Australia’s ability to sail through the global financial crisis without a single quarter of negative growth is as much about property as it is about commodities. Since 2010 the country has been in the grip of a construction boom, with investment in residential and commercial real estate making up for a plunge in mining projects.
The property industry now accounts for one in every nine dollars generated in the economy and provides employment to millions of people.
The promise of ever-rising prices has made buying a home or rental property a national pastime and led to a 60% increase in household debt – mostly in mortgages.
The hype has been further fuelled by foreign buyers, both high-net-worth individuals and institutional funds, attracted to the country’s stable economy and a lower Australian dollar which has slashed the price of assets by 30% since the currency peaked in 2011.
According to the Foreign Investment Review Board (FIRB), Chinese investment in residential and commercial real estate has doubled every year since 2013, reaching A$24.3 billion ($18.3 billion) in the 12 months to the end of June 2015.
Foreigners now own 10% of all residential property and 52% of commercial real estate – or even more if foreign investment in locally listed real estate investment trusts (Reits) is factored in.
Recent moves by the country’s regulators to cool the market by applying restrictions to overseas buyers, as well as attempts by the Chinese government to stem offshore capital flows, are making property analysts nervous.
Some say the market could be heading for a wholesale correction as an undersupply of housing switches to an oversupply and buyers who have paid deposits on new apartments fail to obtain a loan when construction completes. There are some 230,000 apartments due for completion and settlement in the next two years.
Unquenchable thirst
Sam Elbanna, chief executive of CPM Realty in Sydney, wants Australian authorities to stop interfering in the property sector so he can continue to sell apartments to cashed-up overseas buyers. “The government would be foolish to meddle with market forces. We are so reliant on the construction industry that if overseas interest dries up, the economy could go into freefall,” he said.
Elbanna flies to China multiple times a year to run property seminars and is virtually swamped by eager investors. “They love the clean air, the mild weather and the views over the harbour,” he said. “They want a bolthole in another country or a place for their children to live while they study at university.”
Anyone who has had the experience of bidding against a foreign buyer at an auction knows they aren’t always driven by financial returns. Elbanna said he had seen Chinese nationals tender a price 20% above the next offer just to clinch the deal, and it is common for them to leave a property vacant.
“They aren’t really interested in finding tenants which is why you can walk around Sydney and Melbourne at night and see buildings where two-thirds of the apartments are total darkness.”
The love affair extends beyond high-net-worth individuals to institutional investors such as sovereign wealth funds. “Australia offers a stable economy and a transparent regulatory environment within the Asia timezone,” said John Dynon, a fund manager at AMP Capital who looks after A$8 billion in separate real estate accounts for institutions. He predicts the next wave of money will come from pension funds and insurance companies.
“We have only just seen the tip of the iceberg in terms of large-scale pools of institutional capital. There seems to be no end to their appetite for trophy properties in gateway cities.”
Tightening the screws
Under pressure to do something about the wall of money coming from offshore, the Australian Prudential Regulation Authority has been urging local banks to tighten their lending practices. Since May, the banks have reduced the maximum amount they will lend to non-citizens to 60% of an asset’s value, and are refusing to count foreign income when assess-ing a borrower’s repayment capacity.
Simultaneously, state governments in Victoria and New South Wales imposed new land tax surcharges for foreigners.
A shift in sentiment also appears to be occurring at the federal government level, where large-scale acquisitions must be approved by FIRB and ratified by the treasurer, Scott Morrison. In August, Morrison blocked the sale of a local electricity distribution business to China’s State Grid and Hong Kong’s Cheung Kong Infrastructure, claiming that the A$10 billion utility was too sensitive for foreign ownership. Similar reasons were given in April when Morrison vetoed the sale of Kidman cattle farm in Queensland to China’s Shanghai Pengxin Dakang consortium for A$370 million.
China’s regulators, meanwhile, have been tightening the screws on the flow of illegal capital out of the country. Controls include ordering banks to further scrutinise overseas transfers, curbing the supply of Chinese yuan to make shorting costlier, and clamping down on UnionPay debit card transactions.
Frank Mirenzi, a senior analyst at Moody’s in Sydney, said the measures had some impact on market activity. “In the first half of 2016, pre-sales of apartment blocks slowed because buyers were finding it harder to get finance,” he said. “And there was a pause in the rate of house price rises in Sydney and Melbourne – two cities which account for one-third of our housing stock.”
But the hiatus may be short-lived. According to Elbanna at CPM Realty, pre-sale rates improved again in August and house prices resumed their upward march. He believes the dampening measures are no match for persistent low interest rates and a global banking system awash with liquidity.
Elbanna says there are ways to combat the reduced appetite local banks have for apartment loans, including accessing non-traditional funding sources. He recently brokered the successful settlement of 40 apartments in Sydney’s Chinatown. “It took longer to reach financial close than it would have a year ago, but our buyers were able to go to non-bank lenders or global commercial banks domiciled in Hong Kong and Singapore.”
Commercial property bulls
The same issues are less evident in the commercial real estate sector where foreign investors continue to snap up office, retail and hotel properties in their global hunt for yield.
James Quigley, head of capital markets at Cushman and Wakefield, said despite the high prices being paid for trophy assets, Australia remained attractive on a total-return basis.
“Foreign buyers spent A$15 billion on Australian commercial real estate last year, which is a 10-fold increase in volumes since the global financial crisis,” Quigley said. “Investors at this end of the market are less deterred by recent tightening measures and there is no sign of a credit squeeze to come. The real challenge is a lack of supply of prime office developments. In Sydney, there is nothing for sale in the A$100 million plus bracket.”
While buyers await new stock, there is a healthy trade in existing assets. China investment Corporation instantly became one of Australia’s biggest commercial landlords in August last year when it bought Investa Property Group from Morgan Stanley for A$2.45 billion.
“The Chinese and Koreans are more recent sources of significant capital and are following in the footsteps of investors from Singapore, Canada and Japan who have been investing here for years,” said Tim Church, head of real estate investment banking at UBS.
Many recent deals have seen assets transfer from one Asian owner to another. In September last year, Singapore’s GIC Real Estate and Frasers Property Australia sold a A$1.1 billion portfolio of industrial properties to another Singapore company Ascendas. Similarly GIC sold an A-grade Sydney office tower to Chinese billionaire Hui Wing Mau for A$390 million, having paid A$230 million for the building in 2005.
The common wisdom is that GIC has disposed of these assets to concentrate on North Asia, but Quigley at Cushman and Wakefield wonders if “some investors view the Australian market as nearing a peak and it is time to offload”.
Pause for thought
GIC’s moves certainly gives pause for thought and raise questions about whether a bubble is forming.
In August, Moody’s took the bold step of downgrading its outlook for Australia’s banking system to negative for the first time since 2009.
“We think the operating environment is deteriorating,” Mirenzi said. “Economic growth isn’t uniform across the country, wages growth is very low and the big banks have around 65% of their loan books exposed to the property sector. This has the potential to drive up bad debts in the short term.
“For many years price rises and developer returns have been driven by an undersupply of housing, but with the amount of supply coming onto the market in the next two years, we may see oversupply in some areas,” Mirenzi said, pointing to the pipeline of A$65 billion in new apartments.
The oversupply is expected in pockets, namely in Sydney and Melbourne – which unsurprisingly is where the Chinese are most active.
Many of the country’s largest developers are reliant on apartment and office sales to drive the bulk of their earnings and pre-sales are used to secure the finance needed to proceed with building. A significant drop in pre-sales could spell disaster for construction companies as banks ask them to tip more equity into their projects.
“At the end of the day the property market is built on confidence,” Mirenzi said. “Borrowers need to be confident they can meet their repayments and confident asset prices will continue to rise.”
The housing market is now so highly leveraged that even a small decline in house prices or interest rates could have a lethal impact. The gross debt-to-income ratio for households with a mortgage has reached a record high of 300%, well above peaks in countries where property bubbles have burst, such as Ireland, Spain and the US.
Mirenzi believes a correction will come when people feel less secure about their jobs. National unemployment figures look low at 5.7% but they mask a disturbing increase in the number of full-time jobs being replaced with part-time or casual contracts. “Underemployment is trending towards 9%, which means people aren’t getting the amount of work they need to meet expenses,” he said.
A steady rise in mortgage delinquency rates – particularly in mining-dependent states such as Western Australia and Queensland – shows what can happen when people lose their jobs. All four major commercial banks reported increased credit impairment charges in the first-half, reflecting a 6.2% jump in 90+ day delinquen-cies to A$9.3 billion.
Similarly, office vacancy rates in Perth and Brisbane are running at 20% and 17% respectively, so when Quigley talks about a shortage of prime office opportunities, he is really only referring to Sydney.
The other risk on the horizon is the chance that China experiences a severe financial crisis in the next few years forcing a widespread liquidation of offshore real estate holdings. With so many volatile factors driving the Chinese investment train, it would be unwise to assume that demand for Australian property stock is stable or can be relied on to mop up an oversupply.
“Nobody really knows how the Chinese will behave if there is a massive correction at home,” Quigley pointed out. “We can hope that foreign institutional investors are here for the long haul but there is no guarantee.”
