banks.

Warning bells have been ringing in the commercial property sector since the start of the year but have got louder as the Reserve Bank of Australia has pushed on with its attempt to crush inflation by ratcheting up rates.

With even higher rates expected by the end of the year, there is the potential for a crash in commercial property values.

Distress sales are not yet widespread, but the higher rates go and the longer they stay high, it is possible banks might be forced to take possession of office blocks, especially older buildings in less desirable locations.

What’s happening is the start of a liquidity crunch, with cash being removed from circulation by its owners, who are reassessing the risk-reward balance of leaving their money in a term deposit or exposing it to the uncertainty of an under-pressure property market.

A once wide and appealing gap between the returns offered by an investment in commercial property and that available on government bonds or a simple bank deposit has narrowed appreciably.

Factors other than high interest rates are at work, including a decline in overall demand for office space, even as many employers try to force workers back to the office.

But the major factor at work is the effect of easy money no longer being available to fund investments that were never going to withstand a market downturn.

Nor has there been an understanding of how long thecorrection might last, though the world’s ultimate bank – Swiss-based Bank for International Settlements (the so-called central bank for central banks) – has put a date on the process: 2027.

In one of the bank’s latest warnings that the outlook for interest rates is worse than widely believed, chief executive Agustin Carstens said governments and their central banks went too far in dishing out COVID cash.

Mr Carstens said the job of reining-in the surplus cash with high interest rates could last another four years.

“While understandable as the COVID crisis broke out, with the benefit of hindsight it is now clear that the fiscal and monetary support was too large, too broad-based, and too long lasting,” he said.

The bill for generous COVID support programs is now being presented in the form of higher interest rates across the world.

What’s happening in the interest-rate-sensitive Australian commercial property market could turn out to be the start of a US-style property downturn, with high-rise office towers in major cities sold at a deep discount on the purchase price.

In New York, the world’s biggest commercial property market, buildings are reported to be selling for less than the value of the land they occupy.

According to a report in London’s Financial Times newspaper, the recent sale of an office block at One Liberty Plaza in New York for $US1 billion represented a price 55 per cent less than the $US1.55 billion value at the height of the property market in 2017.

Scott Rechler, president of major US real estate company RXR Realty, said he was unsure whether anyone had come to terms of how long the property storm would last or how much damage it would do.

“I believe the market has under-estimated the potential severity,” he said.

Resources race

Reining-in the surplus cash created by central banks to support the global economy during COVID has made it difficult for governments to fund their next big spending project – energy transition – which is also starting to hit supply blockages caused, in part, by higher interest rates.

As one of the favoured sources of energy in the migration away from fossil fuels, wind turbines are becoming more expensive as the metals they require rise in price and costs increase due to a focus shift from onshore to offshore installation.

Adding to the challenge is the poor financial performance of wind turbine equipment makers, such as Sweden’s Vattenfall and Denmark’s Orsted, which are being squeezed by rising costs and slow revenue growth.

The inconvenient truth about wind power is that while governments want it, heavy-handed planning laws and a preference for price fixing to aid consumers have made the industry less attractive to investors.

Rising costs have been a factor in the renewable energy business of General Electric, which makes someof the world’s biggest wind turbines but has operated at a loss for the past two years, a situation that can only continue with increased government subsidies.

An additional problem for the wind turbine and solar farm industries is that they consume the same metals used in electric vehicles, which are another government energy transition priority.

As a result, prices for aluminium, copper, nickel and rare earths will continue to rise.

Deep dive

The potential for a shortage of critical and energy-related metals caused by continued strong demand from the vehicle industry was the focus of a recent report by investment bank Citi.

While the appetite of electric vehicles for a variety of metals is well understood, the latest numbers are a surprise and could be the source of another environmental crisis.

Citi reckons the vehicle industry (EV and internal combustion) will lift demand for metals such as aluminium, copper, nickel, cobalt and lithium by 55 per cent, from around 18 million tonnes a year to 28mt over the next seven years.

The EV rush is government mandated, as is expansion of the wind turbine and solar farm industries.

But what no-one seems to have thought through is the question of metal supply; and that’s when a serious environmental question will be asked, because one source could be deep sea mining.

Trials aimed at recovering metal-rich nodules from the sea floor have been under way for the past 20 years but have taken on an added urgency as energy transition drives increased demand.

The obvious irony is that to solve one environmental problem – fossil fuel consumption – something worse could happen by dredging the sea floor.