SINCE the Government announced it would make available at least $2billion of taxpayers' money to bail out commercial property investors, there has been much thrashing about as to the rationale underlying this surprising decision. Perhaps the most curious defence was offered yesterday by the ordinarily conservative economist, Ian Harper.
Harper claimed the Government's action was motivated to forestall a rout in commercial property values that would spill into the housing market: "If there is a major collapse in asset prices in the commercial property market, that could feed through into domestic housing" because the two markets were "too close for comfort".
The good news: Harper is wrong.
Residential real estate and commercial property are as related to one another as infrastructure is to equities. For a start, the residential property market is far larger than the commercial property market. The total value of all listed and unlisted commercial property in Australia is only 7.4 per cent of the $3.4trillion housing market, according to UBS.
The difference between the two markets is also borne out in the lending aggregates: whereas there is about $990billion worth of home loans outstanding, there is only $165billion worth of commercial property debt.
The simple fact is that the two markets share no real commonalities other than those overarching macroeconomic factors that invariably influence all asset classes.
While this is intuitively obvious, it is also an empirical fact. The correlation between the returns to the Australian housing market and listed commercial property trusts during the past 26 years has been distinctly negative (ie, when one moves up the other is likely to move down).
Consider what happened during the last severe downturn, in the early 1990s. Notwithstanding that unemployment rose from 5.6 per cent to 10.9per cent between 1990 and 1992, and mortgage rates averaged an incredible 13.7 per cent (the RBA was very late to act in the early '90s and in 2007-0
, resilient Australian house prices appreciated by 2 per cent a year, according to the ABS.
In contrast, commercial property prices fell off a cliff, with the Australian Office Property Index declining by 24 per cent in the same period. The broader Composite Property Index fell by 11 per cent. It is not hard to see why APRA applies a 100 per cent risk-weighting to commercial property lending but only a 35 per cent risk-weighting to residential mortgages.
The same trend has been evident during the recent credit crisis. Whereas Australian house prices have tapered by little more than 2-3 per cent during 2008, the value of Listed Property Trusts has fallen by
55 per cent.
While some might argue that the housing market is more illiquid than equities, this is a furphy. There are more than 30,000 residential property sales every month in Australia, just under 1000 sales a day. That is to say, there is an abundance of liquidity with which to measure price changes.
What made Harper's statements especially bizarre was that he had been particularly violent in his criticism of the Government's earlier decision to inject $8billion of liquidity into the unambiguously more important housing market. He described the Government's action as "politically motivated", "aimed at reducing pressure on western Sydney households" and claimed that "it won't be the first time the Government has come to the aid of a bleeding industry".
In fact, the Government's decision to provide moderate support to the liquidity of Australia's $240billion a year mortgage finance industry, which in turn underpins the $3.4trillion worth of private residential property (occupied by 7.6 million households) made sense given that the securitisation market had been severely disrupted by external events in spite of Australia's extremely low mortgage default rates (which are just 15 and 30per cent of US and British levels, respectively).
There is also a case for insulating Australia's mortgage finance market from exogenous shocks that have nothing to do with the domestic environment in view of the critical role housing plays in the real economy.
The real elephant in the room - which may go some way to explaining the Government's action - is the enormous gap between the market valuations of listed commercial properties and the subjective human valuations that are used by investors to price their unlisted assets. About 12 per cent of the $1.15trillion worth of Australian superannuation savings is invested in commercial property (this is in turn split roughly 50:50 between listed and unlisted assets). So while the average Australian super fund recorded a return of minus21 per cent in the year to September 2008, this was principally driven by their 50-60 per cent portfolio weight to listed equities (the LPT component of which has fallen by more than 55 per cent).
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Cheers
Marc
Harper claimed the Government's action was motivated to forestall a rout in commercial property values that would spill into the housing market: "If there is a major collapse in asset prices in the commercial property market, that could feed through into domestic housing" because the two markets were "too close for comfort".
The good news: Harper is wrong.
Residential real estate and commercial property are as related to one another as infrastructure is to equities. For a start, the residential property market is far larger than the commercial property market. The total value of all listed and unlisted commercial property in Australia is only 7.4 per cent of the $3.4trillion housing market, according to UBS.
The difference between the two markets is also borne out in the lending aggregates: whereas there is about $990billion worth of home loans outstanding, there is only $165billion worth of commercial property debt.
The simple fact is that the two markets share no real commonalities other than those overarching macroeconomic factors that invariably influence all asset classes.
While this is intuitively obvious, it is also an empirical fact. The correlation between the returns to the Australian housing market and listed commercial property trusts during the past 26 years has been distinctly negative (ie, when one moves up the other is likely to move down).
Consider what happened during the last severe downturn, in the early 1990s. Notwithstanding that unemployment rose from 5.6 per cent to 10.9per cent between 1990 and 1992, and mortgage rates averaged an incredible 13.7 per cent (the RBA was very late to act in the early '90s and in 2007-0
, resilient Australian house prices appreciated by 2 per cent a year, according to the ABS.In contrast, commercial property prices fell off a cliff, with the Australian Office Property Index declining by 24 per cent in the same period. The broader Composite Property Index fell by 11 per cent. It is not hard to see why APRA applies a 100 per cent risk-weighting to commercial property lending but only a 35 per cent risk-weighting to residential mortgages.
The same trend has been evident during the recent credit crisis. Whereas Australian house prices have tapered by little more than 2-3 per cent during 2008, the value of Listed Property Trusts has fallen by
55 per cent.
While some might argue that the housing market is more illiquid than equities, this is a furphy. There are more than 30,000 residential property sales every month in Australia, just under 1000 sales a day. That is to say, there is an abundance of liquidity with which to measure price changes.
What made Harper's statements especially bizarre was that he had been particularly violent in his criticism of the Government's earlier decision to inject $8billion of liquidity into the unambiguously more important housing market. He described the Government's action as "politically motivated", "aimed at reducing pressure on western Sydney households" and claimed that "it won't be the first time the Government has come to the aid of a bleeding industry".
In fact, the Government's decision to provide moderate support to the liquidity of Australia's $240billion a year mortgage finance industry, which in turn underpins the $3.4trillion worth of private residential property (occupied by 7.6 million households) made sense given that the securitisation market had been severely disrupted by external events in spite of Australia's extremely low mortgage default rates (which are just 15 and 30per cent of US and British levels, respectively).
There is also a case for insulating Australia's mortgage finance market from exogenous shocks that have nothing to do with the domestic environment in view of the critical role housing plays in the real economy.
The real elephant in the room - which may go some way to explaining the Government's action - is the enormous gap between the market valuations of listed commercial properties and the subjective human valuations that are used by investors to price their unlisted assets. About 12 per cent of the $1.15trillion worth of Australian superannuation savings is invested in commercial property (this is in turn split roughly 50:50 between listed and unlisted assets). So while the average Australian super fund recorded a return of minus21 per cent in the year to September 2008, this was principally driven by their 50-60 per cent portfolio weight to listed equities (the LPT component of which has fallen by more than 55 per cent).
Read more...
Cheers
Marc
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