The NAB drama and its implications for the US banking system dominated the weekend, so many may have overlooked the importance of the KGB Interrogation of Mirvac CEO Greg Paramor. I advise all those interested in the commercial property market to read it in full, but here are three points that I want to highlight:
– Paramor believes that the Australian property industry is looking at a re-run of the 1990-93 property decline. We are about to experience a sharp fall but probably not as severe as 1990, because we do not have a surplus of commercial property in most sectors. However there are no certainties. Paramor says that in 2008 we are at the equivalent phase we were in during 1990 so the bad times will last for at least three years and possibly longer. Paramor is effectively advising that those with weak balance sheets may struggle to last out the three to five years. We are going to see forced sales and possibly failures.
– Already property selling pressure is building up and Paramor says we are likely to see the base component of property valuation, the so called 'cap rate' , rise by between half and one per cent. My comment on that prediction is to quote Rob Stanton of JPMorgan who says that a one per cent rise in the cap rate would trigger write-offs by the listed property trust sector of about $14 billion, assuming a 40 per cent average gearing. Stanton is forecasting a 0.8 per cent to one per cent rise, so he is in accord with Paramor. Stanton says that when the Australian market for listed property trusts was at its bottom it was expecting much larger cap rate increases and was foreshadowing write-offs of around $40 billion. That would make the 2008-11 property decline larger than 1990. Stanton believes that, given there is no glut of commercial property, the original market prediction was too severe, but interestingly Paramor makes an ominous prediction for the property market, saying that it is likely to turn out to be the worst market in 30 years. He then puts caveats on that prediction, but he has an inner fear because of the looming contraction in the supply of capital.
– I asked Paramor whether Mirvac should raise equity quickly given the rise in prices for listed property trusts. He replied: “You have a point. You might be absolutely correct. We raised some money at the beginning of the year...to make sure we were in good shape." And Paramor is right – compared to others, Mirvac is in good shape. Other less secure listed trusts need to either raise money or sell properties. There is no time to lose.
– Paramor says that the “jury is out” on the stapling of property income trusts to development businesses. I would not be so kind. So far is been an absolute disaster. The institutions have stupidly required big payouts, so the trusts have been paying out non-cash development profits instead of investing back in the development business. In turn this has weakened balance sheets.
If NAB chief executive John Stewart is right about the US banking crisis, then the shortage of capital around the world is going to be acute. We are now seeing banks like St George and Bendigo offering 8.6 per cent for deposit money and the big four banks are not far behind at 8.4 per cent. That means that property loans are going to cost well above 10 per cent and so yields have to be higher again, with lots of properties headed for the market because gearing is too high. That’s why I urge all Business Spectator readers to listen to Paramor and, if they are exposed, act quickly.
