Australia | Sep 04 2009
By Andrew Nelson
Hooray, the banking sector is on the road to re-capitalisation, credit spreads are narrowing and it seems that China is rebounding. These facts plus an increasing flow of actually positive (not as bad as it could have been) data from economic markets around the world has many now hoping the worst is already, or at least will soon be, behind us and that 2010 will mark the start of a brand new cyclical upswing in global economic growth, and by extension, investor risk appetite.
At least so think the economists at ANZ’s Property and Financial System team. It’s not all balloons and streamers though, as the head of property and financial system analysis, Paul Braddick, points out there are still some significant hurdles that need to be cleared and risk still abounds in what continues to be an uncertain market place.
However, Braddick is starting to think that the massive global policy response is starting to gain some real traction and the complete global meltdown (that was going to be far worse than the crash of ’29) is now slowly appearing in the rear-view mirror. Since March, global credit spreads have narrowed, equity markets have rallied and financial markets around the world are well down the path of putting things back together.
So while the team at ANZ is of the opinion that global GDP will continue to decline in 2009, at least forecasts for 2010 have been revised up substantially over the last few months.
It almost turned into a cliche over the last year, the claim that Australia will remain at least somewhat insulated from the worst of the global turmoil. Drum-beaters, like the team from ANZ, have spent the last twelve months pointing at Australia’s strong financial sector, sensible lending practices and the quick and substantial policy response from Canberra. But what started as a cliche looks to be proving itself as a truism (the difference being that a cliche doesn’t have to be true, but a truism, no matter how overused, does).
In fact, Braddick goes so far as to say that the Australian economy has been remarkably resilient, as not only has it defied the ravings of a hundred Chicken Littles, but it has also remained one of the only major, developed economies that managed to avoid technical recession. But he seems savvy enough not to lay all of this at the foot of Canberra and the banks, as Braddick rightfully acknowledges the lucky fact that the resilient domestic housing market and the relative financial strength of those who live in their own houses, is the main reason for Australia’s outperformance of the world.
Remember, it all started in the US and it began with tumbling house prices and falling household wealth. Without these two issues we may have never known that Americans were borrowing too much, to pay for houses that cost too much, that really couldn’t be afforded, so couldn’t be paid for, which cast a cloud of doubt over the securitisation of mortgages, which is the banking industry’s lifeblood, so banks went out of business or stopped lending, which saw global credit disappear.
Braddick thinks the wheel has turned and while noting his aforementioned warnings about not getting too excited too soon, he thinks the relatively subdued recovery that is expected may come sooner than many believe. In Australia, household spending is picking up due to lower debt service costs, Canberra’s open wallet and what has turned out to be an “extraordinarily resilient labour market”.
Taking a look north, and Braddick points out the recent reversal in Chinese fixed asset investment and industrial activity, which opens the door for real prospect that commodity exports and prices will keep performing. This would underpin a resurgence in major mining project investment, which would help lift the two key segments of the Australian economy aside from the Banks out of the doldrums. Wouldn’t it be nice to start seeing higher pricing for BHP and RIO, or some good news for Leightons?
Along with consumer sentiment, business sentiment is also on the mend and with underlying inflation remaining stubbornly high, the Reserve Bank is now shifting its policy rhetoric. It looks like for now, interest rate cuts are off the table and with the economic picture looking like it is settling, the Reserve Bank says it has chosen to focus on getting monetary policy settings back to “neutral”.
This has got the market pricing in rate hikes from November this year, with 200 basis being the even money bet by the end of 2010. But Braddick believes this might be a little too aggressive, instead thinking the Reserve Bank will be a little more light handed out of fear that it could stifle the still sputtering upturn in the economy. In fact, the team at ANZ expects only 100 basis points of official interest rate hikes between February and November 2010.
Still, we are around the bend and the beginning of the upswing in the cycle will soon provide an improving backdrop for commercial property markets, says Braddick. With risk aversion receding, he notes that we are already seeing a lift in sales activity below $30m, with the run of recapitalisation over the past few months reducing the risks at the upper end of the market. Braddick admits the industry will continue to struggle with rising vacancies, falling rents and the lingering difficulties with the cost and availability of credit, but he sees the property market as beginning to struggle forward, not backwards.
Yet while the Australian commercial property has insulated itself relatively well over the past year, with most of the problems in the listed sector due to the reliance on excessive gearing to generate investor returns, there has been some damage. Braddick and ANZ Senior Economist Ange Montalti note the composite commercial property index fell 13% in the year to the June quarter, which pulled values back to late-2006 levels.
It could have been worse, though, notes the pair, if not for the aforementioned overall resilience of the Australian economy and the financial strength of Australian property market stakeholders. This support minimised the level of forced transactions, which in turn protected the broader commercial property market from fire sales that would have pushed prices down across the board.
Even the listed property market is pulling up all right after taking an early crisis bath on falling asset valuations that left entities geared and saw distribution policies slashed to keep what money there was left in hand. But the last nine months of tough capital management and the last few months of balance sheet rebuilding is now meeting up with a rebound in investor appetite. This has lifted equity valuations significantly and combined with lower costs and lower leverage, the spectre of forced property sales is diminishing. This, say Braddick and Montalti, should limit further downside to asset valuations.
This upbeat view on the AREITs is underpinned by the team’s view of commercial property in general. As while the two note that rising incentives and falling rents do pose an ongoing risk to market valuations, they see yields as unlikely to deteriorate much further. So while Braddick and Montalti admit it will be a while before we see the good old days and yes, fundamentals will weaken in the years ahead, it will be nothing like what was seen in the early 1990s.
The key differentiator between the current cycle and the late 1980s to early 1990s is the relatively subdued supply response that we’ve experienced. This is best evidenced in the non-residential building share of GDP. Sure, very low office vacancies and solid rental growth in Brisbane and Perth in recent years drove a renewed surge of development activity, but this influx of money into commercial property markets all but dried up during the GFC.
And this problem still isn’t resolved and the pair expects access to finance will remain a lingering headwind for commercial property for the foreseeable future given the CMBS market is still effectively closed. The roll-over of existing debt facilities also presents further downside risks for prices, given there is still tightness out there, which presents the prospect of higher financing costs.
That said, Braddick and Montalti feel that the above issues will become less of a problem, because even the financiers will be increasingly reliant on investment in the property market. So that market’s underlying fundamentals need be strong in order to assess and support project viability. So while we’re not free and clear just yet, the two feel that there is certainly some light at the end of the tunnel for Australian commercial property.
