Australian housing is at an inflection point
Despite recent data showing home prices have stopped falling and auction clearance rates are strong, I believe these positive signs are no match for the negative shocks that could soon hit the residential construction sector. The upside is that the any stock market volatility could serve up some tasty investment opportunities among residential building developers and their suppliers.
Back in February 2007, US economics observer and commentator Mike Whitney wrote:
“This week’s data on the sagging real estate market leaves no doubt that the housing bubble is quickly crashing to earth and that hard times are on the way. “The slump in home prices from the end of 2005 to the end of 2006 was the biggest year over year drop since the National Association of Realtors started keeping track in 1982.” (New York Times) The Commerce Dept. announced that the construction of new homes fell in January by a whopping 14.3 per cent. Prices fell in half of the nation’s major markets and “existing home sales declined in 40 states.”Arizona, Florida, California, and Virginia have seen precipitous drops in sales.
The Commerce Department also reported that “the number of vacant homes increased by 34 per cent in 2006 to 2.1 million at the end of the year, nearly double the long-term vacancy rate.”
“The US economy is in danger of a recession that will prove unusually long and severe. By any measure it is in far worse shape than in 2001-02 and the unraveling of the housing bubble is clearly at hand. It seems that the continuous buoyancy of the financial markets is again deluding many people about the gravity of the economic situation.” (Dr Kurt Richebacher)
“The bottom line is that inventories are up, sales are down, profits are eroding, and the building industry is facing a steady downturn well into the foreseeable future. The ripple effects of the housing crash will be felt throughout the overall economy; shrinking GDP, slowing consumer spending and putting more workers in the growing unemployment lines.”
Park that to one side.
I recently received the latest copy of CLSA Research’s Blue Book entitled, Succumbing To Gravity.
In the introductory paragraphs CLSA writes:
“Australian housing is at an inflection point. After 10 years of undersupply, 2012-16 saw reduced lending oversight, while offshore buyers drove dwelling starts by 60 per cent and prices by 33 per cent. Recently the property boom has begun to falter. While prices have stopped falling and auction clearance rates are strong, these positive signals are no match for the barrage of incoming negative shocks. The coming plunge in construction work and credit tightening has yet to play out, but eventually these factors will reinforce each other, creating a vicious cycle that will exacerbate the decline in housing, employment and spending, and risk putting the economy into recession.
“Construction employs 9 per cent of the Australian workforce, with residential building accounting for 75 per cent of industry employment. Its forecast collapse has the potential to eliminate 20 per cent of construction jobs and 2 per cent of the country’s total workers. The biggest effect on the economy, however, is the secondary effects on other sectors, including retail. This is likely to push Australia towards recession.
“Dwelling approvals are down 25 per cent, yet construction remains close to peak levels, reflecting projects still being completed. As construction work declines, unemployment and apartment oversupply will increase. Structural issues with apartments will worsen the decrease. Credit availability is one of the most important drivers of housing, and banks continue to tighten loan requirements; ASIC’s response to the Hayne Royal Commission may yet see increased regulation to ensure that the systemic misrepresentation in the mortgage application process is eliminated. being completed). Lee & Andrew expect residential construction to fall by 30 per cent over the next two years, while any recovery in approvals remains at least two years away.
“Strong auction clearance rates, flattening prices and easing borrowing rates will be no match for the cyclone of collapsing construction, tightening credit, falling employment, increasing oversupply, declining foreign investment, decreasing rents, and structural problems in apartments. High levels of household debt make the industry particularly fragile and risk compounding any weakness.”
The data we have is a little different from CLSA’s. From the Australian Bureau of Statistics we find that 9.6 per cent of the Australian workforce is employed by the construction industry – Australia’s third largest industry – and 37 per cent of those are directly employed in residential construction. That’s 3.5 per cent of the Australian workforce.
It’s still big enough to be worrying the RBA and the government. We already know that bricklayers are now aplenty and willing to lay bricks for 36 per cent less than last year. We also know that auction clearance rates are for established homes not the new homes that we need to be constructed if the risks of a recession (which I currently peg at about 20%) are to dissipate.
As we have written already on many occasions, the extent to which RBA rate cuts and government stimulus bring people back to buying new homes will determine whether growth stabilises or slows further.
It is important to note that through reporting season many retailers surprised themselves with better than expected trading conditions, which of course has helped to support share prices.
As value investors with cash on hand in The Montgomery Fund, and with the new Montgomery Small Companies Fund in the wings, we look forward to any volatility that might help deliver mouth-watering investment opportunities.