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Australian population growth and the residential real estate market

Invest / Development Finance

Jun 15 2018

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Keeping focus.

At MP Funds Management, we are constantly searching for the opportunity to extract as much value out of the market as possible with as little risk as possible. 

We are consistently sharpening our focus to define where the investment edge is and how to achieve the best risk-adjusted outcome for our investors.

In addition, what we pride ourselves on at MP Funds Management is that everything is aligned. Our fees are aligned with our investors receiving their equity and returns first and then we get the majority of our fees based on how we have performed. 

What I am investing in personally.

I also personally love investing in property, be it residential, commercial, retail or any property asset class {as either debt or equity} that has strong underlying fundamentals. 

I love the way that (unlisted) property behaves because its predictable and you can price in the risk. There is a level of control from the outset and a limited number of risks that you can mitigate and make an educated judgment call on. 

I recently co-invested some of my self-managed super fund money into one of the investments MP Funds Management made last year, which was the acquisition of a 15,500sqm office tower in the CBD of Sydney located at 9 Hunter street.

MP Funds Management’s investment was an equity co-investment and a non-bank institution provided the senior debt to buy the property. The property was 98% leased to great quality tenants, providing immediate rental cash flow, with about a 5% annual yield flowing into my bank account on a monthly basis.  When it comes to the ‘edge’ for this investment, we identified it as being the potential for significant upside when taking into consideration the purchase price of the property, which was well below the recent sales rates achieved for comparable surrounding buildings.  In addition, the building is under-rented and there is major gentrification works in the immediate surrounds of the Sydney CBD which will improve the values of all assets in the vicinity. We are confident all of these factors combined will bring the overall annualised return well into the double digits. I feel like my equity is very safe in the first instance and we are exceptionally confident in the upside.  Read more here

I also have invested in land senior debt loans via Balmain Private’s real estate investment platform. These land deals are all generally earmarked for development and are geared at about a 40-50% LVR. They return about 7% per annum as monthly distributions over the 1-2-year investment loan terms, and I love seeing the interest payments flow back into my bank account!

What we are working on right now at MP Funds Management 

(and what it's telling us about the market)

Read our 2017/18 MP Funds Management outlook here

At MP Funds Management, we are currently working on arranging and managing several larger senior debt facilities of $60m- $100m for construction of multi-unit residential developments and these are primarily for institutional grade borrowers with institutional grade non-bank lenders. 

What is interesting is some of these deals can get banked by the big four major banks, however, due to the APRA (Australian Prudential Regulation Authority) lending restrictions the major banks are increasingly slow and difficult to deal with. As a result, borrowers are happy to pay slightly more to an institutional non- bank lender to get more flexible and favourable terms, a higher LVR (Loan to Value Ratio) and a faster result.      

What this tells us about the market is that there are high-quality deals to be done but because of government and regulator imposed cooling measures, which are restricting the banks' activity, there is a lucrative opportunity for non-bank lenders to bridge the gap. This is what we are capitalising on currently.  With each of these funding opportunities, we make a rigorous assessment of each on a deal-by-deal basis. The fundamentals of the underlying real estate and counterparty risk are key to our assessment of the merit of the investment and risk return equation to our Investors. 

In some more over-supplied or lesser quality areas of the market, there may be some short-term pain as the market corrects and over-leveraged developers consolidate, however, the upside to this is that land pricing will hopefully come back to a more reasonable level. Right now, land prices are prohibitively expensive to make a profit margin sufficient for developers to take on the risk. 

Where appropriate, for the residential development deals we are looking at funding, in addition to applying an extreme level of rigor to the presales buyers, we are getting insurance on the pre-sale contracts.   

What is ultimately underpinning the longer term residential fundamentals 

The mainstream press is talking the residential market down pretty thoroughly at the moment, and the APRA lending restrictions and Royal Commission is severely affecting the market with development and construction loans increasingly difficult for the major banks to write, meaning the supply of new real estate development, housing and apartments is going to slow.  

Furthermore, the Banking Royal Commission and the APRA lending restrictions also mean that it’s very difficult for the consumer/investor to get a mortgage and it is currently being suggested that consumer borrowing capacity may be reduced by as much as 35% under the new Responsible Lending Guidelines. 

The net effect of this is that for new residential developments about to launch their presales campaigns to the market, buyers who rely on finance are concerned about committing to an off-the plan purchase. because there is uncertainty around being able to get a loan in two or so years it takes to build, and when settlement is required.  This means that new supply coming to the market will be restricted because the sector of the buyer market that is reliant on finance to buy a property or off-the-plan apartment is under tighter scrutiny. For a residential apartment developer, presales are a requirement (to minimise risk in) order to get any residential development funded by a bank or non-bank lender.

This small snapshot of the market is what is largely being focused on by commentary, equities groups, developers, and lenders.

As an overall result of the negative sentiment around the residential market and lending restrictions, the market has cooled significantly with prices pulling back as much as 20% in some markets and Core-logic reporting about 6% pullback across Sydney.  

Currently, the downsizer focused apartment market in the city and fringe in the $1.5m to $3.5m sector is strong and so are various parochial pockets, such as Woolooware Bay, which experienced 6% growth in pricing rather than a decline. Additionally, for those buyers who don’t rely on external financing solutions, including a lot of Chinese-born, Australian resident buyers bolster various pockets of the market.

What this narrow view doesn’t take into consideration is the thing that has kept Australia pumping economically through the Global Financial Crisis and beyond, is our record levels of immigration. If this tap turns off we are going to have a serious problem which is significantly larger than any supposed housing bubble.

Whilst the residential market has cooled on the surface and for the short term, the following factors will mean that we have a systemic undersupply of housing and demand will continue to grow faster than supply can accommodate:

We have a top-heavy aging population. Right now, we are 24million and 14% of that is above the age of 65 years. In just a few years’ time, according to the Australian Bureau of Statistics, our population is going to be 52milion and 25% of that is going to be over the age of 65. So, what is the issue with this?   Our Australian government can’t afford to support that level of an aging population, there isn’t a large enough younger tax-paying population. In the 2017 Federal Budget, there was about a $4 billion improvement in our national deficit as a result of corporate taxation, but also from reducing social spending.  So, what does this mean?

 

  1. We are going to have to increase the numbers of skilled, tax- paying, working population in order for our government to afford the associated health tax concessions and other costs that come with a pending aging population of this magnitude.  The bolstering of the tax-payer population has been and will need to continue to be stimulated via immigration growth. As a direct knock on effect, we will need more housing to continue to accommodate this growing population.
  2. Our government is going to need to spend more on infrastructure projects to accommodate for this population growth, which is going to create more jobs and local economic growth (several new infrastructure projects have recently been announced for NSW and QLD). 
  3. Because of the apparent exodus of off-shore Chinese property buyers, the APRA/ Royal Commission cooling measures and implementation of responsible lending, which reduces consumer borrowing capacity by up to 35%, there is a lack of confidence in the residential market and off-the-plan, sales have slowed (in some significant pockets). Without those higher levels of off-the-plan pre-sales banks and non-bank lenders will not finance new supply of residential housing.
  4. In addition to this, development approvals can be incredibly difficult to get and developers are having to take on more risk and more cost to get a planning outcome. Part of the planning process can be long, bureaucratic and preventative to new housing supply coming easily to the market.

 

All of these factors create an interesting environment with a complex set of key drivers. Our view is that although there is an immediate downward pressure on residential pricing and negative sentiment, its largely been created by the regulator-imposed cooling measures. The bigger picture supply-demand fundamentals paint a more robust long-term story. 

As an example, recent treasury reports note that Sydney alone is expected to grow from 7 million people to 10 million by 2030, which is a growth of about 100,000 people per annum. While current market commentary and sentiment suggests an oversupply of housing, we are in fact, not producing housing fast enough to accommodate for this growth.

What’s more, these same treasury reports suggest that the missed revenue for the NSW government, from stamp duty on property transactions, for this financial year will be about $850 million with a forecast loss of $1.5 billion annually for the next four years.

In addition to this with the 2019 election looming, the Labour Government is making noises about abolishing negative gearing, which will create further potential pressure on the residential market and continued potential lost stamp duty revenue, which our government can’t afford. 

Although the Australian residential property market has experienced exceptional growth over the last few years and there is absolutely more rigor required for any new exposure due to the current, more complex market dynamics, we believe this will play out as more of a rebalancing in the short term. It’s a market we view as having solid underlying long-term fundamentals if approached with a more robust view on risk mitigation. 

Certainly, what needs attention and more public acknowledgment is our reliance on immigration for economic sustainability and growth and then some practical strategy to deliver accommodation for that population growth. 

Written by Mandi Prager             

 

SOURCE:

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