Weekly Reports | Oct 05 2018
Weekly Broker Wrap: housing; real estate; A-REITs; and gambling.
-Australian housing correction broadens and deepens
-Sydney out of “bubble risk” territory but housing still overvalued
-Recent results from listed retailers considered negative for retail A-REITs
-UK online bookies expected to extend global reach, negative for Tabcorp market share
By Eva Brocklehurst
Across Australia house prices fell for the 12th straight month in September, to be down -3% on a year ago. Weakness is centred on detached housing, although apartment prices also fell.
Melbourne sustained the sharpest fall and, Morgan Stanley observes, it appears to be catching up with Sydney and Perth. Brisbane remains the only major city with any price growth. The broker also notes auction clearance rates remain at a level that, historically, indicates future price weakness.
PIMCO notes house prices are still 40% above levels of 2012, when credit was freely available and strong foreign demand powered the market. These factors appear set to reverse in the near future.
Falling house prices and rising costs for debt servicing reduce discretionary income and generate negative wealth affects, and the analysts suggest this will constrain consumption and prevent the Reserve Bank of Australia from raising its cash rate above 1.5% for some time.
This forms the basis for PIMCO's conservative view of a lower neutral cash rate and a benign environment for Australian bond yields. Australian banks are also expected to be negatively affected, given large exposures to the housing sector.
Bailieu Holst notes investors, on average, took 47% of the housing finance in the most recent boom which compares with just 25% of households living in private rental. Although investor loans are down -23% from their peak, a further -33% decline is required, the analysts believe, just to get back to an average share of the market.
Bailieu Holst also points to elevated political risk as the Australian Labor Party, if forming government next year, could procure changes to negative gearing and capital gains tax arrangements. Hence, the analysts suggest the housing bear market is likely to be extended.
A general uptrend in arrears in Australian mortgages is also apparent. As the correction broadens and deepens, Morgan Stanley assesses the risks in the residential mortgage-backed security asset class.
The broker's model points to another -5-10% decline in house prices over the next 9-12 months that will increase the tail of households with negative equity. This particular cohort would be vulnerable to any shock in employment, both in terms of spending and the potential for forced selling.
Thus far, Queensland and Western Australia are the main regions with an uptick in arrears, although the performance of those with mortgage loan-to-valuation ratios of over 80% are much weaker across-the-board, and arrears are tracking at 3%.
UBS, in its global real estate bubble index, suggests the first cracks are starting to appear, as house prices declined in half of the prior year's "bubble risk" cities. Bubble risk jumped in Munich, Amsterdam and Hong Kong.
The growing imbalance stems primarily from house prices in cities decoupling from respective national averages and local incomes. Most households cannot afford to buy property in the top financial centres without a substantial inheritance and rents continued to consume significant share of income.
Index scores fell in one third of the cities and Stockholm and Sydney experienced the steepest drop. Sydney reached bubble risk territory in 2015 because of buoyant foreign demand, low interest rates and exuberant expectations, UBS notes. Having peaked in 2017 the market has since corrected -5% in real terms because of tighter mortgage lending. Yet, despite the index score plunging, UBS considers the city still highly overvalued.
Australian real estate investment trusts (A-REITs) returned -1.8% in September and underperformed the market by 0.5%, UBS observes. Globally, the sector was down -2.0% in US dollar terms. In the year to date A-REITs have returned -2.3% versus the global index at 0.8%.
In September, office A-REITs outperformed both industrial and retail. The main outperformance came from Growthpoint Properties ((GOZ)), Investa Office ((IOF)) and BWP Group ((BWP)). Those underperforming included Vicinity Centres ((VCX)), Scentre Group ((SCG)) and Goodman Group ((GMG)).
At a macro level, part of the underperformance of A-REITs can be explained by rising 10-year bond yields both in the Australia and the US and Shaw and Partners also notes a switch back to risk after tariffs in the US and China trade war were lower than the market had anticipated.
The broker notes those that outperformed relatively also included Centuria Industrial ((CIP)) and Propertylink Group ((PLG)), both subject to takeover bids, as well as Arena REIT ((ARF)) and Growthpoint.
Shaw and Partners has Buy ratings on Centuria Capital ((CNI)), Vicinity Centres, Stockland ((SGP)), Scentre Group, Centuria Metropolitan ((CMA)) and Mirvac ((MGR)) although the latter two are now trading near targets. The broker maintains a Sell rating for Gateway Lifestyle Group ((GTY)), as the stock is subject to a takeover, while Centuria Industrial and Goodman are considered expensive.
Citi believes the implications of recent results from around 20 listed retailers are negative for retail A-REITs. Retailers in the sample reported modest comparable sales growth of 2.8% and only 26% grew sales at, or above, 4%, the level of rental growth embedded in specialty leases.
This indicates occupancy costs will continue to rise for many existing tenants. Retailer margins, meanwhile, declined an average of -38 basis points. Citi points out the impact of subdued sales growth can be offset if retailers enjoy margin expansion, but when margins narrow this compounds the downside risk.
The broker expects retailers will seek reduced rents when their leases expire. To the extent the broker's sample is representative, the risk remains that shopping centre owners continue to add space at a faster pace than is warranted by tenant demand.
Despite intense regulation, Goldman Sachs estimates the world's legal gambling market, ex lotteries, was worth US$300bn in 2017 versus US$187bn 15 years ago. The broker forecasts 7.1% growth per annum in the global sports betting market, with a strong increase in the US following the easing of regulation.
Further online migration is expected and online should expand its share of the global market to 17.2% in 2023 from 13.6% in 2017, with the adoption of sports betting growing even faster.
Goldman Sachs expects those with scalable technology, diversified regulatory and product exposure and strong cash flows will expand globally while the industry will undergo consolidation. The broker expects UK online bookies will increase their global exposure outside of the UK/Europe and local heavily retail-based operators such as Tabcorp ((TAH)) and William Hill are at risk of losing market share to scale players.
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