The bond market, even more so than the stock market, is often a key indicator of investor expectations and the overall health of the economy.

Figure 1 shows the RBA reported bond yields on treasury bonds from 90-day bills to 10-year, long term bonds. From March to April this year, long term yields decreased more than short term ones. This is called “flattening” of the yield curve and is often a sign of lower investor confidence and a bleaker future outlook for the economy. From April to May, the opposite effect can be observed: while yields for all maturity dates decreased, the yield curve steepened slightly. The drop in short term yields reflects the RBA’s decision at the start of May to cut the official cash rate by 25 basis points (0.25%).

So what has happened since the interest rate cut?

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The development space in inner Melbourne and Sydney is set to be severely challenged. Conversations between Secret Agent and various developers over the past month have revealed their increasing anxiety about potential settlement issues. These developers, who have settlements due in the next 18 months, are worried that many of their apartments may not be able to settle due to the restrictions placed on foreign buyers by local banks. This is likely to have substantial implications.

For some time now, developers have used successful business models to sell their projects directly to Asia. Sales companies who specialise in selling unseen apartments to the Chinese market have made large financial gains. These apartments, many of which are tiny by local standards, have been purposely designed for the overseas market. Committed contracts, once thought to be rock solid, are now on shaky ground.

To understand the problem at hand, let us consider a hypothetical situation. An investor group, on behalf of a developer, sells a small two bedroom CBD apartment to a buyer based in Shanghai. The buyer pays $714,000 for the 68sqm apartment, which is $10,500 per square metre, and pays a 10% deposit. Since the transaction was entered into 12 months ago, the investor has no stamp duty to pay at settlement. It so happens that this purchaser defaults. The developer gets to keep the 10% deposit minus fees. The problem is that there is a need to sell the apartment to someone else.

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For the first time since December 2008 in Australia, consumer prices have fallen. According to the ABS, the March 2016 quarter saw the consumer price index fall by 0.2%. This is big news.

Whether the deflation numbers are noise or signal, it’s hard to say just yet. However, it poses an interesting question: what would be the impact on the Australian property market if deflation were to creep further into our economy? Secret Agent intends to cover this a little further over the coming month, but for today, let’s look at the impact on commercial property.

Commercial property is a much desired asset for investors. The allure of a lease that guarantees the investor a return over a period of time is highly attractive, especially in a world of low returns. Rent increases every year are a common component of leases and either a fixed percentage increase or CPI measure is used. This begs the question; what happens if we continue to move into deflationary conditions?

While most new leases use a fixed percentage increase, some leases are still using CPI as the rate of increase. Also, many older leases that are still current operate on a CPI basis. We may start to see leases that produce rent decreases for tenants annually and erode the value of some buildings, especially where long leases and terms have been secured by tenants.

The current reality is that negative bond yields are being acquired globally. A world with deflation could mean future tenants secure a fixed rate of decrease over the term of the lease, or negotiate hard for CPI-only leases.

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Yields down since last month and almost back to levels in April 2015

As part of our continued series on interest rates, Secret Agent has been tracking movements in the bond yield curve since late last year. If you don’t know why bond yields are so important for property investors, download our yield curve report.

So far this month, short, medium and long term treasury bond yields are down by between 0.06% for 90 day bills and 0.16% for 10 year bonds. This is shown below.

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Bond yields provide a reliable way to make predictions about monetary policy. This week’s bulletin explores why this is the case.

What is a yield curve?

A yield curve is made by plotting the interest rates of bonds against their maturity dates. A normal yield curve occurs when long-term rates are higher than short-term rates. This is important for an economy’s liquidity, as banks can make a profit by borrowing at the (lower) short-term rates and lending at (higher) long-term rates.

What is a cash rate?

When banks borrow funds from each other in the overnight market, they can charge a special interest rate set by the Reserve Bank of Australia. This is known as the cash rate.

Let’s look at the current yield curve on Australian Treasury bonds with maturities between 90 days and 10 years (above). Parts of the yield curve are inverted (pointing downwards), meaning short-term rates (90 days) are higher than some long-term rates (2, 3 and 5 years). This creates a disincentive for banks to lend and if the entire curve is inverted, it can lead to a “credit crunch”. This happened in the US during the global financial crisis, when money suddenly dried up because banks could no longer profit from lending out money.

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Bitcoin (BTC) has experienced an extraordinary and turbulent run in the market over the past few months. The conversion rate has at times been upwards of $1000 USD per Bitcoin. If you held one BTC for 12 months you could have made returns in excess of 50x.

Paul Osborne and Julian Faelli recently attended Paris’ LeWeb conference (http://leweb.co/) to explore this intricate currency further and shed some much needed light on the topic.

These digital currencies are a serious play now. The fact that we are talking about it seems to suggest it has some real staying power. US senate committee hearings have deemed the rise of digital currencies as legitimate. Property developers in China have started to offer their apartments for purchase with fixed BTC exchanges from a purchaser. Last month there were three independent Bitcoin events held in New York by Wells Fargo, New York State’s Superintendent of Financial Services and the New York City Economic Development Corporation (NYCEDC), an organisation set up to drive economic development, growth and jobs in New York.

Secret Agent was the first company to accept BTC payments within the Victorian market for real estate services. We are proud to welcome Cosmo McIntyre to our team, the catalyst to our start into digital currencies. Cosmo continues to help Secret Agent explore this emerging market.

There are many sceptics; Jamie Dimon CEO of JP Morgan, arguably one of the most powerful bankers in the world, has recently canned the crypto-currency; “it’s a terrible store of value”. While we still think that the risks are great, there is no doubt that Bitcoin has a future in itself or as a catalyst for paving the way for other e-currencies. It has some very interesting attributes recently highlighted by tech- entrepreneur legend Mark Andeessen who is behind such ventures as Digg, LinkedIn and Twitter.

Bitcoin can be bought, sold and transferred for free with no transaction fees, or for a very minimal amount depending on which broker you use. BTC solves the problem of trust, establishing a fool proof method of transferring money between two unrelated parties over an un-trusted network – the internet. The possibility of other digital property being transferred in this way is very real. Digital contracts, digital keys, digital signatures, and digital ownership of physical assets, could be one day safely transferred.

BTC is a very practical solution for micropayments over the internet. Traditionally merchant fees, credit card fees and exchange rates have been a prohibitive factor when wanting to pay/charge small amounts over the internet. Bitcoin’s ability to be almost infinitely divisible makes it the perfect payment solution for micro payments. Online news publications could charge a fee per article, train tickets purchased individually, and songs streamed over the net could be charged on a per listen basis. These are all very viable solutions.

It’s likely that the Bitcoin currency could fail in its quest to be the prime adopted digital currency. However in doing so it will have paved the way for another digital contender to emerge in its place. There are now over 60 virtual currencies. A home purchase taking place with a virtual currency, or even a landlord accepting rent payments are all future possibilities.

From Julian Faelli, Head of Design – Create By Secret Agent

What defines a city? Is it the environment, the amenities or the people that inhabit it? Michael Storper a ‘economic geographer’ is one of the new breed of academics thinking about what makes our cities unique and livable. He argues that cities that host a large proportion of ‘non routine work’ (creative industries and sectors that continually innovate) will continue to do well out of the increasing trend towards urbanisation.

The end of manufacturing has brought upon the gentrification that we have seen in urban environments and in turn increased the attractiveness of a city as a place to live. This gentrification process has happened time and time again in Melbourne over the past two decades, pushing up the cost of living in the suburbs that have been ‘discovered’. The latest being Seddon – in the inner west.

The most interesting point raised by Storper is that cities and there products are inherently different – they have fine grained patterns of specialization that set them apart and provide a competitive edge in the globalised economy. Cultural context and localism will be the key drivers of successful cities into the future.

With the election around the corner we thought it was timely to ask:

How do elections affect the property market in inner-city Melbourne?

Using data based on over 112,000 sales in inner-city Melbourne between January 2002 and July 2013, Secret Agent investigated the last three federal elections – 2004, 2007 and 2010.

All three elections experienced a decline in average inner-city Melbourne property prices in the twelve month period encompassing both lead-up and preceding six months of the election (Figure 1). These declines were particular evident for the 2007 and 2010 election periods when looking at the last decade of property prices (Figure 3).

It was not until six months after the elections (Figure 2) that housing prices began to fluctuate less and experience steadier, upward growth.

Looking at what has happened the last three elections, with the upcoming election in September 2013 we could see fluctuating, but declining property values over the next few months, followed by steady positive growth over the following year.

Figure 1 – 12 Month Election Period (2013 in red)

Figure 2 – 12 Month Period (starting 6 months post election)

Figure 3 – Average Monthly Sales Price, Jan 2002 – July 2013 

theage.com.au today has an article, which discusses the income required by a couple , with two children – to service a property purchase within Melbourne.

The dark blue areas show were the largest income is required to purchase a property.  What surprised me is not so much the Eastern suburbs or inner city income requirements,  but the incomes required to purchase property in outer Melbourne areas.

An unusual study conducted in the U.S. by the Pacific Northwest Research station has suggested that properties with trees planted on or in the surrounding areas somehow boost the value of the property itself!

In the study, it was observed that rental units with trees on the property experienced an increased valuation of $5 monthly, $21 if the street the unit is situated on is lined with trees and as much as a $13,000 sales price hike if trees are found on the next door neighbour’s property (which was suggested by the utility of shade without the hassle of raking leaves!).

The question to ask is whether this merely relates to a desire for shelter from the meteorological elements or other intrinsic factors. Trees by themselves provide a carbon sink, absorbing carbon dioxide from the surrounding air and thus providing a more oxygen rich environment, and their root systems help to keep soil together, preventing erosion from occurring.

Additionally, on a psychological level, it would make sense that a neighbourhood adorned with healthy trees, lush gardens and well kept lawns would not only suggest that the residents love their homes and neighbourhood but that the neighbourhood as a whole is ‘of the good sort’ to live in.

Whatever the reason, and whether this study is to be believed, there would be no harm in adding a bit of flora to your properties, if not for money then for beauty.