How Much Juice can Australian Property Have Left?

‘More front than Myer’ used to be a popular saying. Well, it’s time to bring it back out again after the Reserve Bank of Australia’s latest crack at Self-Managed Super Funds. In a breathtaking display of chutzpah, yesterday the RBA sounded a warning to those buying property via their SMSF, essentially telling them that they are getting into risky territory by leveraging into property.

Before taking a wild swing at the Reserve Bank of Australia, let’s just take a step back for a minute…

Over the past few years, the RBA has slashed interest rates to all-time lows. Such a policy disadvantages those savers who are looking to derive an independent income, i.e. look after themselves without government support.

With the RBA’s policy giving these people a hefty pay cut, they are forced to take on risk and make up for the loss of income by speculating on capital gains. In effect the RBA has pushed these people into the property sector. Now they have the gall to lecture them about the risks?

But it’s not just the RBA. The government is in there too. Years ago a change to the rules made Australian property a tax free investment for the over-60s. How to get property into super to take advantage of this tax bonus? Set up a self-managed super fund. Then in 2007, SMSFs got the go-ahead to make leveraged property investments.

Throw in historically low interest rates and they wonder why so much capital is going towards property? Now, the morons in charge want to launch an inquiry into the financial services sector!

You really can’t make this stuff up. It’s a result of bureaucrats pushing buttons and not knowing what those buttons really do. But when the results turn out differently to their intentions, they’ll turn around and have a go at those who are simply making rational choices based on the incentives provided.

The RBA also warned banks to maintain ‘prudent risk appetite and lending practices, especially in the current low interest rate environment‘. Again, what does the RBA think is going to happen when you cut interest rates to historic lows? The whole point of lower interest rates is to bring in a new round of borrowers. That’s how you get credit growth.

But when interest rates are so low, you’re going to get a more marginal borrower in the door, either because their income is lower or the debt level they’re requesting is higher. Banks don’t create credit. People do, and they do so by requesting and getting a loan. Banks certainly assist in that process, by making the loan easier to get, but it’s a process fuelled by low interest rates in the first place.

So here’s our message to the RBA: stop warning everyone of the dangers of responding rationally to your low interest rate policies, and instead have a good think about the bluntness of the instrument you’re wielding.

Which brings us to a related matter. There’s now a lot of talk about whether or not housing is in a bubble. As far as we’re concerned that’s too simplistic a debate. Prices are very high, but just about everything is geared towards making the Australian property market that way. Tax policy, interest rates, supply side constraints, labour costs etc.

On top of that you’ve had a major commodity boom that led to an investment boom, national income boom, etc, etc. It’s a well-worn narrative here at the Markets and Money, but all these things have contributed to sky high property prices and a national belief in the indestructibility of housing as an asset. ‘Prices can never go down meaningfully’ is an ingrained superstition in the Australian psyche.

But the reality is that any asset needs new marginal buyers to keep moving prices higher. All the things we mentioned above have all contributed to getting new marginal buyers into the market and keep it moving steadily higher.

Now, the latest marginal buyer appears to be leveraged SMSFs and, in parts of Sydney at least, Chinese investors looking to parlay their winnings from the China property boom. Is this the last bunch of new marginal investors to come into the market? Who knows? When it comes to property the odds always appears stacked on the side of the investor.

Which is why it’s been such a relentless bull market for the last 20 years or so. How much juice does it have left though?

No one knows of course, but we still think China holds the key. China, in addition to providing demand for Aussie housing stock, also provides a great deal of Australia’s national income. And we still maintain that the surety and size of that income is under threat as China tries to rebalance its economy.

The famous China bear Jim Chanos hasn’t changed his tune, and he recently talked with Bloomberg on the current outlook for China, along with jargon-coiner Jim O’Neill, the Goldman Sachs marketing genius (actually, an economist) that came up with the ‘BRICS’ acronym. You can watch it here.

Worryingly for Australia, the bull and the bear agreed on one thing. The host asked Chanos for a ‘concrete example of a concrete company that you can’t stand.’ Chanos didn’t opt for a ‘concrete’ company, instead he replied:

…anybody that’s in the business of mining iron ore right now…where supply is about to come on in late 2013 and 2014…and whether demand holds up or not it’s going to be a difficult market for those people.

To which the China bull Jim O’Neill said, ‘I’d completely agree with that.’

Chanos also made the point that on his best estimates, China’s urban residential housing stock is about 400% of GDP, which compares to levels of around 350-375% of GDP for Japan in 1989 and Ireland in 2007. That’s a worry.

We’re showing our bias, but after watching through the whole video we’d side with the arguments and reasoning of Jim C over Jim O any day. The housing and infrastructure situation in China is clearly unprecedented. And if you’ve just gorged on leveraged property inside your SMSF, you better hope that China is indeed different.


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From the Archives…

How Long Can the Government Charade Continue?
20-09-2013 – Vern Gowdie

The End of Australia’s Boom Economy
19-09-2013 – Satyajit Das

Super… Who’s Going to Buy Your Shares When You Retire?
18-09-2013 – Nick Hubble

Australian Banks in the Firing Line
17-09-2013 – Nick Hubble

Yellen at Stocks to go Up
16-09-2013 – Nick Hubble

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

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