Robert Gottliebsen - Australian housing under attack
October 2010
http://library.westpac.com.au/securities/2010/securities-october2010/articles/article07
Don’t you feel good? The ASX 200 is up 2% for the month and the Australian dollar is powering ahead. In fact, sharemarkets are up around the globe and most currencies are up, except the US dollar.
But today I want to take you into a less pleasant part of the world, to meet the global speculators who are combing the world looking for markets to short. Last week I was in Sydney when I discovered that a week or two earlier several US speculative fund groups had come to Australia looking for ways to short the Australian housing market. Yes, the housing market. By now most of us are familiar with predictions that Australian house prices are about to slump because it is now much more expensive than in many other comparable countries. The Economist, among other publications, has issued such dire warnings about the state of our market from time to time. These traders were inspired by hedge fund legends such as John Paulson and Michael Burry, who made a fortune out of shorting the US property market.
The “house shorting” process in America was relatively straightforward once pioneers like Burry arrived on the scene and worked out they could bet against prices rising by shorting the synthetic securities that underpinned the housing market. Here it is much harder. The traders that came to Australia didn’t find a way to short our housing market because we simply are not funded in the same way as the US. They have apparently come up with a number of alternatives. The first is to short the banks, which obviously have enormous exposures to Australian property. The second way was to short QBE, which has significant interest in mortgage insurance. But neither of these methods give them the pure exposure to Australia’s housing market that they want and, frankly, it would take an enormous amount of capital to mount such a raid. From what I can tell, they went home disappointed but these are serious traders and it is worth taking their reasoning seriously.
Their argument can be very easily boiled down. They believe that Australia, just like the US, developed ways to enable people on low incomes to buy houses. The Americans did it with no-deposit housing loans that had low interest rates for the first few years. Australia did a similar thing via government grants that enabled first-home buyers come up with the deposit. On top of this, buyers enjoyed very low interest rates because at the time the Reserve Bank was stimulating the economy. Since then we have substantially raised interest rates and plan to increase them even further. We’ve also stopped most of the subsidies, so new buyers who will now need to find a lot more capital for a deposit. Banks are taking a tougher line as they calculate how much they are prepared to lend, based on the new higher interest rates, which are also squeezing people out. Of course, we do have a shortage of housing so there is a pent-up demand but some of that demand is being satisfied by people who are living in more cramped quarters, thereby increasing the living intensity in our existing housing stock.
All those who claim to be experts on what the Reserve Bank is going to do (and I don’t claim to be one) say that it will lift interest rates at least another half a percentage point, possibly more, over the next six months. At the same time, banks are facing higher overseas borrowing costs and are planning their own additional interest rate rises to meet those costs. Many people who bought houses with the help of the first-home buyer’s grant are really struggling because they didn’t anticipate such a big rise in interest rates. They have kept their jobs but rising mortgage payments mean they are having to cut back on other spending. If the market is right about higher interest rates, then those first-home buyers are going to be put out on the streets in a similar fashion to the subprime home buyers in the US, although on nothing like the American scale. So the speculators reasoned that if they could short the housing market and, as a safeguard hedge their position so that they also made profits if interest rates did NOT rise, then there was considerable potential to make money.
One could have added that apartment values in Melbourne and Sydney have been maintained by heavy Chinese buying, which has now virtually stopped because of the rise in the Australian dollar and the possible rise in the Chinese yuan, which is currently aligned with the US dollar. If the Chinese stay out of the residential market and rates rise as predicted, then I think there is truth in the conclusion that some dwelling prices could fall. I don’t believe it will be a rout, but it could be a fall of 10–20% in some areas. We are certainly seeing an ugly event looming in Surfers Paradise. There are two towers, Soul and Oracle, which are now coming up for settlement. These are luxury towers and there is a limited market for this sort of thing in Australia. It has been reported that many investors who paid deposits will not take up their presale agreements and forfeit their deposit. Many never intended to buy the units, but planned instead to sell their entitlement before payment was due.
Surfers Paradise is a resort area that thrives on the building industry. Following the collapse of local financiers such as City Pacific there has been a substantial reduction in the amount of funds available for properties in the area. Banks are also less inclined to lend more money. With less building taking place many tradespeople have moved elsewhere. If Surfers Paradise properties fall well below the cost of building, it would be worth looking hard at buying in. Facilities for the commute to Brisbane are now greatly improved and a National Broadband Network will provide better communications and cut down the need for travel. But for now there is no need to rush into the Surfers Paradise market because it may have further to fall. I don’t think Australia is headed towards a substantial catastrophic fall in house prices because, apart from Surfers Paradise and some isolated regional areas, we don’t have a substantial build-up of stock but we could have a period of extended softness in the housing market if interest rates and the currency keep rising.
Self-managed superannuation funds don’t find it easy to be big buyers in the housing market because it is very cumbersome (but not impossible) for super funds to borrow to buy houses. If the housing market falls we could well see more products developed to give self-managed super funds exposure to the residential housing market. Because self-managed funds now represent a third of the superannuation investment market they are now taken much more seriously than ever before. I regard my own residence as simply part of my lifestyle and I don’t treat the recent increase in value as a profit because I would have to outlay a similar amount on replacement housing – and stamp duty on top of that. For now, those who want to invest in the housing market do not need to hurry unless they see a unique or unusual property with great potential. But if there is a fall in the market then those who want to buy investment housing may have a great opportunity on their hands.
'Big Short' on Aussie banks 'will take years' if true, JPMorgan says
Date March 4, 2016
Vesna Poljak
Global interest in a "big short"-style bet on Australia's banks in anticipation of a housing collapse has been challenged again after an investment bank warned clients the trade has always been a "widow-maker" and "will continue to be".
A widow-maker is what hedge funds refer to as a risky trade that leads to huge losses. Mr Tepper argued that Australia's banks are lending money into a housing bubble and foreshadowed up to a 50 per cent plunge in property prices. For hedge funds, the most obvious way to play the trade is to bet the price of bank stocks will fall.
Short positions in the Big Four banks increased following an explosive report by Jonathan Tepper, an economist at Variant Perception, and Bronte Capital chief investment officer John Hempton. Mr Tepper and Mr Hempton's research struck a chord with investors, causing a sell-off that would reward short-sellers. On Wednesday, banks rebounded with the strongest gains this year after a surprise windfall for the Australian economy: it is growing faster than anyone thought, at 3 per cent a year. There were other factors at work too, as global markets flipped to "risk-on" mode, supporting a rally in bank stocks which are still in bear territory. And another take on the housing bet did the rounds via a report titled Debunking the Australian Housing Bubble View by JPMorgan's head of hedge fund sales in Sydney, Sujit Dey.
"The only way house prices crash is if rates go up suddenly and/or unemployment increases materially. Either of these two scenarios will take years," said Mr Dey. His report, which is not part of the bank's equity research and was seen by Fairfax Media, "is a 101 note for those that already live here but I thought it would be of interest to my offshore clients"."Shorting the Australian housing market has been a widow-maker trade and I think it will continue to be the case," he said. Mr Dey detailed all of the ways in which the Australian financial system is structurally different to other jurisdictions with the aim of restraining a sub-prime style meltdown. One of Variant Perceptions biggest criticisms was directed at the upswing in interest only loans, the implication being that Australian property is so expensive that borrowers can't afford to meet repayments on the principal, even at record low interest rates. Well documented angst around housing affordability supported this thinking.
I cannot see a 50pc price crash
The counterpoint, in Mr Dey's view, is that such loans are mostly a byproduct of widespread negative gearing incentivised by the tax system. "The shorts think interest-only loans are a Ponzi scheme but they don't understand why people use them. People don't use them because they cannot afford the principal. "They use them to get maximum deductibility as well as flexibility," he said. Capital gains tax exemption on the primary residence is another way the tax system has helped one's home become "one of the best investments possible in Australia".Full recourse loans, no culture of "honeymoon" discount interest rates and the distortive effect of offset accounts on national debt figures were other reasons he cited.Further, high loan-to-value ratio lending has declined, and "low-doc" lending for troubled borrowers represents only a small part of the market, he said. Mr Dey referenced Mr Tepper's highlighting of the experience in Moranbah, a coal town where the median house price is down 66 per cent in three years. "But what would you expect in a mining town? I'm sure this is the case across all mining towns globally whether it is Western Australia, Texas or Canada. We all know that these mining towns were bubbles but you could argue they have already burst," he said.
Faith in consummer
The broker emphasised his faith in the Australian consumer, saying they are in a strong position, and results from the profit reporting season proved this. "Now I'm not saying Australia will not see a decline in house prices. All I'm saying is that I cannot see a 50 per cent house price crash. My view is we could see a steady 5 to 10 per cent move down due to the oversupply in apartments and tightening lending standards." The Reserve Bank of Australia commands the highest cash rate in the developed world, so "if banks raise rates, I'm sure you will see the RBA cut. Not many developed countries have this luxury". Mr Dey is not the only person who disagrees with the theory of the "big short", though it is no surprise that the property and lending industries have emphatically defended their territory. Mr Tepper later suggested critics of his view were "brain dead" but denied he was seeking a high profile, just "trying to write things as I see them".