The last recession in Australia was in 1991 and it looks like Covid is going to end one of the longest continuous economic growth periods in Australian economic history. Since then there has been significant leverage built into the system and we feel the strong run in house prices pre-Covid and the subsequent decline poses one of the greatest risk to the wider economy in a downturn.
Dividend Investing has put together a list how to short Australian housing market to take advantage of decline in house prices. Another way of looking at the list of ideas below is to be aware that if you are not aware before, these positions will have a downside exposure to the property market.
In any trade timing is just as important as entry price. The goal of the play book is to prepare ahead of time and when the situation does rise, the groundwork has been to execute the strategies.
Short Idea 1: Shorting Australian Banks
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One of the most direct means of shorting Australian housing is to short Australian Banks. The Australian residential lending market is dominated by the domestic banks where they have more than 70% of the total market share.
This means that the banks are especially susceptible to fall in property prices. Furthermore as banks are in the practice of borrowing short and lending long on a levered basis any decline in house prices will have a magnified impact on bank earnings and equity value.
We expect the headwind of increase bad debt charges not just from housing but also from consumer loans and the market has already started to price in future falls in earnings and dividends through sell off in the bank share prices. Albeit this has recovered somewhat.
Bank earnings are procyclical which rises faster than the broader market when the times are good. During periods of stress, especially real estate related stress the inherent leverage of the banks magnify the erosion of capital and shareholder value.
Book values of banks in times of broader real economy weakness is not to be trusted. We are skeptical on any bounces in the share prices until there is a clear visibility to the end of the recession and we suspect it will only arise once there is a long term solution in dealing with the virus.
The downside of this idea is the high cost of carry in holding the short position. For example based on Westpac dividend history the stock is trading a high single percentage dividend yield and higher once franking credits are included. Even if dividends are cut this can make a pro-long hold of the position very expensive.
Short Idea 2: Short A-REITs ETFs
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Real estate investment trusts are investment funds directly own and operate real estate assets. Australia does not have residential REITs and the listed REITs represent predominately the commercial and industrial real estate sector.
We think short real estate in general or avoiding REITs is another good way of shorting the Australian property market. As we saw from the US experience during the financial crisis when there is a slow down in the residential markets there will be overflow impact on the broader commercial real estate market as well.
The impact of Covid is already seen in the performance of the retail REITs as a large portion of the tenant base simply stopped paying rents. As time goes when a larger portion of the workforce is able to work from home efficiently we think the office sector will also not be immune as companies reevaluate their occupancy footprint with an eye in managing costs.
Short Idea 3: Short Australian Dollar
The Australian corporate lending market sector is severely concentrated in the big 4 banks. Any weakness in the property sector will have flow on impact for the broader economy access to credit.
The tightening of credit will affect both businesses and consumers which will magnify the impact across the non-real estate sectors of the economy.
On a macro level, a de-leveraging recovery means a prolonged weakness for consumer spending and long recovery trend. We expect the shape of the recovery to be inline with the European economic recovery post the debt crisis.
The best way to take advantage of wider systemic risk similar to short housing is short the Australian dollar either against the USD or JPY. Given the record low interest rates, the negative carry cost of holding the position is now very limited.
Any government initiative in stabilising the system is equivalent of risk transfer from the private sector to the public sector. Arguably short term a positive but long term negative which is not good for the AUD. But if government let the crises run through the system with minimal intervention this will also put pressure on the AUD as well.
It is one of those ideas in which upside from a shorting Australian housing could come from a number of avenues.
Selling Specific Property Stocks
There are a number of sectors and stocks which directly operate in or benefit from activities in the property sector. These are just some specific names which immediately comes to mind.
Short Idea 5: Listed Real Estate Developers
Share price of developers like Mirvac, Lend Lease and CIMIC will not escape any slowdown unscathed. Although if you can get borrow, we would focus on smaller residential developers which are not as diversified as the first two and has more project concentration risk.
Short Idea 6: Real Estate Listing Companies – Domain Holdings (ASX DHG) and Realestate.com.au (ASX REA)
One name we are keenly keeping an eye out is REA Group. REA Group owns Realestate.com.au which is a listing site for Australian residential properties. REA is essentially a secondary derivative play on the housing market which it is earnings is wholly dependent on the overall health and volume of the residential market.
A number of factors makes shorting REA group one of the best way to short the property market.
- Pure exposure to Australian real estate sale volume is big negative for REA as there are no offsetting earning streams in the business. REA earns fees when sellers list their property on the market. Previous earnings were driven by increase in penetration of internet listing and growth in the sale volume which both factors will slow down going forward.
- One lesson we learned and follow is not shorting a company based on high valuation. In REA’s case, the high valuation provide support but not a primary driver of our short thesis.
- The Australian market is dominated by high dividend stocks but REA is not one of them. It is more attractive to short REA verses the likes of the Australia banks given the high carry cost bank dividends. REA dividends yield is not material given the high share price in relation to the dividend amount paid annually.
- One of the recent new product or development for the company is offering financial products like mortgages as part of the product suite. Given the expected slow down in housing approvals nationally and slow volumes make us feel that this part of the business will generate as much earnings as you expect going forward.
The market has priced in the stock at a level where the historical earning growth is expected to continue into the future. We would question the growth assumption going into a weaker housing market environment and the stock price could be negatively impact if growth fails to materialize.
It does own real estate listing sites in Europe and parts of Asia as part of its growth story however as an avid growth investor, we see these parts of the business to be immaterial to earnings for at least 3 to 5 years down the track.
We don’t mean to pick on REA as by all signs the management has a good grasp of the business and done well for shareholders. The issue we point out is more of a macro headwind where the business will be swimming against the tide for awhile and it will have to work a lot harder to maintain the momentum going forward.
Short Idea 7: Avoid Consumer Discretionary Stocks
Discretionary retailers can also be a good opportunity to express this view. The likes of JB Hi Fi and Harvey Norman are already under pressure from ecommerce and Covid just accelerated the trend (lessen the time for them to adjust). We like Wesfarmers for its hardware sector exposure but it still own Target / Kmart which won’t do well out of this.
Risk Identification
In summary there are number of ways to short Australian real estate. The exact means of executing the strategy is dependent on the investor risk tolerance, ability to short specific names through the broker. But the list is just as applicable for long investors in these names as the underlying thesis and drivers of the value for most of these ideas are a strong and healthy housing market which is difficult to see in the next few years.
In a way this is an outline of the risks of owning going long A-reits, specific names, the Australian dollar and more important the Australian banks.