Archive for the ‘Property’ Category

Does house price crash follow unemployment or is it the other way?

Wednesday, June 8th, 2011

One of the most common idea floating around in Australia is that as long as unemployment rate does not spike, mortgage defaults will not rise and consequently house prices will not crash from mass foreclosure selling.

That idea, taken in isolation, is self-evidently true. But is it logically correct to leap from this idea and jump to the idea that as long as the tide of unemployment holds low, there wouldn’t be a housing crash in Australia?

To answer this question, let’s take a read at this interesting article from MacroBusiness,

Australian banks pretty much only know how to lend against property. From time to time they rabbit on about lending against cash flow, but the truth is they do not have the skills. They vanished in the 1990s when merchant banks started disappearing. ?Investment banks are just financial tricksters fiddling with assets. As we see with Macquarie?s fate, they do not know how to invest in real businesses that achieve steady growth from serving customers.

There has been a sharp rise in business credit for SMEs since the mid 1990s, which pretty much tracks the property asset bubble.?In 1996 it was about $13 billion, two thirds of which was secured against property. By 2008 it was $63 billion, 75% of which was secured against property. In 2010, it fell to $56 billion. Again, about 75% is secured against property. About two thirds is secured against residential property.

This level is high by developed world standards. According to the World Bank,the average for developed economies is to have 56% of SME loans secured against property.

Banks are still lending, but mostly only where the loan is fully secured by tangible assets and personal guarantees (and, in some cases, key man insurance). Where there is an existing loan, banks are requiring additional security. Members stated that lenders were no longer prepared t provide finance on ?soft? security ? such as cash flow or good will (unsecured finance) ? as had been available pre-GFC.

In Australia, residential properties underpin much of the collateral for SME loans. The implication of a decline in house prices is the reduction in the value of the loan collateral. That will result in a tightening of credit. A precipitous decline in house prices will result in a credit crunch for SME. A credit crunch for SME will result in cash-flow problems, which in turn will result in mass layoffs (i.e. higher unemployment). A decline in house prices will also sap away consumer confidence via thewealth effects, which in turn will drain consumer spending out of the economy, which in turn will result in high unemployment in the retail sector.

So, the first round of impact from falling house prices will be rising unemployment. That will feed into the second round of impact of lower house prices, which in turn lead to further rising unemployment. This will feed into the? third round of impact.

Also, falling house prices can happen at the margins. You don’t need a mass selling panic to trigger a fall in house price. As we wrote inSpectre of deflation,

One thing many people fail to understand is that values of financial assets can vanish as easily as they are created in the first place. It is a fallacy to believe that just because money has to move somewhere from one asset class to another, the overall valuation in the financial system cannot contract. The very fact that all the money in the world cannot buy up all capitalisation is proof of that fact. This leads us to the next question: how do financial assets derive their value?

As we mentioned in The Bubble Economy, we have to understand the principle of imputed valuation. Suppose you have a house which you bought for $100,000. What happens if one day, your neighbour decide to sell his house (which is similar to yours) for $120,000? When that happens, your house would have to be re-valued upwards to $120,000 even though you had done absolutely nothing. The same goes for stocks. All it needs for a stock to increase in value is for a pair of buyer and seller to transact at a higher price. As long as the other shareholders do absolutely nothing, that higher price will be imputed into the values of the rest of the stocks. Thus, when asset values rise, all it takes is a handful of them to trade at higher prices in order for the rest to be re-valued upwards. If assets can ?increase? in value that way, it can ?decrease? in value that way too.

To put it simply, credit drives house prices, which in turn drives credit. Falling house prices will drain credit, which in turn pushes down house prices.

Thinking of shorting Australian house price?

Tuesday, May 10th, 2011

Recently, we received an email from one of our readers:

Just wondering if you’d like to touch on possible investment ideas for hedging australian real estate?

I’ve had a look at puts on the banks before but the banks have mortgage insurance along with an implied guarentee from the gov so I was thinking that while their may be some correlation, it may not be as high as one would like when the chips are down.

As such any other possible hedging ideas would be appreciated, ideally it would have to be highly leveraged to act as a suitable hedge.

Looking at other places that suffered a debt/property collapse with a low housing supply may be a good place to start? (UK?)

Today, we will talk about this topic. We haven’t talked about Australian property for quite a long time. But you can read through our old archives and know where we stand on this topic. Also, please take note that nothing that is said in this blog should be construed as financial advice. Instead, we are just voicing out our ideas and suggestions for discussion and brainstorming. With that disclaimer, let’s dive into it.

It is no secret that Australian house price is heading for stagnation at best and a crash at worst. Even the most optimistic forecasts from the vested interests call for stagnation. Already, house prices in Perth have been falling for over a year already. There are reports of rising supply of homes for sale while at the same time, demand is weak and auction rates are weakening.

So, if you reckon Australia is heading for a house price bust, what are the ideas for shorting/hedging Australian house prices? Since there exists no financial instruments that can short Australian house prices directly, we can only do so indirectly through the side-effects of falling prices.

First, before we run off to take up short positions, it is helpful to envisage a few possible scenarios:

  1. Professor Steve Keen sees that we are facing a scenario whereby house prices fall 40 percent in nominal terms over a period of say, 15 years. That’s basically the Japanese scenario whereby the housing bubble deflate with a slow hiss. In this case, the fall in prices will be so slow (a few percent a year) that it becomes almost imperceptible.
  2. A rapid fall of say 10-15% followed by slow deflation.
  3. A big crash of say, 40-50% in a short period of time, say a couple of years.

In the first scenario, there is nothing much to short. The economy may be able to muddle through in stagnation for a very long time.

In the second scenario, the banks will suffer heavy losses but they will probably survive. The obvious idea is to short the bank shares. In this scenario, we can imagine consumer spendings will be depressed as well. Therefore, shorting retail related stocks is another idea. Property developers and builders will be shorting candidates as well. In this scenario, we imagine that the AUD will be weak as well, as the RBA will have to cut interest rates.

The third scenario will be the nightmare scenario. Such a precipitous fall in house prices will put the Australian banking system in serious trouble. For one, since property is the most popular collateral for lending in Australia, a house price crash will result in a credit crunch. As you can see what happened in the United States during the GFC, a credit crunch result will ultimately result in rising unemployment, which will in turn will feedback into a second round of effects into the economy through more mortgage debt defaults. If the entire banking and financial system falls into deep trouble, we will likely see an AUD currency crisis (see Will there be an AUD currency crisis?). In this scenario, we will not even bother to short Australian banking stocks. The financial and economic situation in Australia will be unpredictable and volatile. As we wrote in Protecting yourself against currency crisis.

Personally, we feel that the best way to protect yourself from a currency crisis is to leave the country before TSHTF. If not, stock up some physical cash (both foreign and local), physical gold and silver (see our book, How to buy and invest in physical gold and silver) and supplies- these will tide you over while the sh*t is hitting the fan. For the longer term, you may want to move some of your savings overseas- you may not be able to use them in the midst of the crisis, but when it is all over, the local currency may no longer exist (e.g. you may have to convert the old currency to a new one at unfavourable rates).

Even if the AUD is to survive, we may witness rising interest rates as the RBA sought to defend the AUD from speculative sell-off.

Now, some people may ask, what if the Commonwealth government bail out the banks? Will that avert a crisis?

The problem with this question is that the word “bail out” is too vague. Does that question ask whether the government will bail out depositors? We imagine the government will do that. But does it mean that the government will bail out depositors and bank bond holders? Or even better still, will the government bails out depositors, bank bond holders and bank stock holders? Obviously, the more stakeholders the government bail out, the more expensive it is going to be. Will the government be able or willing to fork out that much?

With that, we turn to our readers. What are your thoughts and ideas?

How the government rip you off with hidden taxes when you go shopping

Sunday, December 19th, 2010

In Australia, one of the major secular trends that is happening is the growth of online shopping. More and more consumers are discovering the joys of bargain hunting through the Internet, thereby bypassing the traditional bricks-and-mortars retailers in the local shopping malls.

One of the pet complaints by Australian retail businesses is that they are unfairly burdened by the need to pay GST. Australian consumers avoid GST by buying from overseas web site. Worse still, the strong Australian dollar makes overseas products even cheaper.

So, is GST really the root of the problem for Australian retailers who find themselves increasingly unable to compete with foreign web sites?

Well, let’s hold a thought experiment. Imagine that all the goods at your local retailers are reduced by 10% (which is the GST amount). Will that make your local retailers more competitive than their overseas online competitors? Will that make you switch from buying from overseas web site to your local retailer? If the answer is “No,” then it means that we have a structural problem in Australia.

For one, consumers are complaining that the range of products sold by our local retailers are too small. In other words, they can’t get what they want locally and therefore, have to shop in foreign web sites to get them.

More importantly, many goods sold by foreign web sites are very much cheaper than identical ones sold at your local shopping mall, even after you include shipping costs. For example, when you compare the prices at your local Dymocks bookshop and Book Depository, you will find that the latter is much cheaper (by the way, if you shop at Book Depository through our link, you will help us and help yourself financially). That means that even if the government can somehow enforce GST on foreign online retailers, our local retailers will still bleed.

So, if you accept the theory that this is a structural problem, what could it be? Recently, we found this very interesting comment that may possibly answer this question,

How can local retailers compete with overseas retailers when their operating cost here are significantly higher than overseas. The biggest single cost, after labour, is commercial and retail rents, which are at least 50% higher here than overseas … this is reflected in the price of the goods.

The enquiry should centre around why retail rents have skyrocketed in Australia, and why the institutional property owners force retailers and small business to pay extremely high rents. Try starting a small business here when you have to pay $200- $400 per sq metre in suburban Sydney, yet in the US, the same premises rent out for $50 – $150 per sq metre.

The Government is complicit in that it has a vested interest for property values to be as high as possible to ensure the land tax revenues keep coming in … Australians are being taxes artificially at all levels in the community .. from the goods they buy to the cost of electricity .. behind all of these costs are hidden government fees.

So, this is another example of unintended consequences of the property bubble in Australia.

Reserve Bank of Australia (RBA)- property spruiker?

Monday, October 4th, 2010

In page 12 of the September issue of the Reserve Bank of Australia (RBA)’s Financial Stability Review, you will find that this chart is presented:

Graph 21-Dwelling Prices

Graph 21-Dwelling Prices

According to Alan Kohler, one of the most prominent financial talking head in Australia, this chart shows that

Australia has not had the biggest rise in house prices in the past 8 years, New Zealand has

So, what’s wrong with this analysis? The answer can be found on the last paragraph of page 18 of How To Foolproof Yourself Against Salesmen & Media Bias.

Is the RBA spruiking property? Well, take a read at this paragraph in this article:

So who are the people most likely to snap up investment properties? Interestingly, it appears that Reserve Bank officials are the keenest investors in rental properties. ?We are not sure whether to be relieved or concerned that of the five central bankers who were brave enough to note their occupation on their tax form, all five had an investment property!?, the report says. ?Of the 200 occupations classified by the Australian Tax Office, the employees at the Reserve Bank topped the list with respect to their investment property exposure.?

What do overseas property investors see that Australian property investors don?t?

Thursday, August 12th, 2010

Foreign investors are getting spooked by the ?perky? Australian property market, according to this article:

Overseas bank investors are becoming increasingly jittery about Australia’s housing market. Bank analysts are fielding calls from overseas-fund managers about the sustainability of a surge in prices over the past year.

So while Australian property investors celebrate increasing prices, overseas investors are getting wary of an overheated market.

In Australia we have been inundated with theories regarding restricted supply, immigration, lack of land release, low interest rates and any number of other ?fundamentals? to explain the continued rise, and possible sustainability of Australia?s property market.

But are we exposed more than we realise?

According to this article, Australian banks are increasingly exposed to the cost of foreign sourced credit:

Australian banks now finance much of their lending from offshore because our national thirst for credit outstrips our collective ability to fund it.


The nightmare scenario goes something like this: International investors refuse to extend our banks credit at a reasonable price. This forces the banks to pass on additional costs to their customers and, in some cases, refuse credit. These tight credit conditions could squeeze property developers and highly-geared property investors alike. Many developers would be forced to offload housing stock quickly- by reducing sale prices – to raise cash to repay their loans as they fell due and/or cover the increasing costs of their debt.

Overseas property investors will be acutely aware of the value of the Australian dollar, as their investment will be bought and sold at a relative exchange rate. They will need to understand the current and future Australian dollar trends and risks.

But local investors are not encouraged to look into global economics. In fact, the level of financial education in Australia (and perhaps a large portion of the world) is unfortunately weak. Instead of being a ?smart country?, perhaps we are only the ?lucky country? after all. Will an external shock end our run of luck?

So, what do you think will happen to the Australian property market? Vote below and tell us what you think!

Another biased media report: home loans on the rise?

Tuesday, July 13th, 2010

In our report, How To Foolproof Yourself Against Salesmen & Media Bias, we wrote about how the media uses headlines to slip in their bias.

Well, here is a great example from this article in the Sydney Morning Herald (SMH)- Home loans on the rise:

The number of home loans issued to borrowers have marked their first rise in eight months are buyers looked beyond higher interest rates to wade back into the market. In a sign of caution, though, the size of a typical loan shrank.

In an another article from the SMH- Home loans up for first time in eight months:

A WEAK spot in the property market is showing tentative signs of recovery, after a surprise bounce in new lending to home buyers.

The headlines from the Daily Telegraph isn?t much better.

Despite the positive spin in these headlines, there?s a little detail that caught our eye. What is it?

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China: gigantic property bubble in the midst of exploding supply of vacant brand new homes

Thursday, May 13th, 2010

Today, we planned to continue from our previous article (Will a crashed Chinese property market lead to an embrace of gold? Part 1- Chinese characteristics of property market). But one of our readers, Paul, emailed us a couple of very informative comments (which we’ve posted on the comments section of that article). With his comments, we feel that we have further points and observations to add, which requires a separate article. Please note that our observations of the Chinese property market are made from the point of view of a foreigner, which may not be entirely accurate or correct. So, please feel free to correct us if we are wrong.

In Paul?s second comments, he wrote

Personally, I find it amazing that they would not want to have a tenant in the apartment and collecting rent on their investment, but no, most private landlords look only at the long term capital appreciation.

To add to his comment, we have some interesting observations that may perhaps explain such strange behaviour in China’s property market. You see, in Australia, when you buy a brand new home, it is mostly done up (e.g. complete with kitchen, oven, tiles) and ready to move in. In China, brand new homes are usually ‘raw’ (e.g. no tiles, concrete walls)- you need further renovations before that home is ready for moving in. Obviously, landlords cannot rent out ‘raw’ homes because they are unliveable. That’s where the Chinese mindset differs- if the ‘raw’ home gets renovated (so that it is ready for moving in), that ‘raw’ home is no longer ‘brand new.’ As our reader said,

… it is very difficult to negotiate deals in the secondary market or rental market.

Once a home loses its ‘brand new’ status, it loses value and goes to the secondary market. Given that the secondary market is extremely weak in China, it explains why Chinese property speculators rather keep their apartments ‘raw’ and un-renovated than to renovate it and rent it out (unless the rent is high enough to offset the loss in value).

Furthermore, we guess that the domestic rental market in China must be very weak because of the “account” system. In Chinese cities, families must own an city residency “account,” which qualifies them for government services, school enrolment, etc. The “account” is defined by the address of your owned home. The implication is that if you sell your only home (and consequently, have to rent another home to stay), you lose your “account,” which will be very disadvantageous to you. That probably explains why the rental market seems to be non-existent in China (except for foreigners and maybe for migrant workers who don?t have their own ?account? anyway). These characteristics explains why in China, there can be a gigantic property bubble in the midst of exploding supply of vacant brand new homes. It is very similar to what we wrote in Why oil cannot function as currency reserves?

Then the demand for tooth pastes will rise to the moon, not because the demand for oral hygiene increases, but because the demand for tooth-pastes as money increases. Not only that, no matter how much tooth-pastes Colgate produces, there will always be shortages because there will be mass-hoarding of them as money.

That is the consequence of monetary inflation, which undermines the store-of-value function of money. When residential property takes on the store-of-value function, the result is a gigantic price bubble in the midst of over-supply.

In the next article, we will continue the story from the previous article. Keep in tune!

P.S. Paul has this comment regarding this article:

Your comments about the condition of the home or office when sold new are true.?? For homes however, it is more usual to dress them.?? For offices, no.

But I want to pick up on your second part.?? By “account” I assume you mean “hukou”.?? If so, your facts are wrong.?? It is not based on the address of your owned home, but on where you were born.?? The original purpose of the hukou was to identify and control peasants.?? A person’s hukou identifies
whether they are a city person or a rural one, and is based on the province in which they were born.?? My Chinese wife was born in Xinjiang, but her parents came from Anhui and Henan.

Every Chinese citizen has a hukou.?? Rural migrants coming into the cities to find work still have a hukou.?? But it identifies them as being not from the city, making them ineligible for social security, schooling or other benefits.?? People with hukous from outside a city can buy property in that city.??? But the vast majority can’t afford to, because they are rural migrants looking for work.

One more point.?? Anecdotal evidence, but I present it just the same.?? My Chinese friends, and indeed my wife’s family, all wonder why I rent instead of buy.?? If possible, Chinese people will buy, as they see renting as a waste of money.??? They would rather scrape together the money from the family to buy a modest place than to rent.?? By the way, my wife’s brothers
own their own homes here in Beijing, despite them all having Anhui hukous.

If I may make one final observation, based on the work I do here.?? In a falling market, the Chinese will stay away in droves.?? They much prefer to wait and see how far it will fall, before making an investment or purchase decision.?? I consult to the global primary aluminium industry, and I see the same thing when it comes to raw materials.?? Any hint of softness in
price will cause the Chinese to stop buying.?? Conversely, any hint that the price is set to rise, and they will rush in.?? Hence why the Shanghai index has such wild swings.

Will a crashed Chinese property market lead to an embrace of gold? Part 1- Chinese characteristics of property market

Tuesday, May 11th, 2010

In our previous article, What if China crashes?, we wrote,

? the Chinese government seemed to be getting really serious about cracking down on property speculation, even to the extent that it is giving the impression that it wants the property bubble to burst.

Will the Chinese then rush to gold should their government succeed in cracking down in property speculation? To answer this question, we must first understand some things about the Chinese mindset on property and investments. Currently, interest rates in China are pathetically low- so low that they are below the price inflation rate. Because of their currency peg, the People?s Bank of China (PBOC) is constrained from raising interest rates (see Can China raise interest rates to control its property bubble?). Also, the Chinese are known to be savers.

So, that creates a problem. Imagine you are a typical Chinese saver. What if you want to save and the cash at bank is yielding returns that are below the rate of price inflation? That results in a very great disincentive to save your money in the bank and pushes you to ?invest.?

The next question is where can you ?invest? your money? Remember, a lot of other people are facing the same problem because the Chinese government?s policy of force feeding credit into the economy is creating a gigantic rain of freshly printed money- a lot of people are having too much money on their hands. Unfortunately, in China, with its underdeveloped financial system, there is not much avenue to ?invest? your money.

The range of financial instruments in the stock market is limited. There are hardly any derivatives available for you to short the market (but currently, stock index futures are on the trial phase). Not only that, the standard of disclosure and reporting has too much to be desired. Most average mum and dad stock investors in China can only take long positions on a stock market that is highly volatile and speculative (due to lack of disclosure). No wonder investing in stocks is not that popular in China.

Thus, the only investment outlet for this mountain of freshly printed money is the property market. There are a few characteristics of the Chinese property market that most foreigners will not know. Perhaps these characteristics explain why the property bubble in China is so enduring.

Firstly, the Chinese property bubble is definitely bigger than the property bubble in Australia. But you may be surprised to learn that the consumer leverage in the residential property market in China is in fact smaller than Australia. In China, you need at least 40% deposit to qualify for a mortgage loan. As Patrick Chovanec wrote here,

According to the latest statistics I?ve seen, approximately 50% of all residential purchases in China today are financed with mortgages, which are mainly provided by the big state banks.  That?s a sharp increase from just a few years ago, when nearly all such purchases were made in cash.  In theory, the rules allow 30-year mortgages, but anything longer than 20 years is rare, and the presence of high prepayment penalties tend to push buyers towards mortgages with even shorter terms (our own mortgage was, believe it or not, 3 years, which is more like an instalment plan!).

A lot of residential real estate transactions in China are made in cash!

Secondly, the secondary market for residential real estate in China is extremely weak. As Patrick Chovanec wrote here,

What we see in China, though, is an extremely weak secondary market.  In the U.S., the ratio of secondary to primary residential property transactions for the first half of 2009 was 13.45; in Hong Kong it was 7.25.  In China as a whole, that ratio was 0.26 (four times as many new home purchases as secondary sales).  Even in China?s most developed markets the ratios were just 1.30 for Beijing, 1.56 for Shanghai, and 1.35 for Shenzhen.

If you combine these two characteristics together, you can conclude that a lot of real estate purchases in China are made with relatively little borrowing (or none at all) on brand new homes. As a result, the Chinese are, as Patrick Chovanec wrote,

? in that sense, the people using real estate as a store of value, a place to stash their cash?

That explains why there is a lot of idle and empty apartments in China as more and more of them are being built by property developers.

But the fact there is relatively little consumer leverage in the Chinese property market does not mean that there?s little leverage in the property sector. In China, the leverage is placed on the shoulders of property developers. In other words, the Chinese property ?investors? are de-leveraging the developers!

Now, what if the Chinese government succeeded (whether accidentally or deliberately) in smashing the store-of-value function of property? We will go into that in the next article. Keep in tune!

Interesting chart: Number of home loans vs Size of home loans

Thursday, March 11th, 2010

Today, we will show you a few interesting charts.

The first chart is this:

Number of loans vs Size of loans (Total)

Number of loans vs Size of loans (Total)

It shows the total number of home loans and the size of loans. As you can see, from September 2009, the number of loans crashed, but the size of loans still remained in a steady up-trend.

Now, let us break it up the numbers into First-Home-Buyer (FHB) and non-FHB:

Number of loans vs Size of loans (FHB)

Number of loans vs Size of loans (FHB)

As you can see, since the doubling of the First-Home-Owner-Grant (FHOG), the number of FHB home loans surged to a record high. But still, the size of loans still remained in a steady up-trend

Number of loan vs Size of loan (Non-FHB)

Number of loan vs Size of loan (Non-FHB)

For the non-FHB, it is clear that the total number of loans remained in a down-trend despite the surge in 2009.

There is a common characteristic among these 3 charts: despite the number of loans declining, the size of loans keeps on growing.

What do you think this means?

Yet another real estate spruiking by mainstream news media

Thursday, March 4th, 2010

Today, as we look up the Sydney Morning Herald (SMH), we saw yet another blatant attempt at real estate spruiking. The offending article reported,

It’s a figure to break the hearts of first home buyers: Sydney’s median house price is inching towards $600,000 – almost double what it was a decade ago.

The subliminal message to prospective home buyers is clear: buy property now before it is too late.

The article reported that ‘wherever’ you look, the supply of housing is low and prices are going up. Then it picked a few locations here and there and sought the opinions of real estate agents (of all people) as examples to ‘prove’ that point.

Really? Is it really ‘wherever?’

If you read the comments below that article, one person wrote,

I just did a quick search on the Internet for properties available in Upper North shore Sydney and found over 200 in about 5 seconds. How this counts as a shortage I’m unsure… If there is a shortage wouldn’t it be hard to find a place?

Indeed, this is journalism on the cheap. Get a median (while conveniently leaving out the details and context), spin a story by taking the biased opinions of a few real estate agents located in a few places and then hope that readers will fall for the story through a mental pitfall called lazy induction.

We have one comment about the median. For those who are initiated, the median is obtained by lining up all the sale prices in ascending order and then pick the one right in the middle.

There are two facts about first home buyers:

  1. They tend to go for the lower end of the market.
  2. Since the first home-owner grant was phased out in 2010, first home-buyer activity declined significantly.

These two facts implies that sales are skewed towards the higher end of the market. That means the median figure will move upwards by definition. Conveniently, this basic analysis is omitted from the SMH article.

It’s bad enough to read cheap journalism. It’s worse to read cheap and biased journalism. We wouldn’t be surprised if the real estate industry is one of their biggest advertisers.