East coast property to go boom boom boom

Chief Investment Officer and founder of Aitken Investment Management
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Moody’s is the latest offshore commentator to join the chorus singing for caution on the Australian property market. But most of the comments on Australian property from offshore people are very generic and really don’t understand the nuances of the Australian property market or how mortgages are granted in Australia.

They don’t understand that the Australian cultural psyche is you will pay your mortgage under any circumstances, no matter what. Our “property correction” was property going sideways for about five years.

If there had been a massive overbuild then I would be worried but at the moment there seems to be no oversupply, there seems to be undersupply and I continue to be bullish on East Coast residential property prices and a new home construction/ renovation/mortgage credit cycle.

I believe the rise in the Australian household savings rate is temporary. It is a post GFC/minority Government household “lack of confidence” reaction and unlikely to be maintained. It also coincides with a period of relatively flat median property prices for the last five years. My view is when it becomes more obvious to the average Australian that property prices are rising and the return on unfranked cash is being crushed in real and nominal terms, they will revert to their traditional form of tax free saving known as “property”.

In the medium-term, I believe the household savings rate will drop to around 5.00% in the years ahead. However, it’s worth noting in periods of previous residential property booms it has actually gone negative as FOMO (fear of missing out) became contagious.

Local demand

Australia is also in a period of strong population growth with household formation increasing. The Australian population is growing by 1000 people per day.

Due to a decade of chronic underbuild the rental markets remain tight. Rising rents and rising property prices, when combined with 53 year-low interest rates, push the buy/rent equation in favour of buy. Further pushing the buy/rent equation in favour of buy is affordability, where 53 year lows in interest rates have seen debt servicing ratios as a percentage of after-tax income drop to around 35%.

This is starting to dawn on the population with the “Time to buy a dwelling index” on its way to pre GFC highs.

Auction clearance rates are trending higher – and reached 80% in Sydney on the weekend (see here for our regular analysis of clearance rates).

International demand

But the missing piece of the residential property price and new property construction cycle has, until recently, been the Australian dollar bubble.

The bursting of the AUD bubble is extremely positive for Australian residential property markets. Australian property just became 15% to 20% cheaper in global dollars (particularly USD pegged Asian dollars) and we are all underestimating what that means for foreign investor demand and also, importantly, demand from Australian expats looking to return home with their families. It’s worth remembering over 1,000,000 Australians live/work overseas and the currency has previously kept many of them overseas for longer than they anticipated.

Real estate agents tell me that inquiries from Australian expats have “gone through the roof” since the AUD fall and foreign investor inquiries are also up sharply.

The Government’s overarching principle is that foreign investment in the housing sector should be into activity that directly increases the supply of new housing. There are rules that relate to new dwellings, vacant land, redevelopment, temporary residents and foreign companies providing housing for Australian based staff.

Additionally, there is also a new 888 significant investor visa, which allows you to do whatever you like if you are approved and invest $5 million in an approved security (usually State Bonds etc.). Only two have been approved so far and another 300 odd have been invited or are in the process of being potentially approved. This 888 significant investor visa will have more effect on the super high end of the residential property market, but high end price rises do drive psychology in the broader residential property market, as they get plenty of press attention. In January, I forecast that high-end residential property would rise up to 15% this year, and while very hard to quantify, I believe that forecast is broadly on track judging by the volume of high end sales and prices. I also forecast median prices to rise 5 to 10% and I think that forecast is also broadly on track with half the year gone.

For the vast bulk of foreign investors wanting to invest in Australian residential property the only option is a new dwelling. This bodes extremely well for developers, but particularly those who focus on high-density apartment complexes within 10kms of a CBD.

Major bank mortgage LVRs

It’s also worth noting where major bank average loan to value ratios (LVR’s) start as we head into higher residential property prices.

ANZ: Average LVR at origination 65%, average dynamic LVR 52%

CBA: Average LVR at origination 48%E, average dynamic LVR 49%

NAB: Average dynamic LVR 52%

WBC: Average LVR at origination 69%, average dynamic LVR 48%.

Dynamic LVR = current balance/current valuation and the lower the better.

The best play

I continue to believe the Australian mortgage banks are the equity way to play the coming residential property price and residential home construction boom. As I have written numerous times, they are financial cyclicals and their rising profitability leads to rising fully franked dividends, further enhancing demand for their equity in a domestic world of structurally rising compulsory superannuation contributions.

Where I differ from other strategists is on the medium term. While I strongly believe the boom part of the mining and mining investment cycle is well and truly over, on the other side of that I believe an East Coast property led boom is starting. I also believe that property boom will be assisted by monetary and fiscal policy accommodation aimed squarely at the residential property cycle.

ANZ, CBA, NAB and WBC remain core members of my high conviction buy list ™, while BOQ and BEN also look good medium-term investments to my eyes. I note the credit ratings agencies are also coming around to a positive view on BOQ.

The chart below of the ASX Financials Accumulation Index (XFJAI) and the ASX Metals & Mining Accumulation Index (XMM) shows the post GFC total return performance has crossed and financials continue to widen their outperformance of miners. This is the equity market attempting to tell you the Australian GDP growth baton is being handed from mining and mining services to the East Coast property sector. We are going back to the future.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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