ECONOMIST: Frank Gelber From: The Australian December 10, 2009 12:00AM
WE leave this year in a lot better shape than we entered it. The worst of the global financial crisis has passed and the damage is nowhere near as bad as many feared.
Certainly, there have been casualties among highly geared, financially engineered operations.
Most have weathered the hit to their asset values and gearing, refinanced debt and survived. Some remain wounded, but many companies have repaired their balance sheets and, with debt and equity finance starting to become available, are in a position to get back to business. Australia was never going to have the magnitude of recession facing some economies.
Unlike the experience of the 1980s boom and 90s recession, Australia didn’t have major oversupply in property markets causing writeoffs by banks and a financial crisis. Overseas, many investors did.
There was a shift from greed to fear in debt and equity markets, causing a credit squeeze and an equity squeeze plus a correction following the excesses of a boom driven by financial engineering.
Property markets were particularly affected. Most of the impact on property returns came from investment markets. Yields blew out and property values fell.
Rents held on to a greater or lesser extent, depending on the impact of the downturn on demand. It’s not that we did anything special. BIS Shrapnel forecast before the event that most markets would have collapsed through oversupply within five years. We were just slow into the game. We didn’t go so far over the top on gearing, and we didn’t have time to significantly oversupply markets.
In effect, the banks did us a favour by pulling the rug from under supply before the cycle had a chance to run its course and oversupply property markets.
At the beginning of the year, doomsayers were dominant. Many thought this would be the worst slump since the Great Depression.
In property markets, financial considerations had taken over from property logic. The listed-property trusts in particular were under enormous strain from banks to reduce gearing, with property prices falling and loan-to-valuation ratios rising. Substantial injections of equity were needed to replace debt and bring gearing down to levels acceptable to the banks.
The extreme pressure on the whole market felt earlier this year has passed for some players, but not all. Many listed property trusts were able to go to the market for equity, eliminating fire sales.
For them, the cash squeeze is easing. Indeed, some are now in a position to purchase assets or spend on development.
Having been hamstrung this year, they will start, slowly at first, to get back to business next year.
Others, unable to raise equity at sensible prices, face a longer road out. Unlisted trusts, wholesale and retail, being valuation-based rather than market-based and more rigid in form, are still working through issues of gearing, maturity and redemption. For them, raising equity is more difficult and some are vulnerable to takeover. Others will sell assets, but for most it’s a loss, not a disaster. Some say there will be a great rationalisation. That could solve problems for over-geared and capital-constrained vehicles, but with the panic past, much of the urgency has evaporated.
Confidence, in both the economy and property markets, has picked up with a run of good news.
Unfortunately, we are getting ahead of ourselves. Weak household disposable income and falling construction will constrain growth, and hence property demand, keeping conditions tight for another year before recovering investment drives strong growth, starting in 2011. However, given the weakness of supply, it won’t take long for demand to absorb excess stock in property markets.
Further, risk-averse debt and equity markets will curtail speculative development. Development is unlikely to proceed until property feasibilities again stack up, and given lead times between starts and completion of projects, that sets us up for a strong upswing in the next phase of the cycle.
I think we’ll see boom conditions in some markets. Indeed, that’s our forecast.
The classic questions point the way forward. Where will demand come from? That’s easy: from economic recovery. And given the collapse in development, we know there will be little supply to prevent tightening in leasing markets. Where will the money come from? First equity, then debt finance will come back when confidence returns as leasing markets recover.
Already, the bargain-hunters are well and truly out, and there’s still plenty of opportunity to buy property below replacement cost.
This is just the beginning, however. After the bargain-hunters comes a focus on leasing strategy and repositioning of properties, and then comes development.
How will markets adjust? The correction in yields and property values leaves prices well below replacement cost in many markets.
As leasing markets tighten, rents will rise to levels that will underwrite new development.
And, given the new risk-averse conservatism of banks and investors, we won’t have much development until they do. Rents will bear the burden of adjustment. They will be much higher in many markets by the middle of next decade.
The next decade will be characterised by rolling investment cycles. For property markets, this is a time of great opportunity, but also a time to take care. It’s a complicated tapestry with no easy answers. This is the time to take a position in markets on the threshold of a strong upswing, often at prices below replacement cost, which will set up returns three to five years hence.
Frank Gelber is chief economist for BIS Shrapnel
