Usually when I read headlines predicting a gloomy future, my first instinct is to look for buying opportunities.
It’s the contrarian in me I suppose.
Or like most investors, maybe I think I know better than everyone else?
Overblown ego aside, it can be a useful first step when you’re researching an investment idea. To play devil’s advocate and take the opposing viewpoint first.
But the key thing I’ve learned — through bitter blows to aforementioned ego — is to not just stick stubbornly to an opposite position for the sake of it.
Occasionally the herd are indeed right. Or even if they’re not, they can look right for an uncomfortably long time.
As the famous 20th Century economist John Maynard Keynes put it after being at the wrong end of a currency trade:
‘The market can stay irrational longer than you can stay solvent.’
In other words: timing matters as much as direction.
Which brings me to the one asset in Australia that everyone has an opinion on….
What is it?
The great Australian dream of course — property.
The fortune tellers of the financial world — economists and analysts — have been predicting calamity for property prices for quite some time now.
Investment bank UBS has been the most vocal in its dire predictions for Australian property of late.
UBS analyst Jonathan Mott said:
‘With households now expecting prices to fall, demand for housing falls sharply, sentiment in the housing market turns from FOMO (fear-of-missing-out) to FONGO (fear-of-not-getting-out). Changes to negative gearing and CGT (capital gains tax) relief exacerbate the problems.’
UBS worst case scenario is a 30% fall, beating AMP’s Shane Oliver who believes a 20% fall is now likely due to a ‘perfect storm’ of factors.
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There’s three parts to this ‘perfect storm’ in my opinion…
A crash in three parts
The Royal Commission is clearly the ‘curtain-opener’ to this unfolding tragedy.
Week after week of revelations showing the big banks to have failed miserably in any sort of fiduciary duty.
Profit was paramount and any sense of injustice was to be tempered at the boardroom door.
I’m not sure we should be surprised at this?
And maybe we’re not…
But the key point is there will now be practical implications.
The Royal Commissioner will make recommendations. The upshot of these regulations is likely to be a credit squeeze.
And it will take a brave politician to reject these in the current white-hot era of banking outrage. Especially in an election year.
In other words, it’ll get harder to get a loan from the bank who now needs to know why you spent an extra $50 last week on lunch at work, when you could have taken a perfectly good sandwich from home…
This will be the biggest hit to home values in my opinion. Because excited buyers will not be able to get finance at the prices the sellers have become accustomed to expecting, even if said buyers want to!
You can see that already in auction clearance rates.
Sydney and Melbourne rates have stalled at the 40% mark over the past few weeks.
Some think this is savvy buyers reading the economists’ tea leaves and refusing to bid up. And maybe it is to an extent. But in my opinion, it’s mostly the banks cutting off credit.
Homes are emotional purchases a lot of the time and it’s easy to overpay if you really want something. The banks will put a lid on this for now.
Now usually this type of market would instead attract investors like bees to honey. They’d be sniffing out the bargains and using their tax breaks to build up their property empire.
But not this time…
Anecdotally I’ve heard from lenders that investors have gone AWOL.
The potential of an in-coming Labor government with changes to negative gearing laws has spooked them as well as the higher interest rates on investor mortgages due to so-called ‘prudential regulations’ from the current mob in charge.
There’s no doubt the property investment equation is looking shaky.
Even if negative gearing is grandfathered — and investors keep tax breaks on existing properties — it won’t help your property rise in value if future buyers can’t negative gear.
Credit squeeze — check
Political risk — check
What’s the third thing then?
The current USA-China stand-off over trade has us sitting between a rock and hard place.
The simple fact is that China is economically our most important partner. And the USA is our most important military partner.
If these two don’t come to an agreement sometime soon, market sentiment is only going to get worse. If that starts to hit the real economy, we’ll be in for a double whammy.
Not only will our bank cost of funding go up as Australia’s AAA rating comes under threat — possibly increasing our mortgage rates — but this will happen even as economic conditions decline.
Make no mistake this would be Armageddon for property values…
Will Aussie property actually crash?
Now at the start, I said I like to look for the contrarian position in situations like this. I then went on to spell out doom and gloom ahead!
But the thing is, try as I might, I can’t see much for property investors to get excited about right now.
Even if the US-China thing sorts itself out, an incoming Labor government dedicated to increasing wages could end up causing interest rates to rise as a consequence.
If the Coalition win it won’t be much better.
They’ll relax any new bank rules the second they can of course, but I fear the horse will have bolted by the time they do. Sentiment will have shifted down bringing values with it.
And there was a report out yesterday saying the Coalition’s plans to cut down immigration numbers would put pressure on house prices too.
Remember the knock-on effect of even one distressed seller is high.
It only takes one seller in the street to bring down everyone else’s prices. New buyers will anchor to any panic sales prices that happen.
The best-case scenario in my opinion is a few years of drift.
A bit of time for new housing stock to get filled, for people to pay off debts, for first home buyers to build up savings, and a gradual relaxing of lending standards to creep back in.
But Australian property doesn’t have time on its side in some respects.
The problem is there’s swathes of baby boomers retiring or going into aged care over the next decade. And they’ll all be trying to cash out of their property portfolios at the same time.
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This is likely to keep a lid on prices to a certain extent no matter what happens.
I’m sorry I can’t find an optimistic angle for all you property investors out there.
Maybe there’s a scenario that will reduce interest rates and push up wages? Maybe there’s a fact I’m missing in all of this? A secret spark set to keep our never-ending property juggernaut rolling forever upwards?
If there is, I’d sure like to hear it!
All I can offer is that if property prices do correct by 20–30%, there’ll probably be a bunch of younger buyers waiting eagerly.
And maybe that’s a good thing for society in the long-term?
Editor, Money Morning