How China’s Real Estate Market Sways Aussie Interest Rates

What a sorry state of affairs this is.

Could you have imagined 15 years ago that Chinese real estate developers would hold the kind of influence over Australian policymaking they now do?

What about the prospect of having the power to sway the Reserve Bank of Australia? Imagine that; Chinese real estate developers forcing the RBA to lower interest rates. If that sounds absurd, it should. But when has absurdity ever gotten in the way of reality?

It is one thing for Australia to base its economic wellbeing on resource exports to China. But to direct monetary policy on the health of China’s real estate market takes this dependency to a whole new level.

‘But…’ we hear you ask… Yes, we know. How can we separate the two? A property market needs iron ore, for steelmaking, to expand. So any downturn in Chinese real estate would inevitably hurt demand for Aussie iron ore.

But bear with us. There is another point, albeit a long shot, to all this that deserves our attention.

What is it?

The RBA’s quarterly Statement on Monetary Policy gives us a clue.

According to statement, China’s real estate market had a significant role to play in the bank’s decision to lower interest rates this week (emphasis mine):

The board has taken careful account of developments in [Australia’s] housing market, noting the effects of supervisory measures to strengthen lending standards, the easing in housing credit growth and the abatement of strong price pressures.

Recent falls in [the Chinese] residential floor space sold and the slowing in residential construction investment raise some doubts about the durability of the pick-up in demand earlier in the year.

A substantial slowing in demand in the Chinese property market would pose risks for property developers and related industries, including the steel industry.

The concern over a decline in iron ore exports is valid, but it might not be the only one.

Of course, it’s true that China’s real estate market requires a vast amount of resources, including iron ore and coal, to grow. Any decline in demand for these resources would, in turn, hurt Australia’s economic growth potential.

None of this is news to you. This type of economic relationship is to be expected. Trade has facilitated economic growth since the dawn of time. Especially in countries like Australia that are dependent on its exporting sector.

But that’s not what we’re concerned with here. We know that exports to China are part and parcel of what makes the Australian economy tick.

Chinese Real Estate Impacting Australian Monetary Policy

The bigger story is how the Chinese are directly affecting policymaking through their interests in Australian real estate.

As you may know, many of China’s largest property developers are doing business on our shores. And they’re doing so across both the residential and commercial market.

Should business take an unfortunate dip, it would affect everyone that’s involved in pre-purchased real estate projects Chinese developers are carrying out in Australia. These include local contractors, banks, and, most importantly, the investors that have paid deposits upfront for off-the-plan properties.

You can just imagine the scenario.

You’ve put down a 5% deposit on a $400,000 off-the-plan apartment. You’re $20,000 out of pocket. No small change, I’m sure you’ll agree. You wake up one day to find the Chinese developer that’s funding the project has gone bust. What do you think your chances are of getting your full deposit back? Slim to none.

However likely or unlikely this scenario, it’s clearly one that’s been weighing on the RBA.

In a way, what the RBA seems to be saying is: We need to ensure that Chinese real estate developers remain active…and we’ll do our bit here in Australia to offset sagging demand in China.

Now, this might be stretching a little. Maybe we’re just taking two and two and making five.

We could also say that, indirectly, this is no different than the RBA simply reacting to the state of China’s economy.

But let’s try and make this point as plainly, and bluntly, as possible:

The RBA understands how important the Australian real estate market is for the economy. Any significant downturn in the property market would devastate the economy.

The RBA is also fully aware that Australia has a two-speed property market. Meaning that we have high growth exceptions (Sydney and Melbourne), in an otherwise subdued market.

The RBA has admitted in the past that it has put off rate cuts in a bid to prevent further price growth in Sydney and Melbourne.

Now, if the RBA lowers rates, it inevitably pushes up demand in high growth markets. That boost helps create demand for things like, oh, say, off-the-plan purchases. The kinds of off-the-plan properties that Chinese developers have stakes in.

Meanwhile, in China, there are signs of a market cooldown. Something the RBA referenced directly in its quarterly statement.

This slowdown has the potential to ruin property developers. Such an event could, in turn, affect demand for steel, and thereby iron ore.

Can we conclude then that the RBA has indirectly decided to prop up Chinese developers by boosting demand for real estate in high growth Aussie markets that many Chinese developers are active in?

We could.

And we could be wrong. Or we could be right.

And when we read something like this, from the ABC, we can’t help but think we are right:

In order to conclude that the risks of an east coast housing bubble had dissipated, the Reserve Bank has thrown out a long-standing preference for CoreLogic’s (formerly RP Data) figures, and adopted Fairfax-owned APM and the Real Estate Institute of Australia instead.

“While one source of data recorded strong growth in housing prices in April and May, that growth appears to have been overstated and other sources suggest that housing price growth was modest over those and more recent months,” the RBA cooed in its dovish statement.

In effect, the RBA is opting for figures which support rate cuts. Ignoring the figures which actually suggest price growth continues to surge in markets at most risk of bubble-like activity.

If you squint hard enough, you might come to the conclusion that the RBA lowered rates to help Chinese property developers remain solvent.

Mat Spasic,

Junior Analyst, Markets and Money

PS: Markets and Money’s property expert, Phil Anderson, says house prices are yet to hit their peak. And he thinks we’re at the edge of another boom that could last a decade. With the RBA heading lowering rates one step closer to zero this week, his prediction looks prophetic.

Phil’s 20 years of experience as a property analyst and advisor has given him a keen sense for where the property market is, and where it’s going. He predicted a housing market crash in 2008. He also went against the mainstream in 2009, saying house prices would go on to boom this decade.

He was right on both accounts.

In a free report ‘Why Australian Property is on the Verge of a Decade Long Boom’, Phil guides you through this coming decade. He’ll show you the right time to buy property at its cheapest, and how you can use this to time your investments. To find out how to download his free report, click here.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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