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New Wealth Drivers: SMSF's and China

Monday, October 14, 2013

By: Jon Giann

 

There were quite a few comments on my last piece that i thought were worth fleshing out a bit.

If you missed it, the argument in a nut shell is that self-managed super funds (SMSFs) are now sitting on a massive pile of cash (bigger than Westpac). They have a fairly small exposure to residential property, and surveys suggest they’d like to increase it. If they did, and took advantage of rules that allow them to leverage, we could see a huge surge into property.

First of all, thanks to Greg M for picking up on a mistake. I said that SMSFs could leverage against assets. As he correctly points out they can’t. SMSFs are allowed to borrow to invest, though the exact rules have changed a few times in recent years.

My reading is that it works the same for SMSF as it does for you and I, with certain deposit and loan to valuation ratios enforced by the banks. This means that SMSFs can leverage, but only off cash holdings.

I got a bit lazy with the distinction between cash and assets there. But it doesn’t change the numbers at all. SMSFs have more than enough cash to cover the kinds of property exposure they’d reportedly like, so those quick back-of-the-envelope calculations I did still hold water.

But thanks Greg for keeping me on my toes. It’s good to know my readers won’t let me get away with intellectual sloppiness.

Second, Amanda was wondering that if there was a demand for 700,000 properties from SMSFs, who would fill them? As she rightly says, “they have to fill those houses with tenants to see a return on investment… 700,000 or so more tenants need to be found in a very short time…”

The answer to Amanda’s question is exactly the dynamic that is going to drive prices higher.

If SMSF demand suddenly caused an increase in supply of 700,000 homes, then that’s right, there would be a glut of rental properties, and rental and property prices would fall.

But that’s never going to happen.

It’s funny. I write around 1,000 words per article and some people get a fixation on one single point like the 700,000 homes. The reason I mention it is to highlight how much money is in SMSF’s and what potentially is possible.

Here’s the reality…

As I said, we build about 70,000 homes a year at the moment, so unless we really start cranking up production, it would take ten years to build that many homes.

And as Amanda says, SMSFs are going to want to see a return on their investment. So the most likely scenario is that the SMSFs will just go after existing properties that are tenanted already.

That means they’re going to start competing for the existing investment properties already out there. Maybe some will build off the plan, but typically investors favour established dwellings.

But there’s only a limited number of those. So that means that all this extra demand is just going to jack up the price.

Remember it’s 700,000 properties at current price levels. As the price level goes up, SMSFs will need fewer actual homes to get the exposure they want. Some other investors will cash-out or get squeezed out of the market, and at some point, the market will find a new equilibrium.

I don’t know exactly what that end point would look like, but the only guarantee in that scenario is that prices will be a heck of a lot higher.

My mate John Fitzgerald pointed me to some back-of-the-envelope calculations he did. Now John is worth squillions, and has over 5,000 property transactions to his name. When he talks, I listen.

John agrees with the basic maths I’ve got. But he compares the SMSF appetite to the value of sales. He says that in Australia we sell around $190 billion in residential property each year.

With gearing, he reckons 30 percent of SMSFs alone could buy every residential property sold in Australia, for the next three years!

As he says, almost 3,000 SMSFs are being set up every month! In his mind, it’s a total game changer.

He reckons this is one of the factors that helps explain one of the property market puzzles of recent times. We’ve seen prices, particularly in Sydney growing strongly (if we annualised September’s growth we get something close to 30 percent!).

But credit is only growing at 4.7 percent. How can that be? How can we have a boom without credit growth? That’s never happened before.

He reckons the answer is that there are new buyers in the market that we’ve never seen before. One is SMSFs.

The other is the Chinese.

And he reckons it’s taken the market by surprise, because 6 years ago, neither buyer existed.

As he says, “I look at China and you can take my numbers on SMSF and quadruple them and still not come near the capacity there. John McGrath told me that one of his Sydney auctions in September had 16 registered bidders – all Chinese origin and all cash buyers.”

“The top two house sales in Australia this year were for $52m and $33m, both to the Chinese and both in cash.”

I’ve been saying this for a while too. I don’t think most people realise the kind of wealth machine that China has become.

Before the GFC, to make the top 50 wealthiest list in China you needed $6 million. Today, you need $3 billion. These days, they’re creating 25 billionaires per month!

China’s top 20 percent had $1.4 trillion in bank savings last year. John notes that just 13 percent of that would buy every house in Australia, in one year.

Thanks John. That’s some serious food for thought.

(And I think this probably answer’s Tom’s question from the last post, right?)

We’ve got a cyclical upswing combining with a massive paradigm shift in the make up of the market, with the twin giants of China and the SMSFs letting their presence be felt.

It’s going to be HUGE!

And thanks everyone for the comments. I don’t often have time to respond but I do follow them closely, and I’m always impressed and humbled by the intelligence and knowledge that’s on display.

As I said, it definitely keeps me on my toes. I can’t slack off with you lot around!

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