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Stand by for a big correction in apartment prices

04082016_Image

Stand by for a big correction in apartment prices

Are you worried about housing affordability?  Anxious that your kids can’t even get onto the property ladder, never mind climb it?  Well, an oversupply of apartments, plus an increasing number of failed settlements, means all that is about to change.  Cheaper apartments are on the way.

As you know, we have a strong conviction that apartment oversupply will cause a correction in apartment prices and that the historical absence of volatility in property prices will render the correction, and its magnitude, a surprise to many.

In short, our thesis is:

  • Apartment oversupply; 96,000 total – new and existing – apartments sold in the last 12 months versus more than 92,000 off-the-plan-only apartments due to settle this year and 120,000 new apartments – presold and unsold – to hit the market this year, combined with
  • Failed settlements; Chinese investors cannot withdraw sufficient funds from their homeland and domestic investors face lower LVRs and lower bank reveals prior to settlement), will
  • Require developers, those trying to move unsold stock to meet their own debt obligations, to discount their apartments.

To be clear we do not believe that it will be investors desperate to sell that will force apartment prices lower.  We don’t believe job losses or higher interest rates will be a necessary catalyst for lower apartment prices.  They will decline because developers will be left holding the baby – a ton of unsold stock – with obligations to the banks.

It has already begun.

We are already seeing evidence of the ‘softer’ forms of discounting by developers;

In Melbourne, eastern suburb developer DealCorp is offering trips to Europe and luxury Asian resorts. There is a piece on this in the AFR (might be firewalled) Offers of free holidays and 10-year rental guarantees are also already evident.

The Latest

The failed settlement scenario may also be beginning.  Many lenders that provided deposits to local buyers are refusing to provide the additional funding amid growing concerns apartment values are falling, particularly in Melbourne thanks to over-supply and falling demand.

“More than one in three of our clients who bought off the plan are having problems,” says Peter Ristevski, a partner with Chan & Naylor, a national advisory group.

Overseas investors from China are also experiencing the issues we anticipated. “Lanny Xu, chief executive of Iron Fish China, a broker’s agent in Shanghai, said about 20 per cent of his clients who purchased Australian apartments cannot complete the deal and are trying to sell.”

The AFR’s Larry Schlesinger reported 3 July 2016 that roughly one in 20 Melbourne off-the-plan (OTP) apartment buyers abandoned their purchases in June, with roughly two-thirds of those foreign-based, according to law firm Maddocks.

Background

According to UBS, Australia’s residential crane count has surged 165 per cent since September 2014 to a record high 525 units, with the biggest lift occurring in Sydney. That’s more than a doubling of the number of cranes operating in the residential sector in just 21 months.

Dwellings under construction as a share of GDP at over 3.5 per cent are now at all-time highs and more than double the percentage observed in 2000. Moreover, most of the dwellings are multi-story apartments, rising from a total of $5 billion in 2001 to $40bn today.

Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management. To invest with Montgomery, find out more.

INVEST WITH MONTGOMERY

Roger is the Founder and Chief Investment Officer of Montgomery Investment Management. Roger brings more than two decades of investment and financial market experience, knowledge and relationships to bear in his role as Chief Investment Officer. 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.

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30 Comments

  1. Hey Roger, Great blog you have! I partoicularly wanted to compliment you on your writing style, it’s very engaging.

    Im a little late to the discussion but I have been doing some extensive research on the oversupply problem, particularly in Sydney and the facts are quite interesting. I will elaborate here to get you up to scratch.

    Basically, a lot of apartments are not settling with an added emphasis on foreign buyers of off-the-plan apartments. Harry Triguboff who owns Meriton stated that there was a 50% settlement failure of apartments selling to Chinese foreign buyers of Meriton apartments in Australia.

    But the government was quick to jump on this, making apartments which fall through on settlement still classified as brand new instead of being then 2nd hand where they could then only be sold to the domestic market. Now they can freely be traded around, almost like a commodity.

    The defining factors influencing high house prices, particularly in Sydney & Melbourne are low amounts of land releases, negative gearing, high net migration, the first home buyers grants, investors grants, stamp duty exemptions for cheaper properties, capital gains tax discounts along with an increased share of properties bought by foreigners.

    When all this is added up I cannot see house prices falling over the short term, especially with iron ore and other commodities increasing in price I believe Australia will be safe over the short term.

    I would love to get your thoughts Roger, thanks.

    • Thanks for sharing. Our thoughts are pretty well known. The factors that you say will support prices also have the capacity to overinflate them. But the weight-of-money argument has never prevented corrections in any asset class.

  2. Hi Roger

    I do not disagree with anything you have written – and am very pleased that you are shining a light on the bubble – but I note that Abacus Property Group highlighted in both their FY16 Results announcement & presentation the following :
    “We have … new and existing projects providing total assets of $500 million in property venture investments. Abacus controls over 9,000 units or land lots which equates to c$55,000 cost base per unit/land lot. This low average price provides evidence that the property ventures business has
    prospects for strong returns.”

    They also point out that 73% of project capital is invested in Sydney

    I have 2 sons who cannot afford to enter the Sydney apartment market due to the bubble so I would welcome a correction – but at only $55K plus associated build costs per unit maybe future pressure on apartment developers may be not as strong as forecast?

    • Hi Bradley, The argument is identical as that used by commodity traders who say that commodity prices cannot fall below the cost of production. History has shown that prices can and do fall below the cost of production. That is what produces losses among companies. Also, associated build costs need to be added rather than ignored or treated as a rounding error.

  3. Wait a minute this article refers to 120 000 apartments to hit the market. If we assume 10 000 per apt in infrastructure charges ( which is a gross under estimate) then that would be 1 200 million dollars in infrastructure charges collected by the BCC. Where or where has that money gone???? Surely the residents of all inner city areas where the majority of this development is happening should be seeing great new recreational facilities and park land for that sort of money. I think the BIG question we need to be asking is what oh what is the council doing with all of this money, surely some infrastructure for the actual residents

  4. Hi Roger,

    Keep up the good work and continue to question.
    I find it strange that people criticise you for delving into the risks currently facing Australian residential property. Particularly in Sydney and Melbourne.
    It shows how much emotion is clouding analysing the intrinsic value of property in this country. I doubt if you were questioning the value of a Business you’d get such a reaction.
    It’s interesting to note that Australian residential property contributed 182.5 billion dollars to GDP in 2013-2014. Mining by comparison was less at 140.9 billion. Retail only 75 billion.
    To compound the issue Residential mortgages as a percentage of total loans is 63% in Australia. In the USA this figure is only 32%, the UK 20% and Germany only 18%
    The data certainly suggests the Montgomery funds should continue to pay attention to the gravitas of the situation.

  5. Con Katsiouras
    :

    The biggest driver of property prices, IMO, is access to cheap, timely credit. So the question for me is 1. Is the likely fall or crash in apartment prices likely to lead to a slow down in the distribution of credit towards this asset class, 2. Will the slowdown in credit extend to the broader property market eg detached housing, commercial etc.I see this as a likely,but not certain,scenario playing out over the next 2+ years.
    Note that our local banks are unlikely to be severely effected by settlement failures. They have not directly financed projects with large % sales to foreign purchasers and have only conservatively financed projects in Melbourne and Sydney CBD.

    However, any material adjustment in housing prices will impact Banks Balance sheets and I believe this is also a likely scenario to play out over time.

    There are many mezzanine lenders, superannuation funds who have participated in higher risk lending in this space and they will definitely be experiencing some pain through this cycle.

    The fallout in the property construction industry really couldn’t come at a worst time for Australia given our sluggish economy. Add to that, any major fallout will likely be exacerbated by an increase in local interest rates, most likely from foreign investors who will be demanding higher rates for our bullet proof RMBSs and you start to get a feel for how quickly this apartment oversupply could spiral out of control and impact the broader economy and markets .

  6. Hi Roger.
    I’m concerned that many people have confirmation bias on property.
    It’s a false assumption that a person will continue to profit from housing simply because the last twenty years have been successful. People paying record sums for houses seem to think their purchases are disaggregated from Apartments.
    But the major catalysts have been
    1.Falling interest rates
    2.Liberal and Labour vendor grants 2001,2008
    3.Non bank lending and greater competition.
    4.Recession free(So far) economy, and one of the biggest mining booms in our History(Tapering off)
    4.Record high Levels of debt pushing prices higher.
    5.A drug like addiction for residential property
    Eventually all asset classes return to a mean value. Residential property is now multitudes the size of the Australian economy with the big four banks leveraged along with the population.
    How do you see this panning out?
    Personally I see it as a Ponzi scheme where only new entrants wishing to take on extraordinary debt can sustain prices. Good luck to the baby boomers who bought on 2-3 times average earnings. Think it’s 12 times now in Sydney and up there with the record highest in the world.
    Every day Domain boast of housing, “Warren Buffets” who bought a house a year or two years ago and have doubled their money.
    So are we different to Spain,UK,Ireland,Japan? Can we just slap ourselves on the back as the lucky country and continue this trend Infinatum? Or does it take a shock of sorts(and to quote Buffett) to only see who’s naked when the tide runs out?

  7. david.keel.3597
    :

    I would have to disagree with this assessment.

    I have written this before in the comments section but, just as CSL is not Qantas, so is a well-located 3 bedroom house in an inner ring suburb NOT a 45sq metre apartment in the CBD on the 50th floor.

    They are chalk and cheese.

    Also, it seems you are spending an inordinate amount of time studying housing using top-down analysis – with respect, I would have thought The Montgomery Fund should focus on the polar opposite (being bottom-up analysis of businesses).

    And, if your predictions are correct, how do you plan to take advantage of it (if at all?) Shorting the Big 4 banks in the Montaka Fund? Shorting the mortgage insurers such as Genworth? I would have thought the latter would be the best proxy, but it seems quite risky with other moving parts in those businesses that are unrelated to the housing bubble.

    I would tend to believe someone working in the property industry – especially as their is far less reliance on assumptions of dwelling approvals, completions etc..

    Anyway (again with the greatest respect because I have been following you for 5 years and the fund has performed fantastically) I think you should focus more on buying businesses below their intrinsic value and stick to your knitting.

    • Hi David, we look for three things in an investment candidate; 1) Quality, 2) Value and 3) bright prospects. It is the third aspect (prospects) as it relates to the our positions in the banks, REA group and others that we must think carefully about the impact on profitability and our low-case valuations for those companies.

      Every time we buy or sell a share someone has disagreed with us (the other party) so we don’t mind disagreement. In thinking about the prospects for the construction industry and property prices, we are very mindful of its relevance to our ‘knitting’. We debate frequently whether reliable signals can be gleaned from the data we are looking and so we rarely if ever jump at shadows. nevertheless we are doing the work that produces the results you so kindly complimented us for.

      • david.keel.3597
        :

        Appreciate the reply, and I hope you continue the good work. I don’t think property V shares is an either or scenario though, both have a lot of pros.

        I feel obliged to go in to bat for property in this debate:
        – little buy/sell decision making required
        – can leverage highly with no chance of a margin call
        – capital city property has the best exposure to population growth in Australia over the next few decades.

        In regards to Kris’ comments, I think most rational players are aware that the following 2 decades will look nothing like the previous 2 decades in Australian property.

        Financial deregulation, household debt going from 50 to 150% of DI, interest rates dropping from 17% to <4%, increase in two income households, these are not repeatable phenomena.

        However in a low interest rate, low inflation, low growth world property may still be a decent investment candidate – provided you don't buy the Qantas/AMP/ABC Learnings and stick to the CSLs and Sirtex of the property world!

      • Sorry David, did you say one of the reasons property wins is because it can be highly leveraged? Not sure that will work out for recent Brisbane and Melbourne apartment buyers.

      • david.keel.3597
        :

        Indeed I did, and I was not referring to off the plan buyers sucked in by glossy brochures (or trying to get money out of China) in Melbourne and Brisbane.
        I was referring to buyers purchasing in inner-ring suburbs who plan to hold the asset for 30+ years.

  8. Warren Meacham
    :

    Seems to me that those who are calling for a passing-on of the full RBA Cash Rate to ‘mortgage-holders’ are also those who would benefit the most from such a passing-on. I see no low-income persons calling for such a decrease in mortgage rates. Low income earners hold their meagre savings in a bank; pensioners with term deposits rely on savings interest rates; first-home deposit savers would prefer a higher savings rate.
    While cutting mortgage interest rates would benefit a few home-occupiers, it is apparent to me that property investors with a number of properties and therefore outstanding debts would be the biggest beneficiaries of a mortgage rate cut.
    Congratulations to the team for the outstanding results produced by your funds, too. Disclosure: I am a happy holder of Montgomery Fund and Montgomery Global units. :)

  9. Hi Roger,

    You say apartment prices “will decline because developers will be left holding the baby – a ton of unsold stock – with obligations to the banks.”
    Also the numbers for the new constructions are massive.
    I may be misreading this but it seems the article suggests a major fall which will be quarantined to the developers in the apartment market.
    Would there not be a contagion in the banking and construction sectors leading to a much more broad correction for the Aussie economy as a whole? Or is the apartment market too small compared to the whole economy?

  10. With some of the mortgages I hear about, those houses own their mortgage holders. Would I prefer a 750k house 1 1/2 hours commute from work that owns me or a 400k apartment that I own outright 20 mins out? Something to think about.

  11. Phil, I would rather die than move to an apartment from my big comfortable suburban home with big back yard, swimming pool, 3 car garage etc,
    and so would many people I know.
    there is more to life than just making money out of property,
    and there will always be a huge demand from Australians for houses instead of
    sardine can lifestyle of apartments, especially those of us with families.
    I couldn’t care less what happens to apartment prices and I won’t be selling my house for financial gain.

  12. We have all been sold a pup over the years that property cannot fail.
    Investors never learn

  13. I’ve already floated the idea of selling my highly priced outer suburban home in Melbourne and moving into an inner city apartment. If I’m thinking about it, then so are other people.

  14. Hi Roger,
    I have two questions for you:
    1. How do you see this affecting other residential property prices? I know you’ve stated in the past that property is priced relatively-people won’t buy a 2 bedroom house if there’s a cheaper 2 bed apartment round the corner, but how does this play out in other sectors? I would argue that a young family looking for a 4-bed with large back yard close to schools etc are unlikely to consider an inner city apartment block, cheaper or not. Hence, these properties wouldn’t experience the same falls? In any case, that’s the situation I find myself in-perhaps I should not assume others will act like me.
    2. Or do you see this as the catalyst for a market “crash”? In this case, do you envisage this will spill over to equities?
    3. You’ve mentioned Sydney and Melbourne, and while substantial, there are more Australians NOT living in those two cities, than those who are. In addition, apartments are generally limited to fairly close proximity to the CBD. So what effect on the rest of the country? Surely an oversupply in Melbourne and Sydney is only going to affect Melbourne and Sydney? See question 1, someone looking to buy in Adelaide doesn’t care if Melbourne apartments have gone down 20, 30, 50%?

    • Hi Sam,
      Granted houses and apartments aren’t perfectly fungible but lower apartment prices will take some attendees out of the house auction attendance pool. The third observation you make begs the question; could a possible fall in the prices of property in Sydney and Melbourne really leave the other capitals immune or would buyers ask :why am I paying such a high prices when the leading city economies have lower property prices?” In any event the bigger issue will be interest rates. All assets are valued using present cash flow calculations that adopt bond rates as part of the answer to the question of what is the cost of capital. As a result rising long bond yields (note they have been in decline for 30 years) will act like gravity on the values (and prices) of all assets. I note that a commercial property with KFC as a tenant sold yesterday on a yield of 3.7%. That is not normal.

      As an aside another blogger here – who didn’t leave their name – wrote: “I’d really love to believe this is going to happen.

      But last time prices were going to fall the Federal Government stepped into prevent it. Labor’s Chris Bowen allowed temporary residents to buy existing property and first home owner grants (read: vendor grants) were provided by the government.

      The Federal Government (Labor and Liberal) are also running a Big Australia immigration program adding 2000 people to Sydney and 2000 people to Melbourne every week.

      I’m not saying that the poorly-built, mostly-empty dog boxes in the sky in Melbourne CBD will not lose some value, but can you really see any significant value coming down on Sydney dwelling prices?

      With a million-dollar median and even places 50km+ from the Sydney CBD going for around a million, I think it would take more than this to bring housing affordability to Sydney.”

      • Thank you again for your insights Roger.
        I am only just starting my investment journey, I have already learnt a lot from you so your every word is invaluable me! I’m planning to buy your book once I get through some of my backlog… I would love to have your skill managing my investments, however I don’t have that level of cash, yet!

        The other blogger raises an interesting question as well, what of the government? I have lived my entire life without Australia experiencing a recession and it seems they (along with most of the rest of the developed world) are obsessively trying to avoid another, (kicking the can down the road, as you’ve said before) instead of letting the economy reset some of the imbalances.
        Surely they would step in again?

      • There seems to be enormous interest in a housing crash and experts have been calling it for 5-8 years

        good article / agree with Roger

        a few of my thoughts-
        there wont be a major ‘50% correction’ in ‘detached ‘housiing on land due to –
        1. too many buyers in the wings waiting for a 10-20% drop
        2. Australians love affair with property is self fulfilling
        3. if houses fell 50% what do you think will happen to equity markets Roger where you make your living ?
        4. imagine the fallout from a 50% correction in housing- even if you could brag ‘I told you so’ you wouldn’t wish that kind of fallout on anyone anywhere
        5. Steve keen is calling for a 50% correction so there is another contrarian indicator to buy
        6. not talking about apartments – would not argue against / they should fall 10-50% and even then I think that would only see a 10-15% fall in detached housing because such a fall in apartments would cause people to think I’m much better buying detached property, apartments are too risky
        7. I read an article that chinese familys are combing 3,4,5, family members cash to come up with deposits for houses in Sydney, could aussies go the same way?

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