Economic Backdrop

2 March 2017

This week saw a series of economic news paint the latest picture of the Australian economy – and there’s positive news for the country. Corporate Profits Firstly, Australian Corporate profits recorded a rise of over 20% on last year, the fastest gain since 2001. Surprisingly, retail trade, accommodation and food, transport and warehousing were all lower, however financial services, mining, construction and professional services were all substantially higher. The exceptionally strong commercial and residential real estate markets and the related construction and finance activities have contributed to the strength of corporate profits. The profit change results by sector are shown in the graph below. The lack of profit growth in wholesale, retail, transport, administration, accommodation and food are not good signals for the property sector seeking strong rental growth to offset the inevitable rising cost of debts in the medium term. Current Account Deficit Australia’s Current Account data was also released this week, revealing the lowest deficit since 2001. Surging exports (notably iron ore and LNG) despite a strong Aussie dollar was offset by a minor increase in imports. Export volumes are expected to continue to rise subject with China, the predominant recipient. Gross Domestic Product The improved current account deficit, buoyed by higher commodity prices and larger volumes provided a strong foundation for an improved economic growth rate. After posting a negative GDP growth quarter in September 2016, the December quarter figures announced this week bounced back to a high of 1.1% bringing the annual GDP growth rate to 2.4% and avoiding a technical recession. Household spending and exports both added 0.5 percentage points to GDP, while public investment contributed 0.3 percentage points. The strongest contributors to growth were agriculture, mining, and professional services which is consistent with the Company Profit stats released earlier in the week. By state, the strongest final demand gains were recorded by the Northern Territory, up 3.7 per cent, Victoria, which rose 1.7 per cent, and the ACT, up 1.6 per cent. NSW grew 0.8 per cent, with Queensland, South Australia and Tasmania all posting 0.9 per cent gains. WA posted a 0.4 per cent rise. Property Debt Exposures The Australian Prudential Regulatory Authority (APRA) released its latest report on property exposures this week. Commercial property exposures increased $13.8 billion (5.6 per cent) to $259 billion compared to 31 December 2015. All property exposures are within limits with Office (30%) and Retail (24%) comprising the bulk of lending exposures. Interestingly, foreign banks have stepped in adding 50% to their exposures to commercial properties, now accounting for about 10% market share. Residential property exposures were $1.49 trillion, an increase of 8.0% on the previous year. APRA have increased pressure on the banks to ensure credit growth in residential lending remains below 10%. The actual statistics show that owner occupied loans were up 9.8% and investor loans up 4.7% on the previous year. APRA’s pressure has mainly impacted investor loans for new housing which was down 5.8% for the year. As local sources of capital become constrained, opportunities to place investment capital into senior or subordinated debt are expected to increase. New Home Sales New home sales in Australia showed a progressive decline, down 2.2 percent from the previous month to 7,379 in January 2017. Sales of houses fell by 1.5 percent and those of apartments slipped by 4.3 percent which likely reflects the tightening credit markets. Building Approvals Also this week, the ABS released the Building Approvals data for each of the states. Overall, there was an unexpected rise in the headline number of Approvals compared to last month, however the key measure is the seasonally adjusted annual number of approvals, and more specifically for Dwelling Units. The graph below show how this number for each state compares to the previous 12 months. So for NSW, a total of 73,316 dwelling units approvals were provided over the past 12 months, an increase of 2,170. All other states (except SA) showed a decrease in approvals with WA down 7,159 units and QLD down 5,130 units. The decrease in approvals will ensure that any current overhung of stock in these states will be absorbed within the short to medium term. Of course, approvals do not always equal completions as many sites obtain approvals in order to add value prior to a sale or find that funding or construction constraints result in a project being deferred, despite the approval. Putting it all Together Australia continues to experience a strong economic climate and is a preferred destination for global capital however investors still need to be cautious about investment positions to avoid being disappointed in the medium term. The current account deficit indicates that Australia is less reliant on imported goods, services & capital than it has in past years, however much of the expansion in the country has been from an increase in credit which is growing at a rate faster than the economic growth rate. In other words, readily available credit has enabled asset prices to increase in the absence of investment returns. The growth in credit and the regulatory response to curtail credit growth is the key risk and key opportunity to monitor. The risk is that excessive lending will continue to provide conditions for short term asset price growth which may result in unsustainable & unserviceable levels of debt as interest rates rise, ultimately leading to the re-pricing down of asset values and the potential withdrawal of foreign capital. The recent slow down in building approvals and new home sales are signals that the regulators are monitoring this closely, however excessive constraints will lead to further reductions in supply and increased pressure on pricing. To avoid asset excessive price growth, regulators need to concurrently encourage supply and limit demand. Implications for Property Investment Selecting the right investment is as crucial as ever. In the context of high asset prices and tightening of credit conditions and the forecast increase in interest rates, the immediate opportunity is to offer senior or subordinated debt funding in place of domestic banks in the expectation that funding constraints will abate and asset price stabalise. Once company profits appear more broad based, the risk in residential markets abates, and asset prices reflect more appropriate risk / reward metrics, then direct property will look more attractive in a relative sense. If you are interested in this and other insights, join our client group and receive regular updates as well as exclusive access to our Property Transaction Database. Click here for more information. Thanks