London based research firm Variant Perception’s bold claim that Australian property is now the biggest housing bubble of all time has stirred emotions.
But if talk of the “Big Short of Blacktown” has inspired you take the other side of the Australia’s crazy obsession with property, you’re probably asking how you can be the unlikely hedge fund hero.
Here are a few ways to be a true outcast by betting against your friends, family, nurses neighbours and Uber drivers that have geared to the eyeballs in property debt.
But be warned. While many average Australians have made millions in the property market famed and fabled hedge funds have lost millions themselves taking the other side of the trade.
1. SHORT THE BIG AUSTRALIAN BANKS
This is the most obvious way that hedge funds have bet against the property market.
Given more than 60 per cent of Australian bank assets are tied to residential mortgages, Australian banks are (almost) on the front-line of the property market and a rise in defaults will hurt profits while falling collateral levels may compel them to raise even more capital.
The banks and rating agencies have conducted stress tests (which don’t always do a good job) to show all is okay.
CBA says they expect to lose $3.75 billion over three years if unemployment doubled and house prices fell 30 per cent but would recover $1.4 billion from mortgage insurers.
It’s a lot of money but remember the bank reported a $4 billion interim cash profit for the first half of 2016. They’re also starting from a point where home loan defaults are only around 1 per cent.
Foreign hedge funds have tried and failed to succeed in ever since famed Boston hedge fund manager Jeremy Grantham called ‘bubble’ way back in 2010. And some are still cautious even as short selling interest in Australia’s banks rises to an all time high.
Andrew Macken of the Montaka Global Fund says it’s dangerous to short what are “high quality businesses” that are guaranteed by the government.
“We can all agree that housing prices are inflated, by and large. But so are the prices of many assets. For a short to be successful, you need a strong handle on the timing of the collapse. There is not anyone who can accurately predict the timing of any potential downturn in the Australian housing market, in my view.”
2. SHORT THE SECOND ORDERS
There are a whole range of Australian companies from real estate investment trusts to finance companies to retailers that have ridden the wave of the housing boom.
“Any ASX listed company with an East Coast focus has benefited from the virtuous circle of rising asset prices, more spending and more jobs but the process can flick into reverse every so often,” says Totus Capital’s Ben McGarry.
The Variant Perception report has pointed out that finance, insurance, real estate and mining account for one fifth of Australian economic activity but “the multiplier for these sectors is much higher”.
McGarry says regulatory pressure on the banks and a potential slow down in housing hasn’t kicked off.
“But we have a soft economy. The sectors that are doing well are inbound tourism, outdoor advertising and wellness product exports to China, but they’re crowded niche industries.
A slow-down in the housing mania will have knock on impacts. Here are some sectors that are most exposed.
The mortgage insurers: These businesses are the front-line. CBA showed that Lenders Mortgage Insurers would absorb 37 per cent of the bank’s losses. Given Australia’s low default rates, LMIS have often been described as “a solution in search of a problem”, but if a housing crash comes, it will just be a straight out problem.
The Variant Perception report found to its surprise just how little visibility those on the front line have on the mortgages they are insuring noting that QBE doesn’t have to give prior consent if a borrower switches to a 10 year interest only loan.
The financiers: There are a few ASX listed companies which rely on these alternative funding markets to be running smoothly to operate and are arguably at as much risk of not delivering on their promises to investors as any other part area in the share market.
The newly listed Pepper Group, which finances loans using the residential mortgage backed securities (RMBS) market; Eclipse group which securitises car loans; and FlexiGroup, which funds consumer loans in retailers such as Harvey Norman, IKEA, Apple resellers, Fantastic Furniture and the like. These three companies are at the most risk of disappointing investors as banks look to preserve their capital and the risk of a bubble begins to come to fruition.
Currently these companies are on fairly sweet deals in terms of their cost of funding, but when they go to raise financing next time around their margins could blow out as the securitisation market becomes less accessible and bank capital starts to look more expensive.
“Growth for these companies looks significantly different than it did less than a year ago,” said Omkar Joshi, Watermark Funds Management investment analyst. Watermark has taken a short position in all of these companies in recent months.
“At the end of the day they have to go back to the banks and see what they can do for them. They’ll have access to funding but it’s more expensive which will kill their competitive edge,” he said.
As of November last year the banks have been asked to hold more capital on so called warehouse facilities – the financing arrangement in which a bank line of credit is used to house loans.
“The banks are happy to do it but they just charge more for it. As the existing arrangements roll of and the new ones role in that will start to hurt these companies,” Mr Joshi explained.
The retailers: Harvey Norman is one hedge funds have focused on because its sales of consumer goods are leveraged to the housing market but so too is its property portfolio. Beacon Lighting and bedding firm Adairs are also seen as exposed.
The landlords: Property stocks such as Lend Lease, Mirvac and Stockland have been heavily tied to the growing demand and rising value of apartment blocks. If it turns out they’ve built too fast and too furiously, these stocks could get hurt.
3. SHORT THE AUSTRALIAN DOLLAR
This is a trade that the man or woman on the street can actually execute and perhaps makes the most sense. As Variant Perception points out Ireland and Spain’s housing bubbles caused more pain than they should have because they couldn’t devalue their currency. Australia can.
“In the case of Australia, the AUD will be the adjustment mechanism and it will fall hard. A weakening currency is what we have seen in almost all other banking crises.”
Even if you don’t feel a crash is coming Australia’s property obsession is still a factor that could keep the currency pinned down.
Australia’s rising household debt to income ratio, to become the highest in the world, means that household’s sensitivity to interest rates has increased, constraining the Reserve Bank’s ability to raise interest rates. If rates can only stay sideways or down, that makes a lower currency more likely.
4. BUY AUSTRALIAN GOVERNMENT BONDS
If there was to be a housing bubble, most Australian stocks would get hurt. But bonds should benefit from a RBA response that would see interest moved lower, and held lower for a sustained period of time.
The simplest way for the individual Australian to short the property market is to sell the home and rent one instead. In fact the bearish case for Australian property is that there is no ‘supply shortage’ because if there was, rents would be rising.
Instead rental growth is at a multi-decade low. But as much as property speculating is a national sport, renting, or paying someone else’s mortgage is a national shame, so be prepared to be a true outsider.