Jul 03 2018Add to Favorites
Maslows Hierarchy of Needs theory and real estate investment.
Real Estate is often the talk at dinner or a BBQ, the great debate about what the residential property market is doing, what house or apartment sold for, what price was achieved and who paid it.
Everyone has an opinion and yet is always keen to learn more because the fact is that the Australian $7.6 trillion residential property market impacts all of us. As Maslow so rightly identified, our most primitive or basic needs include a roof over our heads, whether we are homeowners or renters.
Currently, 52% of our household wealth is held in residential property and there are more than 465,000 sales of residential property made every year, with a total transaction value of just under $300 billion.
Maslows theory suggests that further up the hierarchy, psychological needs drive achievement and independence through investment and creating a portfolio of wealth, but fundamentally this also ties into those base needs. Especially as we age and stop working, the most primitive of needs is ensuring financial security and quality of life long term.
A significant amount of the inflows of Chinese capital to Australian real estate has been driven by this basic need and although the inflows may be less overt recently, the inflows are certainly still happening.
Australia is fortunate to enjoy an outstanding quality of life and this is something that culturally, we have come to expect. We have incredible government support for our elderly, in the form of medical benefits, financial support and tax concessions on superannuation withdrawals.
What’s interesting is that the aggregate Australian superannuation $2.5 trillion has a fairly low exposure to real estate. According to a report by Jones Lang Lasalle, Australian superannuation has approximately 10% exposure in total and that 10% broken down into a ratio of 60% direct property, and 40% via REITs (Real Estate Investment Trusts) and other indirect unlisted real estate exposure.
Of the approximately $2.5 trillion total pooled Australian superannuation, about $700 billion is made up of individual Self-Managed Superannuation Funds (SMSF’s), and this segment has only a 19% exposure to real estate in total.
Wealth and real estate.
Private family office wealth has traditionally included real estate as a core part of a diverse investment portfolio. In Australia, the top 200 single family offices had a total wealth of $267 billion as of June 2017. Analysis of the group shows that more than half have made their money in property and finance, according to Deloitte’s, Australian High Net Worth Study.
What I find really exciting is that according to the Australian Financial Review, the number of individuals with net assets of $40.5 million or more has grown by 85 percent in Australia over the past decade to 2016. That number is expected to grow an additional 70 percent by 2026 which highlights that opportunities are available for active investors.
Interestingly, analysis by Core Logic has illustrated that approximately two million people in Australia own one investment property, or around 8.0% of the population and only 80,000 people (0.5%) own more than four residential investment properties. This would indicate that out of our population of 25 million, most of the residential asset exposure is people owning the homes they live in, with an unidentified number still renters. The question is, is just owning your own home enough exposure to the Australian real estate market to see you through retirement? And how much do we need to invest to be able to live life comfortably when we stop working?
Restrictions on new supply emerging.
With the exceptionally strong growth in all real estate sectors in Australia over the last decade, investment in residential real estate specifically has become prohibitively expensive for those looking to enter the market, for both a roof over the head or investment. This dynamic has been driven over the past years by the cheap availability of debt, strong national economy and the overall supply-demand fundamentals that underpin our residential housing market, namely, lack of new quality supply in core growth centers and demand driven by population growth lead by high levels of immigration.
However, over recent years, planning bodies have been more responsive to these limitations and have moved to improve supply in a number of key markets, but particularly Melbourne, Sydney, and Brisbane which have experienced high levels of construction and a run in supply.
The combination of cheap debt, undersupply, strong population growth, low unemployment levels and positive economic performance has provided a buoyant market for house prices. However, it has also lead to low wage growth, high levels of household debt and an interest rate sensitive economy, which could be susceptible to a downturn once interest rates start to increase.
In response, regulators have moved to ease some of the heat out of the housing market through a combination of tighter regulatory controls on foreign ownership and lending practices by banks. Aggressive regulatory scrutiny by APRA and the Royal Commission initiatives have markedly increased the standards of responsible lending and has imposed higher lending costs on investors. This has lead to a reduction in the availability of debt for buyers seeking mortgages, thereby reducing demand.
The impacts of the regulatory restrictions are already being felt. We are seeing reductions in development funding as a result of the tighter credit conditions, local Councils have been and are continuing to resist further planning approvals out of concern over lack of infrastructure to accommodate the population growth and losses in local amenity and character. Despite a surge in first-home buyer lending since mid-2017, there is a decline in overall mortgage lending as buyers remain cautious.
These changes have led to cooling values in most major markets over the last 12 months, with Sydney, in particular, seeing prices fall by approximately 4% over the last 12 months, with predictions of a further 5% to come over the balance of 2018.
However, these reductions in prices are predicted to be a cooling in market conditions, rather than an overall slump as curtailing demand will also lead to a reduction in supply bringing the forces back into some type of equilibrium.
Over the last 10 years, our population has increased by approximately 380,000 on average or 1.6% growth per annum which is one of the highest global growth rates.
Without reductions in the rate of population growth, the ongoing underlying demand for real estate remains, once any surplus in supply is absorbed, we expect to start to see a return to price growth. In fact, Core Logic-Moody’s Analytics is forecasting modest recoveries in most markets in 2019 on the back of ongoing demand.
Credit markets and property market cycles.
Taking a snapshot of the residential market right now, it’s the upstream supply of new stock currently under construction, the reduced availability of traditional mortgage bank credit to buy property, as well as the diminished availability of traditional bank credit to fund new supply that is causing downward pressure on pricing. However, this is also restricting new supply to the market. How and when the major banks come back into the market remains to be seen, but we are confident in the long-term fundamentals, which we believe are primarily underpinned by our strong reliance as a nation on immigration of skilled, tax-paying working population.
Fundamentals underpinning demand for residential real estate.
What does all of this mean? And why are we so confident in Australia's population growth? Well, Australia, like many other developed nations, has a problem on the horizon with its aging population ratios. As a country with a population of 25 million, which for the past decade has been growing annually by almost 400,000 people per annum, we have a current working population that is (barely) sufficient to pay enough tax to support the 14% of the 25 million that is over the age of 65 years. In just a few years’ time according to Australian Bureau of Statistics (ABS) data, our population is going to be 52 million and 25% of that 52 million is going to be over the age of 65.
Our government already has a deficit issue. In last year’s 2017 budget, about a $4 billion improvement was made in this deficit from the collection of corporate taxes also and most notably from cutting social support and spending.
With the most recent budget announced just a few months ago, there has been some commentary on how improvement on the deficit is going to be made from the collection of personal taxes, however, the labor market remains highly competitive and we are only just starting to see fragile signs of wage growth. Key top three anticipated revenue segments from the 2018-19 Federal Budget include individual income tax $222.9 billion, sales taxes $72.1 billion and non-tax revenue $34.1 billion.
Looking into the future it is apparent that the convergence of the aging population and working populations occurs at about the time my generation reaches retirement age, which prompts a scary thought: “When we are over the age of 65 are we going to have the kind of medical, financial and superannuation concessions that we see offered today? And; “Is our government going to be able to afford to offer this support?”.
One thing that is clear to me is a slowdown in immigration or population growth may have serious consequences for the wider economy. If the government stimulates inflows of skilled, tax-paying migrants it means we will be more crowded, yes, but it also means that there should be sufficient tax-payer dollars to support future generations as they age.
Some sectors of government see this important issue on the horizon, with recent NSW Government treasury reports estimating that Sydney alone is forecast to grow by about 100,000 people a year, bringing us to 10 million by 2030.
What this means is that although there is a constriction in the real estate debt markets right now and buying a home or residential investment property is harder, the balance will be restored as future growth in population continues to underpin demand.
The big numbers.
Interestingly there are only about 10 million residential dwellings in Australia, to house a population that is currently at 25 million and growing at about 400,000 people a year.
The total value of Australia’s residential real estate market is estimated at $7.6 trillion, with $1.76 trillion in outstanding mortgage debt (~23%), implying the remaining homes are unleveraged.
So, the residential sector is worth $7.6 trillion, the commercial real estate sector is worth $0.97 trillion and by comparison, Australian listed stocks are at about $1.8 trillion. Based on these numbers it is surprising the small allocation that real estate as an investment class receives when it comes to what we see as one of our most valuable investment platforms, being superannuation.
(These are all figures from CoreLogic's most recent housing market update for June 2018.)
SMSF and real estate.
As mentioned previously SMSF’s account for close to $700 billion of the $2.5 trillion Australian aggregate superannuation funds. The circa $700 billion SMSF capital is split across approximately 695,000 individual funds with an average of about $1 million in each SMSF fund.
Only about 19% of this pool of SMSF capital is invested in direct real estate (as an overall asset class) and less in residential real estate, only about 2%. We see this as largely being due to real estate having higher barriers to entry when compared to equities, attributable to its higher entry price point, entry taxes (stamp duty) hence less opportunity for diversification. There are also quite a few hoops to jump through when obtaining debt to buy property through an SMSF.
We see opportunity at MP Funds Management to gain diversified exposure to syndicated real estate investment, which means essentially that you get exposure to a range of institutional-grade real estate assets at an achievable level of exposure for an individual and across various real estate sectors, including residential development, commercial offices, mixed-use, retail and industrial.
We intrinsically see the residential market as having long-term strength on the back of our strong population growth, despite short-term cooling. We are very much pro-residential development and we are currently working with several institutional non-bank offshore financiers to provide more sophisticated and commercially-minded funding solutions for developments of high quality and well-located residential housing in and around Sydney CBD.
Sydney CBD growth.
Specifically, we are excited about the medium to long growth in Sydney CBD across all real estate asset sectors, with the $64 billion upgrade and injection of government, local and foreign capital into key areas to improve transport, infrastructure, and amenity. The evolution of Sydney as a global destination is incredibly attractive. The new metro-rail link is popping up in key locations in Sydney CBD replacing what were previously commercial office towers and continued price-record-breaking residential apartment sales prices in Sydney CBD and surrounds continue to show confidence from locals.
Just as recently as last week, Australian-Chinese developer Aqualand announced their $10.5 million penthouse sale at Blue at Lavender Bay, fronting the north side of the CBD Sydney Harbour, which broke pricing records for the area. The other penthouse in the development sold for about $9 million just a month ago, again breaking pricing records for the area. Both sales were brokered by CBRE.
Landream’s Opera Residences is under construction and due to complete in about the third quarter of 2019. Sold by CBRE, and located on Macquarie Street, fronting at Circular Quay, at c. $96,400 per sqm the penthouse sales broke all price records for Sydney. The Australian-Chinese-buyer acquired one of the penthouses for $26m as well as two of the sub-penthouses for family members, with a combined price of about $31m. Just a few days later, the high profile Salteri family acquired the other penthouse in the development for $27m, the whole of the Opera Residences sold off the plan in a weekend.
Although the market has cooled since these spectacular apartments were sold off the plan in late 2015, the buyers are of the segment of the market that does not rely on external mortgage debt and will settle on their sale on completion of the project, which proves the value of the prices that were paid.
The completion of the light rail, due in about 2019, will close off George Street and recharacterize the area into vibrant and world-class pedestrian mall-way. Goldfields House at 1 Alfred Street, another billion-dollar- project, has changed hands from Dalian Wanda to Yuhu Group for delivery and re-launch to the market. There is also AMP’s Quay Quarter residential and ground floor retail development, where the penthouse, sold by CBRE, to a local high net worth buyer for $17million at Loftus lane on Bridge Street. This is currently under construction and also fronts onto Circular Quay, where a $2bn redevelopment of the foreshore has been announced. Australia’s largest developers are pitching for the tender against global groups like Malaysian Setia, Dutch BAM, Canada’s Brookfield and more.
With 35 million customer trips every year, Circular Quay is one of Sydney’s major transport interchanges. It is also one of Australia’s most visited destinations and a major contributor to Australia’s $126 billion tourism industry. There are currently about 50 million visits to Circular Quay precinct every year and that figure is forecast to grow by more than 40 percent to 81 million by 2041.
There is $3.7 billion of development and infrastructure that is already taking place south of Circular Quay.
Australia’s biggest residential landlord.
Again, another interesting point, despite recent fear of a residential property crash and constant talk of falling house prices in Sydney over the last year or so, Harry Triguboff's wealth (the owner of Australian property development company, Meriton and number two in the BRW Rich List) still increased $1.34 billion in 12 months to about March 2018. He has an estimated wealth of $12.77 billion. Triguboff, who owns a rental portfolio of around 7000 apartments, is the richest of the 51 property personalities that dominate this year's Rich List, worth a combined $86.2 billion. Those figures compare with 58 people worth $78.9 billion in 2017.
Harry’s urban myth.
There is a story about Meriton’s early days that I love; in the 70’s’s a major global banking institution had funded Meriton’s rapid growth and held the debt on the Meriton development portfolio. The bank needed the borrowed money paid back quickly due to some unforeseen trouble it was experiencing. This put a lot of pressure on Harry, his family and his business, he eventually repaid the bank in full over a period of time. As a result of the pressure he experienced in that situation, Meriton significantly reduced their reliance on bank debt and have grown bigger and stronger as a result of the experience.
As the legend goes, Meriton (almost) never used bank debt moving forward and evolved the business model to use primarily equity. I love this anecdote because it’s reflective of pressure creating change to improve. What doesn’t kill us makes us stronger.
Much like our real estate debt markets right now, there will be an adjustment phase as the banks pull back for a period. This will ultimately result in a stronger Australian economy; the $7.6 trillion residential real estate market will continue its exponential growth over the long term, our population will grow because it needs to, and everyone will have a roof over their heads and a solid investment portfolio because they need to.
The market will evolve, driven by the underlying supply-demand fundamentals, the primary of which being it’s a basic human need to have a roof over our heads and a safe place to invest money for the future.
We really love retail property at the moment at MP Funds Management because we see opportunity in the disruption. Australia’s population is growing, our living is getting denser and whilst the advent of online shopping is creating change in the sector, human behaviour causes us to gravitate towards food and entertainment. Whilst some of the retail tenants may be outmoded or a centre underperforming as a result of this evolution, it’s fair to say that well-located and underperforming CBD- located centres, which have a strong demographical catchment area can be turned around with some TLC and well thought out repositioning.
November analysis released by both UBS and Macquarie Bank highlight that potential buyers have become very cautious and expect prices to fall further. Both reports highlight that whilst borrowing capacity has declined, most borrowers don’t borrow at their maximum. The RBA recently showed that relatively few households would have been constrained by the tightening in lending standards over recent years.
Each of the primary property investment sectors, residential, commercial office, industrial warehouses, retail shopping centres has an investment cycle and a market cycle. Its useful to have the ability to move across sectors so that when one isn’t performing so well, others which are performing better can be capitalised on. Also, investing across sectors can build up diversification.
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