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SYDNEY MARKET UPDATE - AUGUST 2008
General Economic Information
There is no doubt that the Australian Economy is slowing. Growth is easing, inflation is on the rise, consumer sentiment is falling, interest rates are high, the Australian dollar is at 25 year highs, retail sales are weakening, and building approvals are dropping - not to mention what is happening on the Stock Market.
Demand for Labour is still strong however, although according to the Reserve Bank of Australia “a moderation in employment growth could be expected soon”.
On the upside, the strength of the Australian Mining / Commodities sector, driven by demand from China and India, along with the income tax cuts, should help insulate the economy from recession. The main danger here though is that both these factors could have the effect of actually accelerating growth, particularly if petrol prices and financial markets return to “normality” - meaning that Inflation may rise further and therefore Interest Rates to put the breaks on.
There is even some speculation that a “duel economy” may develop in Australia over the coming years, with those businesses involved in Mining and Energy continuing to boom, with other sectors possibly slipping into recession - particularly agriculture and manufacturing.
Indications at this stage point to the Australian economy contracting but still continuing to grow. Gross Domestic Product is tipped to fall from 4.3% in 2007 to around 3% in both 2008 and 2009 - still a strong economy in anyone’s language.
Things internationally are looking rather gloomy to say the least - particularly in the Developed World. The United States, United Kingdom and New Zealand all appear headed for recession, along with slowing economic activity in the European Union and Japan. Global Growth over the last 4 years however has been driven by Emerging Economies, in particular China, India, Latin America and Eastern Europe. These Emerging Economies grew by a staggering 7.5% on average, compared to the rather more sedate 2.5% of the Developed World.
Inflation is rising worldwide, with forecasts indicating Global Inflation could hit 4.9% during 2008. This provides something of a dilemma for Central Banks around the world - increase rates to slow inflation but risk recession or decrease rates to stimulate the economy but risk inflation becoming rampant.
One further black cloud on the horizon is China - particularly with respect to levels of activity following the Beijing Olympics. History tells us that countries hosting an Olympic Games go through rapid growth in the run up to the games due to heavy investment in infrastructure, but that activity slows considerably after the event. Chinese growth is certainly tipped to moderate in the coming years down from almost 12% to around 10% by 2009, whether the Olympic Hangover will effect this further remains to be seen.
The “Running of the Bulls” is officially over and there is now a “Bear in there” - to put things simply. The share market has had its worst full year result in 26 years with a fall of approximately 17% by the end of June 08. Those sectors of the market most effected were Consumer Discretionary (down 43%), Industrials (down 37%), Financials (down 35%) and Utilities (down 32%). On the flipside Energy stocks rallied 35% in 07/08, whilst Materials also grew 18%.
There seems to be no end to the gloom, with markets becoming increasingly pessimistic as false dawns are followed by further falls. Market Sentiment is the major enemy here, once that turns, logic should replace hysteria - and not even Warren Buffet knows when that will happen.
The property market has been hot over the past 6 years or so. In fact it has been the biggest property investment boom since the 1980’s. Non-residential investment has grown at an average of almost 12% during this period. That said domestic economic and property market sentiment have plummeted in recent months driven by the global credit crisis, which is described by the International Monetary Fund to be “the largest financial shock since the Great Depression”.
The credit crunch, and the tightening of the worldwide availability of credit, has resulted in a number of major property owners being forced into asset sales - often where there has been pressure from banks to reduce the level of gearing. These forced sales raise the prospect of the market slumping significantly.
Concerning also is a recent IMF statement indicating “Credit quality across many loan classes has begun to deteriorate with declining house prices and slowing economic growth”.
Until recently however, investment intentions still remained positive, with a large amount of work already in the pipeline. Total engineering construction work committed but yet to be done as of the end of March 2008 stood at over $50B - indicating that there is some strength here.
The major problem confronting the industry at this stage is what effect the tightening in credit availability will have on new building starts - which anecdotal evidence suggests is having a major impact.
The outlook for institutional projects looks positive. State and Territory governments have started spending additional dollars on projects ranging from transportation and water infrastructure through to health and educational projects. Total State Government spending is tipped to increase to $49B in the 2008 / 09 financial year - the bulk of this being in Queensland.
In New South Wales the Capital works budget for the coming year is set at almost $14B, with $57B to be spent over the next 4 years. This increase coincides with the Commonwealth Government focussing on upgrading the nations infrastructure through the development of the funds, the Building Australia Fund (Transport and Communications), the Education Investment Fund (Higher and Vocational Education) and the Health and Hospitals Fund (Health Facilities). These funds will provide $40B worth of future capital investment in infrastructure.
Housing markets around the world are slumping, with prices in the USA down 20% from their peak and the UK down 6.3% with possibly more to come. Dwelling approvals are down 8.1% in Australia, 60% in the USA and 45% in the UK. Given that the housing boom in Australia has been stronger and longer than both the USA and the UK, a fall here, should it eventuate, could be quite dramatic
On the positive side, the Reserve Bank of Australia’s tightening of monetary policy over the past 6 years may actually have prevented the housing market from over-heating and therefore negated the prospects of collapse here.
Housing construction levels here have been well below long term averages over the past few years, which coupled with National Population growth at it’s highest levels since the late 1980’s, has resulted in a serious under supply in housing stock pushing up both prices and rents. This under supply could actually result in a substantial surge in house prices when conditions (economic and interest rates) start to improve.
Until recently Economists were predicting a further possible interest rate rise prior to Christmas, however the most recent economic data released (particularly Retail Sales data) has increased the likelihood that interest rates have actually peaked and that they are more likely to be eased over the coming months before easing further in 2009.
Uncertainty and lower consumer sentiment typically translate into lower discretionary spending, which along with slower economic growth and more difficult credit conditions should result in a slow down in retail construction in the coming months.
Approvals data also suggests that after a huge increase during 2007, driven by expansion / refurbishment of suburban shopping centres and regional retail development, construction levels will contract during 2008.
The Tax Cuts in 2006 and 2007, whilst also offsetting the interest rate rises, also drove a rebound in consumer spending in the latter half of those years. This along with low unemployment levels and continued wages growth, sets up the prospect that retail spending could bounce back in early 2009.
Has been one of the busier sectors of the market over the past few years. This has been despite pressures on the manufacturing sector due to intense import competition and a high Australian dollar. This has dramatically altered the Industrial Property landscape with demand for factory space declining steadily, however this has been more than offset by an increase in demand for warehousing space during the same period.
There has also been a dramatic influx in money flowing into the commercial industrial sector over the past few years. Industrial vacancy rates have been very low at approximately 0.8%, which has been the lowest of any commercial property sector.
Again the fundamentals of the sector remain sound, however tightening credit conditions and the drop in business confidence, along with possible falling asset prices, could result in this sector flattening considerably in the short term.
Tourism / Hospitality Projects
The Hospitality sector continues to perform strongly, with high demand from local and international clients. Indeed the bulk of activity seems to be driven out of the UAE, India and Asia, however building approval data suggests that local construction activity should also increase over the latter half of this year due to low vacancy rates and increasing visitor arrivals.
The domestic travel market should remain strong as people elect to take local holidays rather than expensive international holidays, however there may be some decrease in business expenditure on travel, corporate getaways, and the like as business confidence erodes and corporate purse strings tighten accordingly. Anecdotal evidence suggests that this may be happening already.
There is little doubt that the commercial property market will be in for a much tougher time in 2008, with some commentators actually predicting a major collapse. CBD office vacancies had fallen to their lowest levels in almost two decades earlier in the year, however softening economic conditions coming at a time when more new building stock is coming onto the market could result in significant price falls. Prime commercial stock should maintain relatively low vacancy rates, however lower grade stock may be in for a bumpy ride.
There is no doubt that the heat has come off the market here in the past 3-4 months or so. Total positions listed have dropped approximately 35-40% during this period - but to put this into perspective, positions listed are still approximately 50% above what we would call a good market.
What this means in reality, is that the market is still a very tight market. Good staff are hard to come by, and this will not change in the short term. Very few practices are being forced to reduce staff numbers, and the majority of practices still remain confident that the market will bounce back sooner rather than later. In fact anecdotal evidence is suggesting that a small number of practices are “hoarding” quality staff rather than reducing numbers due to the perceived difficulty in replacing them when the market improves again.
The bulk of the fall has occurred in the Architectural Sector, with the position composition moving heavily away from documentation based roles and again focussing on highly talented mid-level staff. The Interiors Sector remains relatively buoyant, generally speaking. Activity across corporate, retail and hospitality seemingly the main drivers.
At this stage indications are that overall hiring intentions will remain positive, candidates will remain in short supply, wages will continue to increase (although at a slower pace), however there could be some ups and downs before the market starts to improve, possibly in the first half of 2009.