A perfect storm is about to hit the property market
When real estate agents start warning you that property prices are too high, it’s time to pay attention. And that’s just what’s happened in the past week. It confirms my strong belief that the market is overheated – particularly new apartments. For many property investors, it will all end in tears.
We are confident that booming apartment construction and the subsequent oversupply in Australia will cause a rental glut for investors and trigger developers to accelerate price discounting – both will put pressure on prices even in the absence of any rise in interest rates. And, with record levels of mortgage debt, watch out if interest rates rise.
And the same problems beset New Zealand. At the risk of oversharing, if I am asked what my favourite pastimes are (when I get the time), they would include mountain climbing, fly fishing and mountain biking. And all of these activities are right outside one’s front door in Queenstown NZ – the Swiss Alps of the Southern Hemisphere. Perhaps unsurprisingly, I occasionally receive a prompt from an agent over there about whether I am in the market and whether I’d like to buy something. I received one such email this morning and I wanted to share with you the correspondence. And keep in mind this is coming from a real estate agent.
Agent: Hi Roger, Long time since we spoke, I hope all is well in Sydney. We have just listed this property, not in the exact spot you were looking, but a very nice elevated spot, let me know if you are in the market.
Roger: Hi Ron, It’s waaaay overpriced. We’re always looking but I reckon I’ll be waiting until the next downturn, which I’ve a sneaking suspicion will start in 2019 and might [offer some bargains] in 2023.
Agent: Hi Roger, I tend to agree with you, interest rates will be a killer over here as so many people are highly leveraged. Let me know if you need anything in the mean time. Thanks
Interestingly, I received the above agent’s email the same day a Mosman agent sent around his weekly email. Again remember the below excerpts are coming from an agent (emphasis is mine):
“It had to happen sooner or later when we start to see real estate sales reach levels never witnessed before, which is exactly what is happening now on Sydney’s lower north shore where sale prices are running amok. The saying that real estate is not an exacting science is so true when one looks closely at real estate prices where the heat is now a blow torch and property valuers are having a lot of difficulty justifying selling prices to the lenders.
“To the untrained eye, it seemed like just another property market run. To the trained however, it resembles a “Houston, we have a problem.” For example, clearance rates on the lower north shore are now well into the 90 per cent zone which is the highest recorded in years.
“Now this is where it gets confusing when you look at household debt which is peaking at record highs and some suggesting that this is to be expected with a record low cash rate. How could this be expected when we have never had a record low cash rate before? Lending remains strong and currently sits well above inflation and wage growth. Although it must be said that our banks are now in a much stronger position, and they will need to be.
“Last year, we observed a fall in interest-only loans which are now on the rise again and that is a very dangerous sign. A recent survey by Digital Finance Analytics (DFA) revealed that four [out of] ten interest-only borrowers had absolutely no idea when, or how, they will start to repay the principal and that 90 per cent are hoping to roll indefinitely their interest-only term.
“Now this will have just the one ending as the banks will start rolling the clients as they should not have been approved in the first place. The Australian Prudential Regulation Authority (APRA) must take a long and hard look at interest-only loans as they are dangerous with a capital D!”
We’ll leave it to you to decide what it all means for leveraged apartment buyers…
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Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
simon
:
You really don’t have to wonder for long, why most people dont ‘invest’ much in shares other than the compulsory superannuation deductions and stick with property long term – I agreeit if yu get 1 or 2 right you can 10, 20, 30x your money but look at the falls of 20-50% (or manipulation by short sellers) in the last 3 months in the following share prices-
VOC
TPM
ISD
REA
ACX
HSO
RHC
then look at the short covering rallies in these to name a few-
BHP
RIO
FMG
BEN
note for the resources, BHP for example: after falling 70% from $50 to $14, bounced 80% (FMG bounced 275%) even after 95% of brokers dismissed them as ‘not worth investing in ‘price takers ‘
Why go through that ridiculous volatility when yu can buy a house for $500-$600k in Brisbane and rent it out for the next 10-20 years and slowly make money.
I dont care what everyone above thinks about a property crash in units or bond rates rising, Im sticking with housing/property /land (not units) long term rather than worry about share prices going down every day !
Roger Montgomery
:
Classic Simon! Some see share price falls as risk and others see it as opportunity. The regular and frequency of sharp declines in shares prices – when the mark treats that which is temporary as permanent – is precisely why I like the stock market so much.
Jason
:
That urge to not miss out and act on it is bubble thinking. Look back at the tulip mania in Holland. Tokyo is a good case to study as well. The demand was still there but prices became just too expensive. They printed money and have had a deflationary environment for a long time.
What concerns me is the case of a younger part of the population without employment prospects. These people have been priced out of existence in their own country. Do they have cash to place into the stock market as well?
travis
:
thanks for the views Roger. Given all this and the rising yields world wide where do you currently estimate the equity risk premium to be for developed countries eg. Australia / US / EU ?
thanks
Roger Montgomery
:
Earnings yield of S&P500 is 3.7%, Bonds are returning 2.35% but TIPS are only providing 0.41%. Using TIPS the ERP would be estimated to be 3.29% (using US10yr it would be 1.35%). It’s somewhere between the two but don’t get us started on all the assumptions that need to be accepted to believe it.
Reiner
:
Hi Roger,
I agree with your sentiment not to buy into an overly leveraged apartment market. But what about investors and owner-occupiers who bought units in sought-after Sydney locations many years ago and are leveraged below 50%? Would you expect the market downturn to be so severe that selling now, then renting and possibly buying back in 2021-23 would be an appropriate strategy to consider?
spiro
:
Hi Roger, wonderful article once again. Lets imagine that its 2023 and prices have come down to or below your expectation and you are ready to buy. May I ask:
1. Do you prefer houses or units?
2. New or old?
3. Would you consider commercial?
4. What yeild would you expect after property expenses?
Sorry for all the questions but rarely am I able to ask property selection questions off a successful businessman and investor. Most have been mum and dad investors that have a plan which end up with one to two properties and defaulting to the pension.
Look forward to your response.
Roger Montgomery
:
1. Do you prefer houses or units? Houses
2. New or old? Doesn’t matter to me, location more important.I understand the tax benefits from depreciation for many.
3. Would you consider commercial? No Never – too much building and not enough land. Industrial better, lost of land and a big simple tin shed on top.
4. What yeild would you expect after property expenses? Higher is better, and will depend on rates at the time with an eye to where those rates might be going.
Steven Tanner
:
Roger, whilst I completely agree with your sentiment I am a little confused at the title of a perfect storm ‘about’ to hit the property market. In your email to the agent you noted that 2023 could offer bargain prices, thats 7 years away?
Roger Montgomery
:
The storm might be about to start/hit but its epicentre and tail could be some years away. The damage bill certainly won’t be known for some years.
simon
:
HI Roger
did someone say ‘confirmation bias’ with regard to all the above comments ?
who knows when (or if) we will get a sensational ‘property crash’ like you all hope for..
but what about the crash in darling growth stocks that have just fallen 20-50%
ACX, REA, ISD, ALU, DMP, TPM, VOC, JHC, HSO, etc,etc, etc
will property ever ‘crash 50% in a month?
no way ever !!
so why does everyone love the words ‘property crash’ ?
..and whats going to be worse the ‘property crash’ or the (already) brutal stock market crash or the bond market crash ?
where do you hide?
simon
Roger Montgomery
:
Hi Simon,
Excellent point! Fortunately most stock market investors aren’t 90% geared as they are in high rise residential property. They also tend to be more diversified, as we are. So those big falls have relatively small impacts on overall performance. With respect to confirmation bias, we’ve just been using the data coming out of the RBA, ABS and Corelogic. If that data had said there wasn’t a problem, we wouldn’t have reported there is.
Andrew
:
Hi Roger,
I will start my first post with a disclosure about my preference for residential property as an asset class. I feel that free standing homes will continue to increase in price by 20% over the next 12 months. The area I live in is experiencing rapid population growth and the appetite for homes appears to be infinite. As low interest rates are distorting traditional yield expectations, investors flush with equity plow into an already crowded market place driving prices ever higher. I have been hearing anecdotal feedback that potential sellers are holding off selling out of fear that they won’t be able to re enter the market, adding to the perception of a under supply of houses. The RBA has the ‘tiger by the tail’ and I think the consequences for the RBA to raise rates is a burden they are unwilling to face.
Roger Montgomery
:
Thanks Andrew. What you have described is an expectation about a price change and the willingness of others to pay more in the future.
Rajneesh Kadian
:
Well well well, I am looking at the 10 year US bond rates and they appear to be on a tear. So your predictions are coming true before anyone could have imagined. My time spent at your website is paying dividends! Roger! So a big thank you.
I am in Waitara, NSW and can’t believe my ears and eyes. A building has come up with 300 apartments on Waitara Ave and struggling to fill them for 5 week now. I went in for inspection and 5people have now inspected more than 10 apartments from one agent. There’s appears to be more than 90 left to rent as per the agent. The rent is down by 80 -100 dollars a week in the area from a month ago. The agent told me there are 2000 more apartments coming up by next year. My jaw dropped. I can see on my street around 300 more apartments coming but 2000 I didn’t imagine. Anyhow then I asked the agent about people buying them, she said the price is dropping there too as the Chinese buyers are refused loans by the banks and can’t get money out of China. If this continues it’s heading one way and and no one will like the destination.
Roger Montgomery
:
Thanks for the encouraging words Rajneesh and thanks even more for the insights!
James Staples
:
Hi Roger
File, save as. Hiding clearly in plain sight. Every forgets the 5 years down before the 5 years (artificially pumped) up. As a credit advisor, the first thing I ask clients is, “are u really sur you want to do this?”. Because better value awaits the patient. Just as Warren Buffet. He bought his family home in 1958 and still lives in it. The bubble continues to artificially inflate over cycles. Just wait for a pin and you can pick some of the best pieces. Those that are older than 40 have seen it all before. We can watch the “horror movie right their on our TV (or new technology)”.
Roger Montgomery
:
Thanks James and also thanks to Graeme Ronald “Shirley” Strachan.
dane campbell
:
Roger, would love to get your take on the NZ situation which I’m sure has a completely different set of variables (bar debt) to the oz dwelling oversupply. The RBNZ’s unconventional use of LVR limits etc makes things a little more interesting to say the least…
Roger Montgomery
:
Hi Dane,
In summary, I think NZ is at an even greater extreme than Oz.
Wayne
:
Much appreciate your regular commentry on the unfolding property cycle. Looking out further , would be likley to assume a negative impact on equities associated with a property (apartment) downturn i.e. funds required to be shifted to compensate for property debts?
Roger Montgomery
:
That’s an interesting second, or even third, order event. It’s possible. I expect however that many of the riskiest borrowers for apartments are, by definition, riskiest because they had to borrow the most. If they had a share portfolio I suspect they might have sold already in order to meet the deposit requirements. In reality however its more likely they don’t have a share portfolio to tap.
CHI KIN
:
Hi Roger, excellent article. I agree with what you said. One point I do want to flush it out is there are lots of cash loaded foreign property buyers out there. The Australia government policy to increase stamp duty for foreign buyers is not working. When these foreign buyers can’t afford to repay the mortgage, that’s when the real bubble starts.
Roger Montgomery
:
Hi Chi,
You wrote “When these foreign buyers can’t afford to repay the mortgage, that’s when the real bubble starts”. Can I suggest that’s when the bubble ENDS!
Rajneesh commented here on the blog and reported a different finding with respect to foreign buyers…
“Well well well, I am looking at the 10 year US bond rates and they appear to be on a tear. So your predictions are coming true before anyone could have imagined. My time spent at your website is paying dividends! Roger! So a big thank you.
I am in Waitara, NSW and can’t believe my ears and eyes. A building has come up with 300 apartments on Waitara Ave and struggling to fill them for 5 week now. I went in for inspection and 5people have now inspected more than 10 apartments from one agent. There’s appears to be more than 90 left to rent as per the agent. The rent is down by 80 -100 dollars a week in the area from a month ago. The agent told me there are 2000 more apartments coming up by next year. My jaw dropped. I can see on my street around 300 more apartments coming but 2000 I didn’t imagine. Anyhow then I asked the agent about people buying them, she said the price is dropping there too as the Chinese buyers are refused loans by the banks and can’t get money out of China. If this continues it’s heading one way and and no one will like the destination.”
jimbo james
:
Struggling with the logic here. If the foreign buyers are cash loaded, why are they taking out mortgages? Similarly, if they are cash loaded why can’t they afford to pay the mortgage? Do they like to play with other people’s money, like perhaps Australian banks, backstopped by the Australian taxpayer? That I can believe!
Roger Montgomery
:
The answer is they’re not cash loaded. We’ve heard many anecdotes of foreign investors unable to export their funds
Troy
:
I tend to agree. With the end of the resources construction boom behind us and the end of the building boom and car industry still to come. If trump goes on a defence and infrastructure spending spree, which will be inflationary, surely this will have an effect on interest rates – perhaps out of cycle – the RBA has no bulletseft in the barrel and govt debt will make fiscal stimulus difficult. If we get rising unemployment, higher rates and and oversupply it could get ugly. But many have been saying this for years. The urge not too miss out is strong. Fear stopped me from buying property after the GFC. I often wish I did buy more. Time will reveal all.