Before we begin this Bennelong Funds Management podcast, we would like to acknowledge the traditional custodians of the land on which we are recording and pay our respects to elders past, present, and emerging. We celebrate the stories, culture and traditions of Aboriginal and Torres Strait Islander communities who work and live on this land, and we commit to an ongoing journey of reconciliation and respect.
Holly Old:
Hello and welcome to the latest installment of our Quay Global Investor podcast series. My name is Holly Old, one of the account directors with Bennelong Funds Management. Joining me today is Chris Bedingfield, co-principal and portfolio manager with Quay Global Investors. Chris, welcome.
Chris Bedingfield:
Hey Holly. Great to be here actually with you this time in Melbourne.
Holly Old:
Sure is. Chris, the Quay team have released their latest investment perspective article, which is focused around probably one of the most discussed topics by Australians, the housing market. And I thought today was a great chance to hear your thoughts on the housing market and where it goes from here. But I just wanted to start with one sort of simple question I wanted to put to you. March, it's been a really wild ride for one single month of the year. What are you thinking around what's transpired during March? And if you can give us some thoughts on that.
Chris Bedingfield:
It's been, as you say, a wild ride and no doubt about it. I mean, we backtrack a little bit. If you go back to January this year, there was sort of this sense that central banks were getting towards the end of the hiking cycle and portfolio did really well in January. We're up around 10.5% I think, and in the hedged product and around 7.5% in unhedged and sort of felt like we were getting towards the end of that cycle, but we sort of bumbled our way through February a little bit. And then you've had, from a macro point of view, a lot of news in March. We've had obviously pretty strong economic numbers coming out of not only the US but Australia unemployment seems is staying very low and pretty strong numbers, economic numbers coming out of Europe, Germany was nowhere near as bad as what people thought the same in the UK.
And so the rate height cycle started again and we got that sort of selloff. And then of course the big news in the middle of the month, Silicon Valley Bank going down, Signature Bank going down, Credit Suisse, my alumni, has been taken over by UBS. And so fears of that global financial crisis, it's like that PTSD that the market has. It’s “oh, no here we go again, global financial crisis”. And then we saw this massive rally in bond yields. I thought that some of our stocks get a bit of a kick along because the bond yields were rallying and in the short term they're sensitive to bond yields, but they got sold off again because that PTSD of the global financial crisis. And so yeah, it's just been that just one hit after another. And I think we're seeing the equity market in the US bounce back pretty strongly.
And I think sensibly, I think investors are looking at the events particularly on the banking side over the last week. And I think sensibly coming to the conclusion that this is not a global financial crisis situation, it's it there's a couple of unique situations that's happened in the banking sector, there's no doubt about it, but we're not looking at this stage at a wholesale shutting down of credit “Lehman style” moment. I think the equity market is kind of taking that into account and from our perspective, a portfolio perspective, nothing much has changed. We've just come through reporting season. Most of our investors have reported recently, not all of them are December period ends, so there's still a couple of companies haven't reported, and there's always some disappointments at the margin and there's some surprises at the upside at the margin as well. And I think by and large, the portfolio is performing in aggregate the way that we thought it should be in terms from an earnings point of view, prices are just, they're just subject to macro at the moment and there's not much you can do about it in the short term.
What I can say is a lot of our investees have very, very little debt to roll this year. Those companies that do have debt to roll this year, they've either got asset sales that they've already executed and yet to settle or they have significant undrawn lines of credit that they can use. So our investees are in really good shape if things do deteriorate from here. And the earnings are still pretty much in line with what we're going for or what we were hoping for. So not much change, but it's certainly been a lot to keep us busy and keep us active and keep us thinking.
Holly Old:
Yeah, great. Has been an interesting month, that's for sure. So as I mentioned at the start, Chris, we had a recent Investment Perspectives that you guys produced and we've distributed and it's focusing around the Australian housing market and which is always an interesting topic for everybody. We've had 10 interest rate rises in a row, is that correct? I mean there's been that many, I've lost count of them now I think.
Chris Bedingfield:
Well, let's call it 350 basis points, 350 basis points.
Holly Old:
Fair call.
Chris Bedingfield:
We'll stick to that.
Holly Old:
All right, excellent. And what does that tell you about the future of house prices in Australia and have you got some comments on that?
Chris Bedingfield:
Yeah, it's interesting. The national housing markets are off around 10% since interest rates started to rise. And that's in the very short term, interest rates can do that sort of shocks a few people out of the market in terms of people thinking they're buying. They sort of sit back a little bit and they look at the market and say, well, I'll just see where this settles before. So there's a bit of a buyer strike, but I think it's interesting. We've also had a seller strike as well. Volume on the market is way down compared to pre-COVID levels. So we haven't seen a lot of stock come through. So not a lot of buying, not a lot of selling. Volumes are down and prices have drifted down over the last 12 months.
Interestingly, the Australian experience is not unique. We've seen exactly the same in the United States. We've seen the buyers step back a little bit in US housing market, but the sellers have also held on. So in the US typically at this time of year, you'd have 1.2 million houses on the market. In the US there's about 400,000 at the moment. So exactly the same as Australia. You've got a seller strike and you've got a buyer strike. And where people are transacting that the prices have gapped down a little around 10% in Australia and year-on-year in the US it's kind of flat at the moment, believe it or not, it's actually housing prices kind of relatively flat year-on-year.
But what's really interesting is we are starting to see, particularly Sydney and Melbourne clearance rates have picked up and prices, if you follow the core logic daily price index, the prices are starting to tick up. I think Sydney's up very close to a 1% so far in March, which is extraordinary given the commentary around interest rates. And a lot of commentators, we think very incorrectly, point to interest rates as the driver of real estate. That's true in the very short term, generally is because of those factors I pointed out. But there's a big sort of different story that's happening in the Australian real estate market that people are aware of but I don't think gets enough attention. And that story is that at a national level, I think you can put forward an argument that we have an under supplied situation of Australian property. We see that in the rental market where rents have been growing at double-digit rates, particularly in Sydney and in Melbourne we have a sort of very tight supply market. We have an immigration program that is likely to bring in another 400,000 net people this year. So we have a demand surge, we have tight supply, and then you have a reserve bank, a central bank, that has been lifting interest rates, sending a signal to developers and builders to stop building and stop developing.
So not only is supply tight, future supply is going to get even tighter. And if you look at housing starts in Australia, they're falling pretty quickly. The development equation doesn't work. Regular listeners to our podcasts know the way we think about real estate is not about interest rates and it's not about comparable sales. It's prices relative to the cost of production. And when prices fall below the cost of production, supply stops. You can do whatever you like with interest rates, but if supply stops and you need to build more supply in the future, prices have to adjust at some stage in order to make the development equation work. And I think we are starting to see that a little bit in Australia. We're starting to see the tightness of the rental market, the tightness in the overall supply of new housing.
Holly Old:
You've got a really interesting acronym then I've heard you talk about FORA as opposed to FOMO. Explain that to me.
Holly Old:
Chris Bedingfield:
Yeah, I'm kicking myself because the paper that you alluded to, and when it went to print, I was thinking that night I was thinking, ah, I thought of a great acronym I should have put in there FORA, yeah. So I think anyone listening to this podcast have probably heard of FOMO, which is fear of missing out. And I guess the real estate market was like that in 2020, 2021. Yeah. I think FOMO, fear of missing out has changed to FORA, which is fear of renting again. And I think that's what’s caused a bit of the supply strike that's happening. And there's a very bearish kind of narrative in the residential commentary at the moment. There's a few pretty public people running with this and the reserve bankers running with this story as well, which is that roughly a third of mortgages in Australia are fixed and half of those are going to expire in the next 12 months.
Holly Old:
So this is this fixed rate mortgage cliff that we keep hearing about?
Chris Bedingfield:
Yeah, the fixed rate mortgage cliff, everything's got to have a cliff because that's scary, right? Fixed rate mortgage ball maybe?
But yeah, that's exactly right. It's the fixed rate mortgage cliff that everyone's talking about. And that sounds scary. You can input some hard numbers around it. I think the RBA says that 800,000 people on these low rates and those mortgages are going to come to market. And that's scary. And the tsunami of supply, the inference is the supply will come as everyone recalibrates. And I think it's very easy to, from a clickbait point of view to write those things. But if you think about it with a cool head and rationally, if a third of Australian mortgages are fixed, that means two thirds of Australian mortgages are floating. So 66%, call it 67%, of Australian mortgages are floating and they've already copped the higher rate and we haven't seen the supply come through yet.
So if 67% of mortgages have hit the higher rate and they haven't panicked, well what's to think that half of the next third are going to panic or 16%? Now I'm sure there's people within that gap, that area, that will need to sell. People always need to sell just part of life; financial reasons, human reasons, whatever. But is it going to cause a tsunami of new supply? Well, we haven't seen it with the 67% of people that have already had the hit, the RBA put out another paper saying that off the people with the fixed mortgages on average, some of them have higher metrics, leverage metrics, but it's only at the margin. So again, if you look at people on fixed mortgages, around 9% of those people have loan to income ratios above six times compared to 6% of people on variable loans. So yes, it's slightly riskier, but it's not that much more risky.
And so I think there's a lot of fear in the market about this mortgage cliff that you talk about, but I think when you really look at it from a logical and a cool perspective, it's probably not as bad as people say. As I said, almost 70% of people faced the rate hike already and they haven't panicked. And the reason they haven't panicked, I do think it's FORA. If you think of someone who saved 10 years of their life to come up with a deposit, they've bought a house last year or the year before, their decision tree is, well, I'll just hold on. I'll cut back on the Netflix's or the Apple TVs, or I'll cut back on some discretionary spending. I'll put off buying the next mobile phone or whatever it is, and I'll hold on. That's one decision. Or they can go the other way and say, I'll sell 10% down. I'll torch my equity. I'll probably be out of the housing market now for the next 15 years as I save again and I have to then go into a blistering hot rental market and try and find somewhere to live. So when you frame it that way, yes, the rates are going up, but I'm not sure it's going to lead to a tsunami supply because of those factors.
Holly Old:
Yeah, that's really good to hear. I just wanted to ask you one final question. Have we learned anything from previous cycles? What makes this different? Comments on that?
Chris Bedingfield:
Oh, well, I suppose some people have and some people haven't. You're alluding to with the banking crisis and whatnot and the GFC, look, I think from a real estate perspective, even from a banking perspective, I think there was a lot of lessons learned by regulators, central banks participants, the banking system, even Ben Bernanke's own words was wildly unregulated in the United States prior to the GFC and Ben Bernanke, sorry, Greenspan I should've said, truly believe that it was in the banker's own interest to protect the balance sheet. And he got it wrong and he admitted he got it wrong. And after the financial crisis, banks were heavily recapitalized. They pulled back on their risky lending, lending against income rather than assets. We have seen a lot of discipline sort of re-enter, and I think one of the problems that we have in financial markets is we're always fighting the last war.
We're always thinking that the next thing that's going to hurt us was the last thing that hurts and it never is. I remember after 2001, 2003, 2004, everyone thought it was another tech wreck that was going to bankrupt the economy, and it turned out it was housing and now it's always, it's the banks and housing that's going to blow up. And it's never that. It's always something else. And in fact, turns out to be sovereign bonds was the thing that kind of blew up Silicon Valley Bank, government bonds was the thing that killed it. I mean, who would've picked that? So yeah, we're always fighting the last war, but I think we have learned the lessons in the banking system. There's always going to be bad banks run badly and they'll go bad, but it's not as systematic as what we saw during the GFC.
It's not banks levered 50 to one lending at 90% LVRs against really, really full valuations. Just don't see that widely. And then on the real estate side in Australia and the United States, I think we've done a tremendous job de-levering and making sure that liquidity is there. Access to liquidity, yeah, maybe the lessons haven't been learned as well in Europe where levering is still pretty high. But by and large, I think a lot of the lessons have been learned, and I do believe whatever the next crisis is, it's something that no one is talking about. It never is. As I said, so many people always looking in the rear vision mirror for the next accident because they only remember the last accident and it very rarely is.
Holly Old:
Thank you Chris, very much for your time today. Your insights have been amazing as always. If you'd like any further information on the Quay Global Real Estate Fund, don't hesitate to reach out to your Bennelong account manager. Thank you again, Chris, for your time, and I look forward to our next chat.
Chris Bedingfield:
Cheers, Holly. It's great to be here.
If you enjoyed this podcast or want to know more, please visit our website, bennelongfunds.com and subscribe to receive our regular insights or contact us directly for more information.
