NAB Economist Reports: Europe Thinks the Australian Economy is Toast, Blames Housing

Yesterday’s weekly markets wrap from NAB [ASX:NAB] contained some worrying hints. NAB’s chief economist of markets, Ivan Colhoun, says Europe thinks the Australian economy is done for.

You know something must be wrong when even the Eurozone thinks you need to get your stuff together.

Colhoun reported that ‘I have never experienced such overwhelming negativity on the outlook for the Australian economy and $A in all my years marketing the Australian economy offshore!One investor…described the Australian economy as “toast”. The bearishness reflected negativity on the usual culprits, namely mining, China and housing.’

He mentioned that ‘There is the prospect of over-supply of apartments in inner-city areas, especially if overseas investors do not settle or sell en masse. Part of the broader concern of a number of overseas investors reflected the view that Australian growth was becoming unbalanced/over-reliant on housing.’ Well, that’s a mild way of putting it.

The risks from overseas investment in housing

Inner city apartments, especially in Sydney and Melbourne, are going up at a rate of knots. They’re very popular amongst foreign investors, who see the allure of a premium location. Plus the fact that they don’t have to bother with all that FIRB nonsense. But the more new developments bought up by overseas investors, the more Australia increases our exposure to events offshore.

You may have read the headlines, seeking to calm down investors by explaining that foreign buyers only represent X percent of the housing market (figure varies, depending on who you ask). It may be true that foreign buyers make up less than 5% of the total market. But they make up much more of the market for new properties.

In May, Credit Suisse put out an important report on the Aussie property market. It claimed that in 2013–2014, Chinese buyers took up 23% of new housing stock in Sydney. And 20% of new stock in Melbourne. While the report focused on the effect that had on housing prices, it missed one important factor. And that’s rescission.

Buyers can terminate contracts for a number of different reasons. For example, they may sign a contract that is ‘subject to finance’. If they don’t get their loan approved, they can rescind the contract. The law also gives them the right to cancel if the developer notifies them of certain changes, and those changes ‘will materially affect the lot to which the contract relates.’ Or if the housing unit isn’t ready by the time a ‘sunset date’ passes.

Even if a buyer remains creditworthy, the bank could value the property at much less than what the developer did. That would mean the purchaser would have to cover the shortfall. If they couldn’t do that, technically they wouldn’t have secured the finance required, and they’d have to rescind the contract. Then the developer, to cover their costs, would have to sell the apartment to someone else as soon as possible.

Even if the foreign buyer didn’t have a valid reason to rescind, they still may not settle. The developer would then have to chase them in court. If indeed they were still in the country. In the meantime, the developer would probably have to sell the property to someone else, and recover the difference from the original buyer at a later date.

If this happened with most foreign buyers, it could cause overall prices to crash.

20–23% of new housing stock dropping dramatically in price would be a real drag.

You might think ‘but that’s just inner city apartments!’ The thing is, different markets aren’t as isolated as you might think. Some buyers may be tempted into apartment living by irresistibly low prices. Some who previously rented detached houses may choose to buy apartments instead for the security, driving down rental yields and removing some investors from the detached housing market. And don’t forget, not all new properties attracting foreign investors are apartments. Some are subdivided townhouses, or so-called ‘greenfield’ developments on city fringes.

Australians too reliant on housing wealth

Overreliance on housing wealth affects Australians on an individual level, too. Earlier this month, the ABS released the latest stats on household wealth in Australia. They showed that owner occupied housing is the largest source of household wealth, with ‘other property’ (investments, etc.) helping to round out the top five.

Mean value of assets all households ABS
Source: ABS
[Click to enlarge]

It’s middle class households that have most of their wealth in their houses. Wealthier households are more likely to own their homes outright. A mortgage makes up a smaller proportion of their household liabilities. At the other end of the scale, lower income households are less likely to be in the housing market at all.

type of assets by wealth group abs
Source: ABS
[Click to enlarge]

There are a number of problems with this. First, many people use the equity in their homes to boost their borrowing power. They may borrow to invest, or borrow to start a business. They may also borrow for personal purposes, such as taking a holiday or paying for a wedding. If the value of their house went down, they wouldn’t be able to borrow as much. That would mean less money circulating in the economy.

Second, high house prices help boost what’s known as the ‘wealth effect’. The wealth effect is when people feel richer, because they own an asset with a high value. Even if that asset isn’t liquid. Some economists and commentators say that current high levels of retail spending are all due to the wealth effect. People feel secure in spending and taking on more debt, because they feel wealthier. Either that, or they feel confident that they could just re-mortgage their property if they accidentally spent too much.

Colhoun noticed something interesting during his visit to the UK. In London, apartment construction is apparently even crazier than it is in Melbourne and Sydney.

London is Sydney on steroids with cranes everywhere – Dubai also had significant apartment and hotel construction. (I am motivated to understand more deeply the extent to which and the probability that foreign investors into Australian apartments may not settle). There were already some stories about some investors not settling in London, owing in part to the strength of sterling and weakness in some emerging market currencies. There was also another anecdotal report of there being few bids for these properties at the present time.’

If comments like these are making you think twice about the housing market, you’re not alone. The good news is, there are other affordable property investment opportunities. In segments of the property market with much less volatility. And actual positive yields.

Alternative property investment options

You can invest in property via the Aussie stock market.

This is done by buying shares in a property company, or units in an A-REIT (Australian real estate investment trust). For many investors, this is an ideal way to add property exposure to their portfolio, without the hassles of strategic decision making. It allows investors with relatively little to spend to experience the benefits of holding commercial or industrial real estate. In other words, it’s scalable.

Money Morning publisher Kris Sayce explains all in his report, ‘Three Best Investments in Australia for 2015 and Beyond’. In this report, Kris explains why, where and how you can invest in property via the stock market. And, he reveals the names and ticker codes of some of his choice property plays.

For all Australians, whether homeowners, mortgagees, aspiring investors or just spectators, it will be very interesting to see just how much housing market changes affect our economy. Whether prices continue to rise soundly, level out, or drop sharply. And how that affects our GDP; whether an unexpected socioeconomic group steps up to the plate with spending and investment. But while you wait for that situation to unfold, spend some time getting smarter about the way you add property to your portfolio. Find out how to download your free copy of ‘Three Best Investments’ today.

Eva Mellors
Contributor, Money Morning

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