Bill Zheng has just sent out a very interesting article on his take on the property market.
Here is an extract:
Link to the full article together with some great graphs - http://info.investorsdirect.com.au/...90277&Token=22C7F6FA04E711D7F179C33A2B178E98E (I understand this has my 'EmailId' in it, although I don't know how to link to it any other way).
Would love to hear peoples views on this.
Here is an extract:
If you examine the first diagram carefully, you will see a strong correlation between residential property prices and finance:
* The money supply of Australia has gone up by average 10% a year, so has residential property prices growth in the same period;
* Finance (credit) for Australia (foreign debt) has gone up by an average 13% a year, so has the total return (growth + yield) of properties if you take away tax manipulation. (For those who care to dig deeper, this is because our foreign debt has to absorb the yield from properties because Australia has no cash flow as a country. All the cash flow generated within our economy is represented as debt at the country level). This also proves that a nation’s wealth is best represented by residential properties.
If you agree with me up to this point, then the key for property prices to continue to go up like before is whether we can continue to borrow money from overseas at the same pace we have been able to achieve in the past.
Imagine you are the person running the Australia family and you are forced to borrow more money from the international lending community each year. In your loan application you would have to write:
* Our family has had negative cash flow every year, because we consume more than we produce.
* Half of our family doesn't work and we have virtually no savings.
* We have been relying on borrowing new debt to pay old debt and living expenses for the last few decades.
* Oh by the way, our LVR is already above 60%, thanks to your generous lending over the last few decades, but if you continue to lend us money at the same pace, we will run out of equity very soon.
* While we have no idea how we can ever pay back your debt, we really can’t survive without more loans from you.
* Could you please not worry about it for now and just lend us the money one more year?”
I don’t know whether everyone would find this loan application amusing. But I can tell you that most sane finance professionals will find it very much so! ;-)
I know some of you think that we are only 65%LVR as a country, why wouldn’t the international lenders let us run our debt to 80%LVR like our residential property?
The short answer is that the larger the debt, the lower the LVR, this is just a general lending principle. For example, you will be hard to borrow 80% on a $5Million house, let alone a $1Trillion one. In my view, 65%LVR would be our limit as a country, and if we continue along our current trend we will reach 65% in 2009!
So the bad news is that the credit line Australia’s property growth so relies on is about to be drawn to its full limit. Australia will be forced to pay down its debt, and there will be less finance available to property buyers. At the very least, the pace of growth for finance will drop.
So if this happens, our property prices will be negatively affected at the national level. Obviously there are still better performers in different locations, while some may drop further than average, others may hold up quite well or even rise against the trend. (I will focus on finance and leave this to Residex to tell you more about this in our November seminar series. To find out more about these events click here).
We have been a lucky country, there are a few positive elements in our financial structure that US doesn’t have, and we have been given extra time to get ourselves prepared, but we shouldn’t take this for granted. We should make the most out of them ASAP.
* The foreign debt of Australia is mainly from the private sector, our government hasn’t borrowed much. When we reach 65%LVR as a country from a private sector’s perspective, international lenders may not want to lend us more money unless the government steps in to borrow. This is very similar to providing a personal guarantee from the government.
* If the government steps in to borrow, we may have more time to run our credit line as a country, and property prices may not need to fall immediately. But you have to remember the problem is still there, we are just given more time:
o The US is a sad example for Australia if we go down this path.
o The US has a huge foreign debt problem just like Australia; their government has also borrowed to the hilt, not just private sector.
o The US government and financial institutions are forced to take extra risk in obtaining debt from overseas to keep things going, they even put their worst borrowers (the sub-prime borrowers) on to help secure the country’s debt.
o The sub-prime borrowers in US are just the weakest link that got broken first, they are the victims of their foreign debt problem.
o The fact that we don’t have sub-prime issue here doesn’t change the fact that we have the same problem source as the US. So everyone be warned, somewhere someone will be the weakest link that may be broken here in Australia, if our foreign debt problem continues.
* Our interest rate still has a few percentage points to cut. This can hold our property prices for a little longer. We are in a much better position here than the US. They do not have much room left to move with their interest rates.
* Our big 4 banks are all AA rated. There are only 14 AA rated banks in the world and we have 4 in Australia.
* Our deposits are guaranteed by the government. This will hopefully avoid any unnecessary domestic pressure on our banking system.
* As a last resource, Australian government can always sell some assets such as natural resources to pay down our debt, or use our fiscal surplus to buy us a bit more time.
Right now, the biggest threat to Australian property prices is not our domestic economy, which I believe is reasonably healthy. The biggest threat is actually coming from the global financial market; it may be too much for our government to handle if the following deadly combination happens too quickly.
This deadly combination is that:
* international lenders pull money away from our market because of their own problems (similar to your lenders recalling your mortgages to meet their own commitment), and
* the slow down of global demand for our exports which we rely heavily on paying our foreign debt (similar to loss of income).
If this happens, I am very much certain that property prices won’t hold up well in many areas of Australia.
Link to the full article together with some great graphs - http://info.investorsdirect.com.au/...90277&Token=22C7F6FA04E711D7F179C33A2B178E98E (I understand this has my 'EmailId' in it, although I don't know how to link to it any other way).
Would love to hear peoples views on this.
