Frank Gelber looks back over an interesting period in the history of property markets in Australia, and concludes that an upswing is coming.
At the risk of alienating those caught up in the course of events, I must say that, as a forecaster/researcher, I haven’t had this much fun since the 1980s boom and 1990s recession. I’ve learnt a lot. Perhaps we all have. Some think that everything will be different now. I don’t. Some things will change. Most will not. Certainly, we’ve seen a clean-out of the financial engineering gearing logic that caused most of the problem, both here and overseas.
The idea was to generate a cashflow that washed its face with yield above interest, and gear it up to improve the return on equity. And gear up we did. Loan-to-value ratios (LVRs) escalated dramatically with the active participation of banks. All of a sudden a given company could spend a lot more on property. And strong returns attracted more equity. At the time, many complained that there wasn ‘t enough property in Australia to place available investment. Some went overseas. The problem was that the sheer weight of money caused prices to overreact. “Yield compression” – that was the name they gave it at the time – saw yields overshoot. Property was overvalued. The financial crisis wasn’t an isolated negative shock to the market from which we will gradually recover. The financial crisis triggered a correction following the excesses of the financial engineeringdriven boom.
Greed turned to fear, both in debt and equity markets. Banks sought to reduce gearing but, for a long time, were locked in. The super funds – the only ones with enough equity to replace debt – went cautious and stayed away. Yields blew out, prices fell. The market panicked. Now, the extreme pressure on the whole market that we all felt last year and early this year has passed. Some have fared better than others. The larger listed property trusts (LPTs) have been able to go to the market for equity, easing pressure on gearing and, for some, placing them in a position where they can once again start to invest. Other listed funds have not been so lucky and remain cash constrained. The impact on valuations of wholesale and retail unlisted funds and syndicates, too, has eased. But the valuation lag is hitting them now. And few have access to significant additional equity. The cleanskin syndicates are in a better position.
The whole market is still experiencing a shortage of funding, curtailing development and, incidentally, ensuring a strong recovery once demand returns. In retrospect, it is easy to see the mistakes we made in succumbing to analyst and investor pressure to gear up, to get rid of “lazy balance sheets” and to forget the old-style property logic. It was a crazy time. Actually, we knew it and still found it hard to resist. Now it’s back to basics for property. This is a time when we need to be clear and to differentiate between property issues and outcomes in different markets, finance issues in both debt and equity markets and vehicles for property investment. It’s interesting to recall that last cycle, in the 1980s, Australia’s superannuation funds owned most of the institutional grade property. For many, property formed a significant proportion of their portfolios – in a number of cases, around 30 per cent.
When the bust came, there was no liquidity – they couldn’t sell. I remember that many wanted to sell after the property crash. It was too late – the horse had bolted. Those that hung on made extraordinary returns in the subsequent recovery. It was the super funds that then built up the LPTs, now real estate investments trusts (REITs), who now own most of the institutional grade property in Australia. And the super funds are the major investors in LPTs. The price of liquidity was volatility. And once again the instinct has been to run after the horse has bolted. But for me, the risk is at the top of the cycle, not near the bottom. The softening of yields and the fall in property prices has taken much of the risk out of property investment. This time is not like the last cycle. We don’t have the oversupply. I can see the light at the end of the tunnel for property markets. Certainly, there are differences by sector and by state. Some markets have further to fall.
And we need to be careful about that. But the irony is that the financial crisis did us a favour in Australia by pulling the rug out from under development before we had a chance to significantly oversupply markets. Meanwhile, debt is still trying to withdraw and equity is still sitting on the sidelines. Is it understandable? Yes. Is it sensible? No. Residential recovery has already begun and construction is being constrained by finance. Retail cash flows remain solid. Office markets in Sydney and Melbourne, where there is little oversupply, will recover with the economy in 2011. Rents will need to rise to levels sufficient to underwrite replacement cost before we can build. And we’ll need finance.
But recovery is not far away. Yet the major players remain hamstrung, unable to take advantage of the opportunity, with many forced to divest when they should be investing to set up returns three to four years hence. Only now are some starting to take positive action. And in the vehicles themselves, I suspect we’ve thrown out the baby with the bathwater. Most of the listed vehicles have businesses stapled to the property trust. Some commentators think they shouldn’t. The market isn’t valuing the business. That’s not sensible. All this will sort itself out when property markets start to recover. Equity will return. Debt finance will return. The businesses will show positive returns. Property investment is fraught with opportunity. There are differences between prospects for markets and players. But there’s a great opportunity. We just need to work out what markets will look like in the next upswing when the financial crisis has passed. Sure, it’s different this time. But the same logic applies.
