Observations: Paper 4

Since my initial “Observations Paper” in February 2013, nothing has changed my expectation of a slowing Australian economy post the investment phase of the mining boom, especially with our productivity still poor by Global comparison.

Our economy remains vulnerable even to a gentle rise in interest rates, the risk being that if a strengthening American economy is a catalyst for higher interest rates, sooner than expected, that if the flow-on effect to Australia precedes some gains from economic restructuring, the consequences will be to frustrate growth even further and increase unemployment.  A lowering of interest rates elsewhere, perhaps in China and the EU won’t prevent the USA lifting rates at its own timing as it considers appropriate to its own economic needs.

“Economic Performance to Remain Below Trend”

The Australian dollar remains resilient at levels higher than are beneficial to most sectors of the economy and is unlikely to fall meaningfully as the RBA will be resistant to lowering the official interest rate for concern about igniting boom investment sentiment, particularly in the residential real estate sector.  There is therefore little room in which to manage the economy, as no longer are there big levers for Government or the RBA to “pull” for quick results, and the impact of appropriate structural change, particularly increased productivity and greater labour utilisation will be slow.

Little is however likely to change for the next two years as interest rates appear to be steady, during which period economic performance will be below trend, and during which, the share market will continue to remain volatile, more likely losing momentum and value from what many view as recent peak performance, expecting that eventual high interest rates will erode gains and are inevitable.  Other circumstances have however just recently been unveiled, which suggests, potentially better times ahead, and from which we can take some encouragement.

“New Era of Opportunity”

The announcement of a Free Trade Agreement with China and the desire for similar arrangements with India, and the genuine personal warmth around the visits to Australia by the Chinese President Xi Jinpingand the Indian Prime Minister Narendra Modi are extraordinarily significant events and suggest an economic and investment framework for China, the Sub-continent the ASEAN Region that will underpin the Australian economy into the foreseeable future.  Whilst the “devil may remain in the detail”, the spirit is clear, the intention genuine, and it should strongly encourage Australia’s greater global participation providing the opportunity is grasped in conjunction with meaningful reforms towards greater productivity.  These new opportunities can be pursued in conjunction with maintaining good relationships with Australia’s other significant trading partners including the USA and Japan.

Apart from the enhancement in commercial and political terms that can be expected of this “new era” of co-operation and friendship, the other very significant benefits will be social and multi-cultural, as tourism, inter-family activity and ultimately greater immigration, flows within the region.  This can be expected to have an enormous impact on the demand for and therefore value of Australian real estate, commercial and industrial property responding to trade demand, retail, entertainment and the Hotel sector to tourism, rural properties to greater agricultural interest and investment demand, and housing in its various forms to greater inbound immigration and wealth transfer.  These flows will be significantly inbound to Australia rather than outbound.

If there were any doubt that the opportunities for Australia with China and India were just talked up exaggeration the events of the last fortnight and the strength of the overtures towards Australia from both leaders of those large economies should be convincing.

There is a very real opportunity for Australia if it can respond with appropriate political and trade policy, commercial and social attitude.  The real work begins now but the rewards will be the strengthening of Australia’s longer term prosperity.

Globally, as central Banks play a more major role at stabilising financial markets, and as Governments work hard at extracting the mutual benefits of greater alignment of social, trade and political agendas, world economic performance is stabilising post GFC, and growth tentatively emerging.  Strenuous efforts elsewhere around the world however will not be sufficient to solve Australia’s challenges, rather, as a nation it must find its resources from within.  This highlights the critical need for robust economic reform, strong Federal Government leadership, and the importance of more frequent and focused trade delegations between Australia and its large regional neighbours.

“Impact on Real Estate”

Whilst a “buckle-up” approach to the economy is wise for the medium term, the new regional prospects if captured by an Australian proactive response will expectedly be of national benefit.  More tourism, sustained immigration, greater investment, and more capital, will cohesively be of benefit to Australia’s economic growth.  I believe it is possible to forecast some consequences, and looking to the medium term 3 – 6 years, expect the following:

  •  Heightened overseas interest for investment in Australian capital city retail and commercial property, especially Melbourne and Sydney.  Accommodation quality to improve sharply in consequence of refurbishment to higher international standards.  Good prospects for overall capital growth.
  • Opportunity for certain classes of industrial and logistics accommodation to improve in value consequent upon demand for it to be vertically integrated into business models.
  • Strong demand for income guaranteed investment into Government backed infrastructure programs including roads, rail, and at regional centres, educational facilities, and accommodation according to social needs.  Not of itself a real estate asset class, but which investment, if it were to occur, will flow through to real estate in proximity to such projects and at the centres of benefit.
  •   Increasing interest in Australian rural sector, especially beef, grain and dairy.  Strong overseas investment seeking economies of scale leading to property rationalisation, amalgamation, and intensive equipment upgrades.  Excellent prospects for capital growth in the medium term, but bigger and greater efficiency will lead to the end of the “family farm”.
  •  Inner urban real estate will continue to be strongly supported, and development of non-detached housing, including apartments and townhouses close to central business districts will be needed and remain a viable business enterprise for decades.
  • Heightened demand for inner urban rental accommodation, as an alternative to the high cost of owner occupation.  The demand led emphasis will be for a new standard of better quality accommodation for which residential leases will move to a new regime of longer terms, typically five years.  This new era of rental accommodation will be driven by high net wealth private and institutional investors.
  •  In Victoria more so than in any other state in Australia, regional centres may benefit as strong population growth is decanted from the Metropolitan Region, to regional cities such as Geelong, Ballarat, Castlemaine, Bendigo, Echuca, etc.  This will be largely dependent on the allocation of infrastructure investment and heightens the probability that within Victoria the broad political agenda will become more regionally orientated.

Whilst the prospect of stronger and more meaningful relationships with large economies in our region is very encouraging, it is still a medium term prospect, yet in the immediate short term, the investment decision is still difficult. The world continues to have strong liquidity, as evidenced locally by the recent massive over-subscription for Medibank Private, and internationally the extent to which the DOW has risen.  Our own share market, despite liquidity, is however uneasy, for the reason that there will be a quick negative reaction if there is any correction to Global markets.

For nervous local investors therefore, and with no rate rises in sight, the residential market still remains attractive despite high prices and consequent more modest yields.  However, let me make it simple:  If you believe in Australia and its future then you should believe in and prudently strengthen your commitment to real estate.