How the falling dollar will affect property

Asurtalian dollar property

Our old friend and property advocate Monique Sasson Wakelin is out today with an analysis of the effect of a falling Australian dollar on property prices. I’m a bit torn by this piece because it tackles macroeconomics, which is almost always lacking in most investment spruiks, so including it is admirable. Sadly, though, it gets it wrong. According to Wakelin:

Those investing in property overseas are most exposed to the vagaries of currency movements. If you’re already invested in overseas assets, then the fall in the Australian dollar has been good news, as the Australian-denominated value of your overseas assets and any income stream has now risen. In contrast, those now considering a property investment overseas are faced with a 10 per cent jump in costs since the start of the year simply due to exchange rate movements. Of course, should they proceed anyway, buy now and the Australian dollar falls further, then they will still profit from their timing.

Investing in property overseas is a glamorous prospect, but be very careful.

It is an inherently speculative pursuit, given the outcome can be so dependent on fickle, capricious currency movements. Add to that an unfamiliar market place, legislative environment and tax regime. To my mind, it’s a strategy only suitable for those who have a portfolio of domestic property assets and are looking to diversify (in that respect, it is akin to the cross-border diversity we all seek with our equity portfolio).

No objection from me here. Investing in offshore property is risky unless you’re plugged in to local conditions, which in itself demands a lot of travel and investment in time. And although I’m very comfortable with my forecast that the Australian dollar will fall much further, it’s true to say that most property investors are probably not forex experts. Certainly there are easier ways to play the currency.

But Wakelin’s biases become more apparent when she turns to the dollar’s effects on  local property:

On the flip side, a lower Australian dollar may increase the attraction of Australian property to overseas investors – in particular, new or off-the-plan property, given that Foreign Investment Review Board (FIRB) rules exclude non-residents from buying established property.

I’ve no doubt that there are scores of developers out there making that very case in their sales material directed to overseas buyers. Some will also seek to entice domestic buyers with the scenario that if they buy now they’ll benefit from the “inevitable” uplift in property prices driven by overseas-buyer demand. Suffice to say, be wary of such claims. The reality is that inward investment flows into Australian residential property are modest, and represent a very small proportion of the total market.

So, Australian investors should be cautious of “capricious” currency movements (despite the trend being favouable) but foreign investors into Australia will not be (despite the trend being unfavourable)?

Not only is this inconsistent, it is wrong. In a former working life I had direct exposure to the foreign market for Australian property during 2008/09, the last time the dollar fell heavily. Believe you me it did not benefit demand. In fact, there was a run on deposits made on new developments to the extent that the banks tightened rules around developer lending with regard to the proportion of foreign located deposits against which they would lend for the build. This contributed to the collapse of several major new developments that the proposed Rudd Bank was designed (stupidly) to fund.

Sure, once the dollar had bottomed at 60 cents, with the downside limited, stimulus pouring into the economy and FIRB rules lifted, demand returned, as you’d expect.

But we’re nowhere near there are we? No. And, barring an accident in China or revelation at the RBA,  the dollar looks like it’s going to grind lower in a series of steps as interest rates fall further. As such, foreign investors into Australian property face rising currency risk for an enduring period.  If this benefits demand I’ll eat my hat.

Wakelin then gets one final point wrong:

A lower dollar raises the price of imports. Given that around 40 per cent of the basket of goods and services that constitute the Consumer Price Index are drawn from overseas, a falling dollar could eventually feed through to price inflation. Were this impact to be significant, then the Reserve Bank would raise interest rates. In turn, the retail banks would raise mortgage rates and this could well see softer property prices.

As I’ve said before, unless the economy rebounds (which is unlikely given the overly slow rebalancing to non-mining growth) the RBA will look through tradeable inflation so the interest rate risk is negligible.

That will be some comfort to local investors but it in no way offsets the currency risk for foreign buyers.

Comments

  1. Good write-up. Lol at the ‘glamorous’ label MSW uses for foreign real estate – clearly an article targeted at the bogan gearer crowd.

  2. TBH whether Chinese investors buy houses in Australia probably has more to do with events in China than it does with exchange rates although moving rates may affect timing.

      • Yes on overseas buyers, as long as they see some dollar stability they will buy, but I think you may be underestimating the effect on local buyers, but I guess we will have to wait and see on that issue.

        Given the history of Japanese buyers who beat a hasty retreat after a decade of buying I do wonder how long this phase of buying will last, what event will change it, and what the exit will be like.

        I think that will be a more interesting story with many opportunities for locals.

        History tends to suggest that the O/S buyers will lose money, or put another way make some locals wealthy with opportunities both on the entry and on the exit – maybe it will be different this time but I doubt it.

  3. Firstly thank you…good logic in a pretty confusing area. So I pose this as food for thought on a slightly different take.

    “so the interest rate risk is negligible”

    Yep! No doubt the RBA will try to ‘goose’ the market for a few more years or for as long as they can. So yes RAT rates will get even more negative. Nominal interest rates may not be quite so benign. I guess it depends on time frame.
    The risk might be that your inflation is not as temporary as you think. Just my opinion but I’ve listed often enough the reasons I believe we are in for a long period of higher inflation.
    Now meanwhile if we get a bout of serious inflationary numbers the RBA might feel it has to hedge its bets a little. It might raise nominal interest rates a little, certainly not as much as the inflation we face, but it might still be significant..
    So cash flow becomes the issue. if one’s earnings, in the face of (temporary?)high inflation don’t rise as fast as inflation and you get nominal interest rates rises one is in deep doo-doo!
    I’m very familiar with this debate as it is one I have with myself every damned day as a result of being faced with more or les immediate decisions to make re warehouses and, indeed, houses.

    One more possible problem is that the iunflation we get becomes reflected in the A$ cost of housing. We’d be caught between the rock of rising nominal rates, the place of falling real incomes, and a rising tide of increasing cost of houses.
    Nice one!!!

    Another possible significant risk here, as HnH as recently written about, is a crisis in the external account leading to funding difficulties. In that case the RBA totally loses control of interest rates and they will be what they will be.

    So again the post here is very helpful and I look forward to other contributions and argument under this heading.

  4. thomickersMEMBER

    “In fact, there was a run on deposits made on new developments to the extent that the banks tightened rules around developer lending with regard to the proportion of foreign located deposits against which they would lend for the build.”

    back in late 2012, I did my Perth “macrotourist” holiday to see how bad the Perth economy was doing (pretty good back then). I attended a few realestate inspections of this new boutique apartment development which got seized by the creditors (Bankwest) due to settlement walkaways/cost blowouts. I would say if you bought or rented in this building right now you would experience an occupancy rate of 10% and a hole in your wallet. Ghost complex!!!

    I will probably visit Perth again towards the end of the year to see how it is going.

      • thomickersMEMBER

        yes.. I went through 5-6 1/2 bedroom apartments. the REA gave me an indication that 2 bedders would cost $900,000 each (and this is after the firesale announcement lol).

      • I was there yesterday – had to get to one of the shops. They said they moved from their old location round the corner because the rent was cheaper (though I got the impression the place round the corner was trying to do some gouging). I’d love to live there, would be a great location for me but yeah the prices are pretty ridiculous. The place feels pretty dead overall, on both the commercial and residential side.

      • Ahh Equus.

        I’ve looked at this place too for a sticky-beak. Wife wasn’t keen on the location, though I think in 5-10 years RPH would have been moved on/shut down and the area will be gentrified under a similar process to East Perth precinct.

        Personally if I had to live in an overpriced CBD apartment I’d have picked up one in the upcoming WACA development.

  5. Tassie TomMEMBER

    I’d be more interested in the effect of the falling $AUS on the willingness of foreign banks to keep funding Australian banks despite losing money.

    Last I heard there had been no bank bond issuances for most of June. Does anybody know what has happened since then?

    • Lending agreements are very likely hedged. I doubt anyone has lost money lending to Australian banks yet!

  6. I think it is worth noting that under standard economic theory, the currency has nothing to do with the decision to buy/sell a financial asset in the currency. This is because both the asset and the returns are priced in that currency.

    In the cases of housing, there is no net financial gain from a 40% fall in currency, as that implies a 40% fall in housing value in foreign currency terms, but also a 40% fall in rental returns.

    Unless of course the investor is speculating in the value of the AUD, then that is a whole different kettle of fish… Though one might then ask, if the investor is interested in currency speculation, why take on debt and sink it into an illiquid asset such as housing? One could easily sign up for an online FX account and take the same punts – safer, cheaper and more liquid!