GM:AR

13 July 2012 The Collapsed and Collapsing Property Market Housing, Commercial and Retail The Housing Market On 9 July The Age reported extensively on Melbourne’s worst-kept secret, that there are tens of thousands of unsaleable properties in Melbourne’s outer suburbs, with lots of property values having fallen well below the amount owed to banks, i.e. their owners now have negative equity. Unlike the United States, the structure of our housing loans means that the owners are trapped in this debt situation long-term. For many it means that their dreams of aggressively reducing their mortgage and then trading their equity in their first home for a home in a better serviced suburb has either disappeared or has been postponed for many years. That has knock-on effects through successive tiers of the market. Melbourne is far from unique. House prices have fallen across much of Australia.

Key Advice If upgrading your home under these market conditions it is vital to sell your existing home first, then buy. Even in prestige suburbs, prices have fallen quickly and dramatically. There are terrible stories of those who bought first and have had to accept a vastly lower price for their old home than they had planned upon.

Residential Rental Units? Over the long-term, these have generally proved to be mediocre investments, albeit that for a time the real estate bubble which preceded the global financial crisis suggested that they merited investment. However, the vital fact that many investors miss is that rental demand is far more elastic than that suggested by either property spruikers or economic forecasters. To put it simply, in good times the population spreads out and in less certain economic times the population crowds together. Examples are:

a. Some immigrant families crowding together in a single dwelling to save rent; or b. Young people staying at home in the spare bedroom at mum and dad’s for a year or

two longer rather than moving into a rental unit because of uncertainty of employment; or

c. People who in good times own both a home and a holiday house by the sea but who in uncertain times restrict themselves to one dwelling.

Rental vacancies have now become apparent in suburbs where house or unit for rent signs never appeared previously; the local agents always having a waiting list of tenants to fill them.

2

There is no magic formula or ratio of houses to population. The ratio varies substantially according to economic conditions; or perceived economic conditions. Thousands of people in the retail industry are fearful of losing their jobs because of the closure of other retail businesses and reduction in sales volumes due to internet shopping. Those people are not bidding up houses at auction or trading up smaller houses for larger houses, or contemplating purchasing a beach house. There are powerful psychological factors involved in the housing market. The housing market in Melbourne is terrible, and it is likely to grow worse before it turns. The property market on the Gold Coast is terrible and is likely to remain depressed. The high Australian dollar means that overseas tourists aren’t coming to the Gold Coast, and Australian tourists find it cheaper to go to Bali or Fiji. There are lots of similar stories around Australia, notwithstanding the odd bright spot. Leisure Accommodation Right now, holiday accommodation as in beach houses, snowfields accommodation or tree change properties are overhanging the Victorian market in large numbers. Similar situations exist in other states. Nor have we seen the bottom of these markets. For many owners, these types of assets are non core. Their core assets are their business or professional practice and their family home. If uncertain economic conditions threaten their businesses, non core assets flood onto the market. In other words they prioritise the security of their home and their business above their leisure assets. Commercial Property A steady stream of companies reducing staff numbers in head offices, together with the odd company going into liquidation or administration is creating vacant space in Melbourne’s CBD. Inevitably similar effects will occur in Sydney. It’s not fashionable these days to have plush head offices, and it is fashionable to shift a lot of formerly head office functions into austere suburban accommodation. A peculiar problem with CBDs is that the virtually unlimited approval to build higher buildings means that there is actually greater scope to over-build at the centre of our cities, and periodically substantial surplus office space emerges. Retail Property Investment Last year we advised clients to sell discretionary retail stocks as in David Jones, Myer, JB Hi-Fi, Harvey Norman, Premier Group etc as they were under attack from internet shoppers. That genie is out of the bottle. Large shopping centres are now adept at hiding vacant space. If you look closely you’ll see large floor to ceiling advertising signage appearing in shopping centres which is actually disguising vacant space behind them. Borders, Angus & Robertson and Colorado Group are in liquidation. Dick Smith Electronics is being restructured (closing stores) by Woolworths preparatory to selling off the remnants of the business. Retravision has toppled. Darrel Lea has gone into administration, probably because other retail failures are reducing foot traffic in shopping centres. Premier Group, which owns a variety of branded fashion stores plus Just Jeans etc, is rationalising its outlets, i.e. closing some. The message is that Westfield and Stockland retail shopping complexes which have traditionally had the power to force tenants to pay high rents now face inevitable emerging pressure to reduce rents in the medium term or have a lot more vacant space hidden behind advertising signage. The internet has changed some parts of retailing forever. The short term outlook for Westfield and Stockland remains profitable because of the structure of rent rises built into their existing leases, and the majority of their tenants will survive. However, in the medium to longer term the weakened demand for retail space will lead to tenants, particularly those tenants with significant bargaining power, demanding much more favourable rent conditions at lease renewal.

3

Shopping centres smaller than those owned by Westfield, Stockland etc are visibly struggling. In a small shopping centre, it is virtually impossible to disguise shops that are vacant. Disastrous Advice It has become fashionable for real estate agents and spruikers desperate to sell property to explain how easy it is to gear the acquisition inside a sub-trust inside your superannuation fund. Bank lending officers striving to increase their portfolio of loans, the amount of which ultimately determines their salaries, also jump on this bandwagon. It’s appallingly bad advice. The success of gearing depends upon the rate of inflation and the marginal tax rate of the borrower. At present, economic conditions are squeezing the life out of inflation, and whereas a personal borrower might have a marginal tax and Medicare rate as high as 46.5%, a superannuation fund has a maximum tax rate of 15%. Gearing properties into superannuation funds with low tax rates and during periods of low inflation rates is simply an appallingly bad strategy. To make it worse, the falling property prices have chilled capital gains. To a significant degree, over-building and property speculation pre global financial crisis was fuelled by a combination of first home buyer grants from both state and federal governments, which in some states and at particular times amounted to over $30,000 together with no doc loans. No doc loans were an open invitation for borrowers to misstate aspects of their income or assets. The global financial crisis has blown that environment away, and properties must inevitably fall significantly to align with more realistic market conditions. Undisclosed Long-Term Costs Worse still is that stringent audit requirements in self managed superannuation funds means that the inclusion of geared property inside sub-trusts creates significant increased annual audit expenses which will stay with the fund on a long-term basis. The real estate spruikers and bank lenders don’t tell you about that. In summary, this is a bad strategy which should be avoided. Overall Verdict on the Property Market Nobody rings a bell at the top of a market or at the bottom of a market, but the evidence suggests that substantial portions of the Australian property market have a long way to fall as yet. Personal Disclosure The only property the Middletons own is their home. Best wishes. Graham Middleton Director Synstrat Management Pty Ltd Ref:J:\DOCUMENT\Management Letters\FYR 1 July 2012 to 30 June 2013\All clients property market 13072012.doc

Synstrat Management Pty Ltd is the holder of Australian Financial Services Licence No: 227169.