On The Oz Property Market And REITs

This story features ADBRI LIMITED, and other companies. For more info SHARE ANALYSIS: ABC

By Greg Peel

The property analysts at Deutsche Bank note the number of Australian housing starts in the December quarter of 2009 rose by 6.4% to 138,000 on an annualised basis, while March quarter building approvals – the leading indicator of housing starts – hit 160,000. The analysts are forecasting a total of 168,600 starts for calendar 2010.

The number of starts will be assisted by the government's social housing program which forms part of its general infrastructure stimulus package. Deutsche assumes government starts will contribute 8.5% to the total. And forever hanging over the housing market is Australia's level of “underbuild” – the gap between demand for and supply of new housing. NSW is particularly undersupplied, yet the cost of building a house is most expensive in NSW at 16.9% of the total house price, notes Deutsche, compared to an average of only 7.6% for other states.

In the meantime, the RBA cash rate increase from 3.00% to 4.50% and the winding down of first home buyer stimulus has seen auction clearance rates begin to come under pressure following a honeymoon of strong clearances and a 20% annual house price increase. Where first home buyer demand has waned, demand from secondary house buyers and investors has picked up to close the gap, albeit not completely. Investor finance has increased 14% from the trough last year, Deutsche notes. But as interest rates continue to rise, will secondary demand also fall back?

The analysts note that investors tend to be focused on house price increases and not on affordability. Thus investors tend to be encouraged by rising interest rates are they are indicative of a strengthening economy. Herein lies the problem with Australia's house price bubble, as RBA chairman Glenn Stevens sees it. A lack of new housing means investors jump over one another to push up prices of existing stock in the hope prices keep rising. As interest rates rise, gearing levels also rise. At some point, the bubble simply must burst. But so far high immigration levels and strong population growth are keeping a floor under prices.

House prices only tend to come under pressure when auction clearance rates fall below 50%, Deutsche says, and at the moment Sydney is clearing 65% and Melbourne 70%.

Nevertheless, the Deutsche analysts feel the market has yet to respond to improving housing demand in respect to building material sector valuations, and they see ongoing improvement in the next twelve months.

Adelaide Brighton Cement ((ABC)) and Boral ((BLD)) have the highest exposure in the sector to local housing, they note. On valuation grounds however, ABC stands out, along with CSR ((CSR)) and New Zealand's Fetcher Building ((FBU)).

Meanwhile, the Australian real estate investment trust (REIT) market is experiencing a sense of deja vu as it watches the Aussie dollar plunge once more. The 36% drop in the Aussie between July and October 2008 blew many a foreign-exposed A-REIT away, notes Citi, and those which survived the GFC moved to close out or scale back currency swaps and reset the denomination of debt books.

The latest plunge has only been around 12% in comparison, and Citi suggests the net affect is actually positive for US-exposed REITs given the above changes were made. Net tangible asset valuations and earnings have seen positive movements once converted back to Aussie but equivalent gearing levels have not risen by much, and sit well below covenant thresholds. And what's more, gearing levels in general are now much lower than they were heading into the GFC.

A-REITs have nevertheless fallen on average 7.5% this month, Citi notes, but from a US investor's point of view they have fallen 15.2% when the Aussie effect is factored in. The question the Citi analysts are asking themselves is: Have the big falls provided a great buying opportunity, or have they simply exaggerated what is otherwise a weak performance anyway? They note A-REIT valuations on an adjusted currency basis are currently at their lowest point since August 2009 and are 20% below October 2009.

Click to view our Glossary of Financial Terms