Property

Sydney has overtaken Tokyo to be the most expensive city in the Asia-Pacific in which to fit out an office. Shortages of skilled resources, material price increases and supply chain disruption are driving inflation in a construction industry that struggled to find enough people even before the pandemic.

The NSW capital, with an average fit-out cost that has risen to $2765 per square metre, has knocked out the Japanese capital – where the average cost of an equivalent project was $2708 per square metre – after five years at the top of the regional list compiled by commercial real estate agency JLL.

The 14.8 per cent year-on-year jump in average fitout costs across Australia outpaced the 4.5 per cent average growth over the region that took in India, Thailand, Vietnam, Malaysia, Singapore, Indonesia, the Philippines, South Korea, China, Hong Kong, Taiwan, Japan and New Zealand.

The effects of a tight labour market, in particular, were driving up costs in Australia as project volumes surged beyond pre-pandemic levels, said JLL’s managing director for project and development services, Scott McCrossin.

‘‘Across the country, strong client sentiment has driven an increase in project volume over the last 12 months which, in conjunction with regional and global headwinds, have led to significant inflationary pressure on construction and office fitout costs.

‘‘Measures to rein in costs have been slowed by global headwinds such as ongoing geopolitical tensions exacerbating the cost of energy and constraining supply chains already under pressure. Damage from weather events – such as flooding in many regions of Australia in 2022 – have further stressed construction costs.’’

Demand for fitouts is booming as building owners reposition their assets to attract tenants or work with occupiers to boost the attraction of a communal workplace and entice staff back to the office.

The report showed the average fitout cost in Australia last year to be $2662 per square metre. Canberra came a close second to Sydney – and also ahead of Tokyo – with an average cost of $2761, followed by Adelaide ($2703), Melbourne ($2676), Brisbane ($2554) and Perth ($2522).

Fitout cost increases will moderate in the next year, JLL says in the report.

‘‘Further price increases will not be sustainable, and many expect the market in Sydney to normalise and the current rate of price increases to moderate amidst talk of a recession,’’ JLL’s Australia Fit-Out Cost Guide 2022/2023 report said. ‘‘The situation is similar in Melbourne with the market stabilising as pent-up demand washes through and activity starts to slow.’’

Shaky property markets across much of the world pose another risk to the global economy as higher interest rates erode household finances and threaten to exacerbate falling prices.

Reports last week have shown the US housing slump stretched into a fifth month, China’s home sales slide continued, and price declines persisted in Australia and New Zealand. In Britain, prices are now in their worst losing streak since 2008.

Sliding home values threaten to undermine consumer confidence and weigh on household spending, which had been a rare bright spot for the global economy last year. Investment too could take a hit as developers scale back projects in response to falling prices, waning demand and higher borrowing costs.

In the past three housing busts, inflation-adjusted house prices have retraced about half of their previous gains, according to Oxford Economics. Prices have risen about 40 per cent around the world since 2012 and the consultancy said in an October report that in a worst-case scenario, housing market weakness could knock global economic growth to around zero this year.

In the US, last year’s run-up in mortgage rates cast a chill on the housing market, leading to the worst annual drop in sales of previously owned homes in more than a decade.

That strain is set to continue during the US Federal Reserve’s campaign to tackle inflation.

Policymakers raised rates by a quarter percentage point at the conclusion of a two-day gathering last week, to a range of 4.5 per cent to 4.75 per cent.

China’s new-home sales tumbled 32.5 per cent in January from a year earlier, preliminary data from China Real Estate Information showed.

The prospect of ongoing weakness in China’s property market is a potential headwind to Nomura’s otherwise upgraded view of this year’s growth prospects, economists led by Ting Lu wrote in a January 31 note. They cited the official narrative that ‘‘housing is for living and not for speculating’’ and declining prices as brakes on speculative demand.

In Britain, Nationwide Building Society said the average home value has fallen for five months in a row. A jump in mortgage rates and the tightest cost-of-living crisis in a generation is squeezing the spending power of home buyers, putting the cost of property out of reach to more people.

‘‘The overall affordability situation looks set to remain challenging in the near term,’’ said Robert Gardner, Nationwide’s chief economist.

The average two-year fixed-rate home loan jumped to a 14-year high of 6.65 per cent in October. Mortgage rates have come down from their peak to well below 6 per cent, but home buyers and households renewing their deals are still facing painfully high monthly repayments.

Prices continued to fall in Australia and New Zealand last month, with the slide likely to continue as neither property market has yet felt the full brunt of last year’s spike in interest rates.

Many New Zealand households are on fixed-rate mortgages that have yet to roll over to a new, higher rate. As a consequence, economists are predicting house prices will fall further and will be at least 20 per cent below their late-2021 peak by early 2024.

In capital city Wellington, prices have already fallen 18.1 per cent from a year earlier, CoreLogic data show. In the largest city, Auckland, prices are down 8.2 per cent.

It’s a similar story in Australia, where a spike in loan repayments for those whose mortgages switch to higher variable rates this year is set to weigh on consumption, according to a report by Bloomberg Intelligence.

Repayments on 15 per cent of home loans could jump by more than 80 per cent when their ultra-low fixed rate expires, analysts Mohsen Crofts and Jack Baxter said in the report. They estimate the hit to household income will be the equivalent of 2.2 percentage points of retail sales.

One bright sign is coming from Hong Kong, which is seeing glimpses of a housing recovery as the border with mainland China reopens. New-home sales in the city may surge more than 50 per cent this year, buoyed by pent-up demand from mainland buyers, according to Bloomberg Intelligence.

Shaky property markets across much of the world pose another risk to the global economy as higher interest rates erode household finances and threaten to exacerbate falling prices.

Reports this week show the US housing slump stretched into a fifth month, China’s home sales slide continued, and price declines persisted in both Australia and New Zealand.

Sliding home values threaten to undermine consumer confidence and weigh on household spending, which was a rare bright spot for the global economy last year. Investment too could take a hit as developers scale back projects in response to falling prices, waning demand and higher borrowing costs.

In the US, last year’s run-up in mortgage rates cast a chill on the housing market, leading to the worst annual drop in sales of previously owned homes in more than a decade. That has put pressure on prices.

That strain is set to continue during the Federal Reserve’s campaign to tackle inflation. Policymakers are widely expected to raise rates by a quarter percentage point at the conclusion of a two-day gathering today (AEDT), to a range of 4.5 per cent to 4.75 per cent.

In the world’s No. 2 economy, China’s property slowdown is showing few signs of abating, even as authorities ramp up efforts to revive the industry. New home sales tumbled 32.5 per cent in January from a year earlier, preliminary data showed this week.

Officials have taken steps to ease financing to cash-strapped developers, unwinding a deleveraging campaign that triggered a wave of defaults and dragged on growth.

Local authorities have also stepped up efforts to stimulate home buying, including by cutting mortgage rates and easing down-payment requirements. Such steps are unlikely to boost sales until mid-year, according to Bloomberg Intelligence analyst Kristy Hung.

Ongoing weakness in China’s property market is a potential headwind to Nomura Holdings’ otherwise upgraded view of this year’s growth prospects, economists let by Ting Lu wrote in a note on Tuesday. They cited the official narrative that ‘‘housing is for living and not for speculating’’, and declining prices as brakes on speculative demand.

Prices continued to fall in Australia and New Zealand in January, with the slide likely to continue as neither property market has yet felt the full brunt of last year’s interest rate spike.

Many NZ households are on fixed-rate mortgages that have yet to roll over to a new, higher rate. As a consequence, economists are predicting house prices will fall further and will be at least 20 per cent below their late-2021 peak by early 2024.

In Wellington, prices have fallen 18.1 per cent from a year earlier, CoreLogic data shows. In Auckland, prices are down 8.2 per cent.

It’s a similar story in Australia, where a spike in loan repayments for those whose mortgages switch to higher variable rates this year is set to weigh on consumption, a Bloom-berg Intelligence report says.

Repayments on 15 per cent of home loans could jump by more than 80 per cent when their ultra-low fixed rate expired, analysts Mohsen Crofts and Jack Baxter said in the report. They estimate the hit to household income will be the equivalent of 2.2 percentage points of retail sales.

Housing is even cooling in Singapore, which has been more resilient than many other markets.

Property Talk about prices hitting bottom may be optimistic.

Predictions that the housing market will soon bottom out are premature because the worst effects of higher interest rates are yet to come, experts say.

The recent rise in auction clearance rates and improvement in the drivers of inflation had prompted some industry insiders to say the housing downturn was about to end and that prices would fall by smaller amounts.

Auction clearance rates climbed to 58.8 per cent, a 12-week-high, last weekend, CoreLogic says. Ray White data showed the number of bidders had risen to 2.5 per auction since touching bottom last month.

‘‘I think we are close to the bottom,’’ said Ray White chief economist Nerida Conisbee. ‘‘With inflation drivers improving and markets feeling more confident about the outlook, it does look like the housing downturn may be over sooner than expected.

‘‘The chances of a sustained downturn and giant declines in prices look to be steadily dissipating.’’

Ms Conisbee said there had been a decrease in petrol prices, and supply chains seemed to be moving a bit quicker in the past seven weeks.

‘‘With inflation starting to pull back, so too does the need to raise interest rates.’’

But AMP chief economist Shane Oliver said the recent rebound in clearance rates was not an indication of a stabilising market.

‘‘There were bounces in clearances in the 2011 and 2017-19 property down cycles that did not signify imminent upswings,’’ Dr Oliver said. ‘‘I suspect the bounce in the last few weeks reflects the combination of bargain hunters and vendors lowering their prices as it has come on lower volumes and interest rates are still rising.

‘‘I continue to see average home prices falling 15 per cent to 20 per cent top to bottom, with the low most likely in the second half of next year after the RBA stops hiking and starts cutting rates, which is not expected until the second half of next year.’’

While the auction clearance rates lifted in the past few weeks, they were still below the benchmark where prices could rise again, said Nicola Powell, Domain’s chief of research and economics.

‘‘I think talk of the market bottom is a bit optimistic,’’ Dr Powell said. ‘‘Yes, we have seen clearance rates stabilise in recent weeks, but they are still below 60 per cent, which is a level that indicates price inflation. At the current level of 58 per cent, it indicates that prices are still going to fall.’’

Despite some encouraging signs, the worst of the downturn was far from over, said ANZ research senior economist Felicity Emmett said.

‘‘I think it’s very premature to be calling the bottom of the housing market when many participants in the market would hardly have even felt the impact of rate rises yet,’’ Ms Emmett said.

‘‘It takes a little while for the rate rise to flow through to mortgage repayments. The May rate rise probably didn’t result in higher mortgage repayments until late June or July.

‘‘With more rate rises expected, it’s really hard to see property prices bottoming out until at least the cash rates have stabilised.’’

ANZ expects interest rates to peak later this year at 3.35 per cent, which will slash borrowing capacity by 30 per cent.

‘‘That is really going to limit how much people can take to an auction or private sale,’’ Ms Emmett said. ‘‘I don’t think there’s any getting away from that, that’s why we think the downturn has a lot longer to run.’’

ANZ is predicting Sydney house prices to fall 20 per cent peak-to-trough, while Melbourne, Adelaide and Hobart are each expected to decrease by 17 per cent, Brisbane, Perth and Darwin will fall 12 per cent each, and nationwide there would be a a 17 per cent decline.

The market could bottom out earlier if the RBA were pause its tightening, said SQM Research managing director Louis Christopher.

‘‘I think we are getting closer to a rate pause where the RBA just sit on their hands for a few months … it’s got everything to do with inflation,’’ Mr Christopher said.

‘‘If we were to see the RBA pausing at the next meeting or the one in October, that could improve confidence and stimulate the housing market,’’ he said.

JB Hi-Fi ultimately proved to be one of the COVID-19 winners even though its share price was trashed at the start of the pandemic when a heavy sell-off across the broader sharemarket meant it lost 40 per cent of its value in a couple of weeks to sink to $24.29.

Fear gave way to pragmatism and home cocooning. Spending on the home spiked as people upgraded big-screen televisions, bought new kitchen appliances and spent up on home work-station technology as the at-home lifestyle was forced upon them. The stock recovered strongly.

By March this year its shares had climbed to $55.85. But then a third of its sharemarket value vanished in less than three months as many investors decided this would be as good as it gets, and the dream run may be over.

Sharemarket investors traditionally look nine to 12 months ahead. Crystal ball gazers peering ahead to early 2023 see a household sector grappling with much higher mortgage costs after sharp interest rate rises, soaring energy bills and petrol prices and confidence low as house prices slide.

JB Hi-Fi isn’t giving up, and showed again on July 19 when it released preliminary financial results for 2021-22 just how resilient the business is.

The core JB Hi-Fi brand and The Good Guys appliances stores are exceedingly popular with shoppers. Overall, group revenue rose 3.5 per cent to $9.3 billion from a year ago, underpinned by strong same-store sales growth of 10.9 per cent in its Australian business in the June quarter.

It navigated the COVID-19 pandemic with aplomb, with its online business roaring ahead, up 50 per cent for the year.

But might Australia’s obsession with real estate and the central role a steadily growing residential housing market plays as a bedrock of the economy finally bring a partial unravelling?

Jarden analyst Ben Gilbert says the market seems to have already factored in hefty house price falls, which are a substantial drag on confidence because of the household wealth effect.

‘‘The market appears to currently be pricing a scenario whereby house prices fall greater than 20 per cent and spending falls 10 per cent-plus for household goods,’’ he said.

Economic data is already showing a slowing in consumer spending. Mr Gilbert says there is no doubt that JB Hi-Fi is an ‘‘industry leading retailer’’ but it is facing growing headwinds.

He has an ‘‘underweight’’ rating on the stock and a 12-month price target of $34.90. JB Hi-Fi shares closed on Friday at $44.46.

Mr Gilbert expects September quarter sales on a like-for-like basis to still be ahead of the same time a year earlier, when Sydney and Melbourne were in extended lockdowns and bricks-and-mortar retailing was severely curtailed. But from then on, it will be cycling much tougher sales and profit levels on a comparative basis.

He also points to rising competition from retailers such as Bunnings and Kmart, and online businesses such as Amazon which is steadily building a bigger presence in Australia with wider ranges.

JP Morgan analyst Bryan Raymond has a ‘‘neutral’’ rating on the stock and a 12-month price target of $44. He says it has a resilient business model and that The Good Guys results in the six months to June 30 were particularly impressive.

But he, too, points to a tougher outlook for discretionary retailers as ‘‘significantly higher cost of living and a slowing housing market weigh on spending’’.

Goldman Sachs analyst Lisa Deng has a ‘‘sell’’ rating on the stock and thinks it will sink to $34.90 within 12 months. She said the trading update showed better-than-expected margins but expects pressures to build in this new financial year as the business faces both ‘‘cyclical and structural challenges’’.

UBS analyst Shaun Cousins is sitting on the fence and has a ‘‘neutral’’ rating and a 12-month target price of $42. He said there was caution among investors about how retailers such as JB Hi-Fi, which have ‘‘broadly enjoyed COVID tailwinds, will perform under more difficult conditions’’.

He adds that The Good Guys has gained market share and is delivering stronger sales and higher margins after improvements to its merchandise, range and in-store selling.

Citi analyst Adrian Lemme is a believer and has a ‘‘buy’’ rating on the stock even though he trimmed his 12-month price target to $47 from $52. Mr Lemme said JB Hi-Fi was a strong operator and well-positioned to withstand the drag from increasing cost-of-living pressures in households.

The discretionary retailing sector was ‘‘unloved’’ and on a risk-reward basis JB Hi-Fi was looking more favourable for investors after its share price dropped by one third between March 30 and mid-June, suggesting investors had already factored in a tougher outlook.

Thanks to the Reserve Bank of Australia’s extraordinary decision to hammer unsuspecting households with 125 basis points of mortgage rate increases in just two months (from May 4 to July 6), which will likely be upsized to 175 basis points of rises at its next meeting, Sydney house prices are falling at a 20 per cent-plus annualised pace.

Using the daily hedonic index data published by CoreLogic, which is the RBA’s preferred housing benchmark, this column finds that the rolling 30-day change in Sydney home values has dropped precipitously from 2.83 per cent in August 2021 to minus 2.21 per cent as at July 11. That means residential real estate in Sydney is declining at an annualised rate comfortably north of 20 per cent.

While this housing crash appears to have shocked many analysts and economists – and the millions of unwitting families relentlessly advised by the RBA in 2020 and 2021 to borrow and spend as much as possible because Martin Place had committed not to lift interest rates until 2024 at the earliest – it is, regrettably, smack bang in line with the central case that this column outlined late last year.

In June, Sydney home values plunged 1.6 per cent. They have fallen at an even more rapid rate over the first 11 days of July, slumping by another 0.7 per cent.

Melbourne dwelling values are closely tracking Sydney prices, albeit with a lag. In June, Melbourne home values fell 1.1 per cent, and they have lost another 0.4 per cent in the first few weeks of July.

Sadly, this reaffirms our dour October 2021 forecast that local house prices would correct 15-25 per cent after the first 100 basis points of the RBA increases, smashing consumer and business confidence (already near GFC lows) and adversely affecting consumption across the economy.

This has slowly become a consensus economist view, although there are some spruikers who claim house prices will continue climbing because higher interest rates have no impact on them.

It’s also worth noting that we are not perma-bears when it comes to Aussie housing. On the contrary, we were the most bullish forecasters in early 2020 when everyone else was expecting prices to drop 10-20 per cent.

While the RBA is setting itself up to increase rates by another 50 basis points in August in response to lagged inflation data heavily influenced by temporary supply-side shocks, we project that the record collapse in the value of Aussie households’ most important asset will ultimately act as a constraint on the extent to which Martin Place can continue to lift rates. After preemptively over-egging policy despite no evidence of a wage/price spiral, there is every chance the RBA will be forced to cut rates in 2023. (Recall the latest CBA data on real-time wage growth suggests it remains very sluggish.)

Aussie households face multiple headwinds: the fastest interest rate increases in a quarter of a century, which are crushing disposable incomes; a massive, albeit hopefully temporary, reduction in real wage growth as a result of a one-off increase in inflation attributable to a conga line of supply-side shocks; a record decline in the value of their largest asset, the owner-occupied home; the largest decline in the value of their superannuation savings since the GFC; and finally, the spectre of fiscal policy dragging on growth as both the federal and state governments eventually turn their focus to budget repair and the need to raise taxes.

On this final point, there have been some interesting developments. This month Victoria commendably raised $7.9 billion from the partial sale of VicRoads. Treasurer Tim Pallas confirmed the funds will go to the state’s new Future Fund that will be used to pay back the tens of billions of dollars of COVID-related debt that Victorian taxpayers have accumulated since 2020. This is modelled on NSW’s excellent Debt Retirement Fund, which NSW has already tapped for $11 billion to help repay its COVID-19 debt bill.

Following the budgets released by the five largest states, we know that the official debt issuance task will be $75.6 billion for the 2023 financial year, which is $10.1 billion less than the $85.7 billion these states forecast for FY23 at the time of their FY22 budgets.

If one accounts for the amount of rapid-fire issuance the likes of NSW and Victoria have been able to do via their record floating-rate note deals, which have attracted $17 billion of bids from banks hungry for high-quality liquid assets, the states’ funding task for FY23 falls from the most recent budget estimate of $75.6 billion to just $64 billion. That is, the five largest states have exactly $10 billion less debt to issue in FY23 compared to their official numbers only a month ago. The $64 billion of issuance in FY23 is also a striking reduction from the $93 billion issued in FY22 and the $98 billion supplied in FY21.

Juxtaposed against the modest issuance outlook is the gargantuan demand from banks hunting for liquid assets, which this column has been flagging since late 2021. On our estimates, banks will need to buy $315 billion-$570 billion of government bonds through to December 2024.

This is because they lose $140 billion of liquid assets after the Australian Prudential Regulation Authority’s decision to shutter the banks’ lucrative Committed Liquidity Facility, which we foreshadowed last year, and then another $188 billion of liquid assets once they repay the money they borrowed from the RBA under the Term Funding Facility. Balance sheet growth and bond maturities off the RBA’s balance sheet also drive additional bank demand for liquid assets.

Our liquidity shortfall estimates are based on banks maintaining their liquidity coverage ratios (LCRs) at more than 130 per cent. UBS arrives at a slightly smaller $275 billion-$375 billion estimate assuming banks can drop their LCRs to 125 per cent. CBA’s researchers displayed even more hope, claiming that banks might be able to get away with 120 per cent LCRs.

There are two problems with this. Treasurers at the major banks dismiss any possibility of them lowering their board-mandated LCR targets. And APRA has recently noted quite pointedly that banks have prudently kept their LCRs in excess of 130 per cent in line with global peers.

Despite this extremely positive demand and supply, the states have had to wear an enormous increase in their cost of debt funding, which has more than tripled. The first driver has been the spike in Australia’s 10-year Commonwealth bond yield, which was around 1 per cent last year and has since leapt to about 3.5 per cent.

Rightly or wrongly, the implicitly Commonwealth-guaranteed states borrow at a margin above the Commonwealth yield curve and this spread has jumped from 15 basis points last year to about 60-65 basis points this month, broadly in line with where state spreads traded in the unprecedented financial market shock induced by the pandemic in March 2020.

State bonds are the only bonds we know of in global credit markets that are trading anywhere near their March 2020 spread levels. This is one reason we like holding them. As an example, five-year major bank hybrids spreads are sitting at about 330 basis points above the bank bill swap rate. Back in March 2020, hybrid spreads traded as wide as 850 basis points over this.

So what explains the unusual jump in the states’ spreads above the Commonwealth curve? An equally unusual increase in hedging costs, as represented by ‘‘swap spreads’’, which have exploded to record levels in the post-centralised clearing period. The principal catalyst has been the RBA blowing up global investors who believed that Martin Place would fulfil its commitment not to raise interest rates until 2024 at the earliest.

The RBA had explicitly backed this commitment by fixing the interest rate on the 2024 Commonwealth bond at 0.1 per cent, the same level as its target cash rate. But in October 2021, it suddenly decided to stop defending this ‘‘peg’’, which was arguably the most humiliating experience for a central bank since George Soros rolled the Bank of England in the early 1990s.

As the RBA concedes in a recent report, this damaged its credibility and king-hit global investors that had allocated capital on the assumption that the RBA’s 2024 yield curve target would remain intact.

There has been market chatter that it has taken larger investors until recent days to exit their long, or received, positions in the 10-year Aussie swaps market, which they had been stopping out of since last October. The process of stopping out of these trades over the past eight months has relentlessly pushed local swap spreads higher, eventually to levels that were more than double the previous peaks recorded in the post-clearing period.

The good news is that since these flows have cleared, spreads have started their long process of normalising back towards their fundamental anchor.^SI

Christopher Joye is a portfolio manager with Coolabah Capital, which invests in fixed-income securities.