GM:AR

13 July 2012

The Collapsed and Collapsing Property Market

Housing, Commercial and Retail
The Housing Market
On 9 July The Age reported extensively on Melbournes worst-kept secret, that there are tens
of thousands of unsaleable properties in Melbournes outer suburbs, with lots of property
values having fallen well below the amount owed to banks, i.e. their owners now have
negative equity. Unlike the United States, the structure of our housing loans means that the
owners are trapped in this debt situation long-term. For many it means that their dreams of
aggressively reducing their mortgage and then trading their equity in their first home for a
home in a better serviced suburb has either disappeared or has been postponed for many
years. That has knock-on effects through successive tiers of the market. Melbourne is far
from unique. House prices have fallen across much of Australia.
Key Advice
If upgrading your home under these market conditions it is vital to sell your existing
home first, then buy. Even in prestige suburbs, prices have fallen quickly and
dramatically. There are terrible stories of those who bought first and have had to
accept a vastly lower price for their old home than they had planned upon.
Residential Rental Units?
Over the long-term, these have generally proved to be mediocre investments, albeit that for a
time the real estate bubble which preceded the global financial crisis suggested that they
merited investment. However, the vital fact that many investors miss is that rental demand is
far more elastic than that suggested by either property spruikers or economic forecasters. To
put it simply, in good times the population spreads out and in less certain economic times the
population crowds together. Examples are:
a. Some immigrant families crowding together in a single dwelling to save rent; or
b. Young people staying at home in the spare bedroom at mum and dads for a year or
two longer rather than moving into a rental unit because of uncertainty of
employment; or
c. People who in good times own both a home and a holiday house by the sea but who
in uncertain times restrict themselves to one dwelling.
Rental vacancies have now become apparent in suburbs where house or unit for rent signs
never appeared previously; the local agents always having a waiting list of tenants to fill
them.

There is no magic formula or ratio of houses to population. The ratio varies substantially
according to economic conditions; or perceived economic conditions. Thousands of people in
the retail industry are fearful of losing their jobs because of the closure of other retail
businesses and reduction in sales volumes due to internet shopping. Those people are not
bidding up houses at auction or trading up smaller houses for larger houses, or
contemplating purchasing a beach house. There are powerful psychological factors involved
in the housing market.
The housing market in Melbourne is terrible, and it is likely to grow worse before it turns. The
property market on the Gold Coast is terrible and is likely to remain depressed. The high
Australian dollar means that overseas tourists arent coming to the Gold Coast, and
Australian tourists find it cheaper to go to Bali or Fiji. There are lots of similar stories around
Australia, notwithstanding the odd bright spot.
Leisure Accommodation
Right now, holiday accommodation as in beach houses, snowfields accommodation or tree
change properties are overhanging the Victorian market in large numbers. Similar situations
exist in other states. Nor have we seen the bottom of these markets. For many owners, these
types of assets are non core. Their core assets are their business or professional practice
and their family home. If uncertain economic conditions threaten their businesses, non core
assets flood onto the market. In other words they prioritise the security of their home and
their business above their leisure assets.
Commercial Property
A steady stream of companies reducing staff numbers in head offices, together with the odd
company going into liquidation or administration is creating vacant space in Melbournes
CBD. Inevitably similar effects will occur in Sydney. Its not fashionable these days to have
plush head offices, and it is fashionable to shift a lot of formerly head office functions into
austere suburban accommodation. A peculiar problem with CBDs is that the virtually
unlimited approval to build higher buildings means that there is actually greater scope to
over-build at the centre of our cities, and periodically substantial surplus office space
emerges.
Retail Property Investment
Last year we advised clients to sell discretionary retail stocks as in David Jones, Myer, JB HiFi, Harvey Norman, Premier Group etc as they were under attack from internet shoppers.
That genie is out of the bottle. Large shopping centres are now adept at hiding vacant space.
If you look closely youll see large floor to ceiling advertising signage appearing in shopping
centres which is actually disguising vacant space behind them. Borders, Angus & Robertson
and Colorado Group are in liquidation. Dick Smith Electronics is being restructured (closing
stores) by Woolworths preparatory to selling off the remnants of the business. Retravision
has toppled. Darrel Lea has gone into administration, probably because other retail failures
are reducing foot traffic in shopping centres. Premier Group, which owns a variety of branded
fashion stores plus Just Jeans etc, is rationalising its outlets, i.e. closing some. The message
is that Westfield and Stockland retail shopping complexes which have traditionally had the
power to force tenants to pay high rents now face inevitable emerging pressure to reduce
rents in the medium term or have a lot more vacant space hidden behind advertising
signage. The internet has changed some parts of retailing forever.
The short term outlook for Westfield and Stockland remains profitable because of the
structure of rent rises built into their existing leases, and the majority of their tenants will
survive. However, in the medium to longer term the weakened demand for retail space will
lead to tenants, particularly those tenants with significant bargaining power, demanding much
more favourable rent conditions at lease renewal.

Shopping centres smaller than those owned by Westfield, Stockland etc are visibly
struggling. In a small shopping centre, it is virtually impossible to disguise shops that are
vacant.
Disastrous Advice
It has become fashionable for real estate agents and spruikers desperate to sell property to
explain how easy it is to gear the acquisition inside a sub-trust inside your superannuation
fund. Bank lending officers striving to increase their portfolio of loans, the amount of which
ultimately determines their salaries, also jump on this bandwagon. Its appallingly bad advice.
The success of gearing depends upon the rate of inflation and the marginal tax rate of the
borrower. At present, economic conditions are squeezing the life out of inflation, and
whereas a personal borrower might have a marginal tax and Medicare rate as high as
46.5%, a superannuation fund has a maximum tax rate of 15%. Gearing properties into
superannuation funds with low tax rates and during periods of low inflation rates is simply an
appallingly bad strategy. To make it worse, the falling property prices have chilled capital
gains.
To a significant degree, over-building and property speculation pre global financial crisis was
fuelled by a combination of first home buyer grants from both state and federal governments,
which in some states and at particular times amounted to over $30,000 together with no doc
loans. No doc loans were an open invitation for borrowers to misstate aspects of their income
or assets. The global financial crisis has blown that environment away, and properties must
inevitably fall significantly to align with more realistic market conditions.
Undisclosed Long-Term Costs
Worse still is that stringent audit requirements in self managed superannuation funds means
that the inclusion of geared property inside sub-trusts creates significant increased annual
audit expenses which will stay with the fund on a long-term basis. The real estate spruikers
and bank lenders dont tell you about that.
In summary, this is a bad strategy which should be avoided.
Overall Verdict on the Property Market
Nobody rings a bell at the top of a market or at the bottom of a market, but the evidence
suggests that substantial portions of the Australian property market have a long way to fall as
yet.
Personal Disclosure
The only property the Middletons own is their home.
Best wishes.

Graham Middleton
Director
Synstrat Management Pty Ltd
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Synstrat Management Pty Ltd is the holder of Australian Financial Services Licence No: 227169.