04/10/2013 - 15:01

Perfect storm’s a blowin’

04/10/2013 - 15:01


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Low interest rates and banks’ enthusiasm to lend money are two factors driving the heating housing market.

IF you think warnings about overheated residential property prices are simply a scare campaign then you’re not paying attention, because there is a bubble forming and it will pop.

The timing of what could be a very painful price collapse is perhaps the only unknown in the residential market, where a perfect storm of factors has created what might be called a ‘boom from nowhere’.

The two obvious influences are super-low interest rates, which have lowered mortgage-servicing costs, and a marketing war as the major banks chase mortgage business to fill a gap created by a slowdown in business loans.

If they were the only two elements at work we would looking at a conventional property-value cycle. They’re not.

There are two other particularly worrying components to the residential boom which, in the case of Perth, has driven prices up by around 11 per cent over the past year despite the resources boom sputtering to a halt.

The other factors are:

• the rush by investors to buy residential property, because returns on other asset classes are low or non-existent (in the case of shares in small resource companies, a WA favourite); and

• changed laws which enable people with self-managed superannuation funds to add debt to their fund to invest in residential property.

It’s the combination of low returns elsewhere and the capacity for self-managed funds to enter the residential market using debt that forms the heart of the time-bomb developing in the property market.

And if you think time bomb is too strong to describe what I believe is a disaster-in-waiting, then consider some of the alarming numbers in a study of the Australian investment property market by the big Swiss investment bank, UBS.

Under the provocative heading of: ‘Investment property – speculators, spivs and tax dodgers’, UBS concludes that the housing boom under way across Australia is a threat to the banking industry, and many self-managed superannuation funds.

The first fact to catch the eye of an open-minded observer is that, between 1991 and today, the proportion of mortgages written by Australian banks on investment property has almost doubled, from 16.5 per cent to 32.4 per cent.

The second fact is more disturbing: Over the same 22-year period, the proportion of residential investment property owners with a mortgage has risen from 17 per cent to 57 per cent.

Those changes signal that a fundamental shift is occurring in the residential property market, which has morphed from being a sector that provides home for families into an investment game being actively fuelled by bank debt and self-managed superannuation funds.

The disturbing picture continues to develop when Australia’s mortgage market is compared with similar countries – our 32.4 per cent investment mortgage ratio compares with 20 per cent in New Zealand and 12 per cent in Britain.

Different tax regimes play a role in the wide gap between countries, especially the ability of Australian investors to negatively gear, or claim a tax deduction, on the gap between rent and mortgage payments.

The killer issue in the UBS assessment is that Australian Taxation Office data suggests the vast majority of Australian landlords are low to middle income earners.

“This implies Australia has a much higher proportion of investment properties purchased for expected capital gains (speculation) and tax minimisation (tax dodgers) rather than for rental income as seen in other countries,” it wrote.

Right now, all is calm. Investors are enjoying the residential property boom. Banks are busy shovelling cheap loans out the door (heard that before?) and tenants are being forced to pay ever-higher rents.

That game will end, if only because there will be too many mini-landlords using their self-managed superannuation to add a residential property to their portfolio, and not enough tenants to pay the rent.

There are two possible triggers for bursting the bubble – interest rates rise or unemployment rises.

“Negative gearing means negative cash flows, and with unemployment this begins to bite,” UBS said.

Banks and landlords then have a significant problem with the rented properties because: “There is no emotional desire (in the landlord community) to save the house, implying large amounts of investment property could flood the market.”

UBS said it was not aware of another country in which the landlord population was so highly leveraged or in the middle-income bracket as Australia.

“In stressed scenarios, Australia’s large exposure to leveraged landlords could lead to a significantly more volatile economic cycle than current stress tests imply,” it said.

“We do not believe that these implications have been fully considered by the banks, regulators or market participants.”

It might sound alarmist, but anyone in the residential property investment market, or thinking about joining the rush, should consider the very stark warning of the bust that will follow the boom.

Damage control

THE dust is yet to settle on the dispute between Fortescue Metals Group and one of its prime contractors, Mineral Resources, but there’s no doubt everyone in mining in Western Australia is closely watching an event that could change the way the industry works.

The issue for mine owners is trying to weigh up the benefits of the economic advantage that comes from using contract mineral processing firms with reputational damage when something goes wrong – a classic in trying to compare apples with oranges.

FMG, after a death at it’s the Christmas Creek facility operated by Mineral Resources, recognised that its reputation was at stake given past health and safety issues, which is why it made the highly unusual move of “stepping in” to take over the running of the plant.

Investment analysts, who tend to look at everything through a financial filter, have been quick to say neither party will suffer significant financial loss.

That view misses the point. Reputational damage is difficult to value, but can have dollars attached at contract renewal time; or when a miner considers the economic benefit of using a contractor over the greater control it has over workers on its sites.

Better dead than …

WHAT value Gindalbie Metals after its latest rescue by China’s Ansteel and a set of accounts that appear to show an increase in net debt from $1.2 billion to $1.9 billion?

One answer from the investment bank JP Morgan is 6 cents a share on a net present value basis (versus a 14 cents on-market price) and a suggestion that the best outcome might be for Ansteel to buy Gindalbie out of the Karara project for around $490 million, a price that values each Gindalbie share at 25 cents – a sort of better-dead-than-alive situation.


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