The Mortgage Industry Omnishambles – The Property Imperative 17 March 2018

Today we examine the Mortgage Industry Omnishambles. And it’s more than just a flesh wound!

Welcome to the Property Imperative Weekly to 17th March 2018. Watch the video, or read the transcript.

In this week’s review of property and finance news we start with the latest January data from the ABS which shows lending for secured housing rose 0.14% or 28.8 million to $21.1 billion. Secured alterations fell 1%, down $3.9 million to $391 million.  Fixed personal loans fell 0.1%, down $1.2 million to $4.0 billion, while revolving loans fell 0.06%, down $1.3 million to $2.2 billion.

Investment lending for construction of dwellings for rent rose 0.86% or $10 million to $1.2 billion. Investment lending for purchase by individuals fell 1.34%, down $127.7 million to $9.4 billion, while investment lending by others rose 7.7% up $87.2 million to $1.2 billion.

Fixed commercial lending, other than for property investment rose 1.25% of $260.5 million to $21.1 billion, while revolving commercial lending rose 2.5% or $250 million to $10.2 billion.

The proportion of lending for commercial purposes, other than for investment housing was 45% of all commercial lending, up from 44.5% last month.

The proportion of lending for property investment purposes of all lending fell 0.1% to 16.6%.

So, we are seeing a rotation, if a small one, towards commercial lending for more productive purposes. However, lending for property and for investment purposes remains quite strong. No reason to reduce lending underwriting standards at this stage or weaken other controls.

But this also explains the deep rate cuts the banks are now offering – even to investors – ANZ Bank and the National Australia Bank were the last of the big four to announce cuts to their fixed rates, following similar announcements from the Commonwealth Bank and Westpac. NAB has dropped its five-year fixed rate for owner-occupied, principal and interest home loans by 50 basis points, from 4.59 per cent to 4.09 per cent. The bank has also reduced its fixed rates on investor loans by up to 35 basis points, with rates starting from 4.09 per cent. And last week ANZ also dropped fixed rates on its “interest in advance”, interest-only home loans by up to 40 basis points, with rates starting from 4.11 per cent. Further, fixed rates on its owner-occupied, principal and interest home loans have fallen by 10 basis points, with rates now starting from 3.99 per cent.  This fixed rate war shows our big banks are not pricing in a rate hike anytime soon.

But we think these offers will likely encourage churn among existing borrowers, rather than bring new buyers to the market.  For example, the ABS housing finance data showed that in original terms, the number of first home buyer commitments as a percentage of total owner occupied housing finance commitments rose to 18.0% in January 2018 from 17.9% in December 2017 – and this got the headline from the real estate sector, but the absolute number of first time buyers fell, thanks mainly to falls of 22.3% in NSW and of 13.3% in VIC. More broadly, there were small rises in refinancing and investment loans for entities other than individuals.

The latest data from CoreLogic shows home prices fell again this week, with Sydney down for the 27th consecutive week, and their index registering another 0.09% drop, whilst auction volumes were down on last week. They say that last week, the combined capital city final auction clearance rate fell to 63.3 per cent across a lower volume of auctions with 1,764 held, down from the 3,026 auctions over the week prior when a slightly higher 63.6 per cent cleared.  The weighted average clearance rate has continued to track lower than results from last year; when over the corresponding week 75.1 per cent of the 1,473 auctions sold.

But the strategic issues this week relate to the findings from the Royal Commission and from the ACCC on mortgage pricing. I did a separate video on the key findings, but overall it was clear that there are significant procedural, ethical and even legal issue being raised by the Commission, despite their relatively narrow terms of reference. They cannot comment on bank regulation, or macroprudential, but the Inquiries approach is to examine a series of case studies, from the various submissions they have received, and then apply forensic analysis to dig into the root causes examining misconduct. The question of course is, do the specific examples speak to wider structural questions as we move from the specific instances. We discussed this on ABC Radio this week.

From NAB we heard about referrer’s providing leads to the Bank, outside normal lending practices and processes, and some receiving large commissions, despite not being in the ambit of the responsible lending code. From CBA we heard that the bank was aware of the conflict brokers have especially when recommending an interest only loan, because the trail commission will be higher as the principal amount is not repaid. And from Aussie, we heard about their reliance on lenders to trap fraud, as their own processes were not adequate. And we also heard of examples of individual borrowers receiving loans thanks to poor conduct, or even fraud. We also heard about how income and expenses are sometimes misrepresented. So, the question is, do these various practices show up more widely, and what does this say about liar loans, and mortgage systemic risk?

We always struggled to match the data from our independent household surveys with regards to loan to income, and loan to value, compare with loan portfolios we looked at from the banks. Now we know why. In some cases, income is over stated, expenses are understated, and so loan serviceability is a potentially more significant issue than the banks believe – especially if interest rates rise. In fact, we saw very similar behaviours to the finance industry in the USA before the GFC, suggesting again we may see the same outcomes here. One other point, every lender is now on notice that they need to look at their current processes and back book, to test affordability, serviceability and risk. This is a big deal.

I will also be interested to see if the Commission turns to look at foreclosure activity, because this is the other sleeper. Mortgage delinquency in Australia appears very low, but we suspect this is associated with heavy handed forced sales. Something again which was apparent around the GFC.

More specifically, as we said in a recent blog, the role and remuneration models for brokers are set for a significant shakedown.

Turning to the ACCC report on mortgage pricing, this was also damming. Back in June 2017, the banks indicated that rate increases were primarily due to APRA’s regulatory requirements, but now under further scrutiny they admitted that other factors contributed to the decision, including profitability. Last December, the ACCC was called on by the House of Representatives Standing Committee on Economics to examine the banks’ decisions to increase rates for existing customers despite APRA’s speed limit only targeting new borrowers. The investigation falls under the ACCC’s present enquiry into residential mortgage products, which was established to monitor price decisions following the introduction of the bank levy. Here are the main points.

  1. Banks raised rates to reach internal performance targets: concern about a shortfall relative to performance targets was a key factor in the rate hikes which were applied across the board. Even small increases can have a significant impact on revenue, the report found. And the majority of existing borrowers would likely not be aware of small changes in rates and would therefore be unlikely to switch.
  2. A shared interest in avoiding disruption: Instead of trying to increase market share by offering the lowest interest rates, the big four banks were mainly preoccupied and concerned with each other when making pricing decisions. It shows a failure in competition (my words).
  3. Reputation is everything: The banks it seems were very conscious of how they should explain changes. As it happens, blaming the regulators provides a nice alibi/
  4. For Profit: Internal memos also spoke of the margin enhancement equating to millions of dollars which flowed from lifting investment loans.
  5. New Loans are cheaper, legacy rates are not. Banks of course are offering deep discounts to attract new customers, funded by the back book repricing. The same, by the way, is true for deposits too.

The Australian Bankers Association “silver lining” statement on the report said they welcomed the interim report into residential mortgages, which clearly shows very high levels of discounting in the Australian home loan market. It’s clear that competition is delivering better deals for customers, shopping around works and Australians should continue to do so to get the best discounts on the advertised rate. But they are really missing the point!

We will see if the final report changes, but if not these are damming, but not surprising, and again shows the pricing power the major lenders have.

So to the question of future rate rises. The FED meets this week, and the expectation is they will lift rates again, especially as the TRUMP tax cuts are inflationary, at a time when the US economy is already firing. In a recent report Fitch Ratings said that Central banks are becoming less cautious about normalising monetary policy in the face of strong growth and diminishing spare capacity. They expect the Fed to raise rates no less than seven times before the end of next year. And while still sounding tentative, the European Central Bank is clearly laying firm groundwork for phasing out QE completely later this year. They now also expect the Bank of England to raise rates by 25bp this year.

Guy Debelle, RBA Deputy Governor spoke on “Risk and Return in a Low Rate Environment“.  He explored the consequences of low rates, on asset prices, and asks what happens when rates rise. He suggested that we need to be alert for the effect the rise in the interest rate structure has on financial market functioning, and that investors were potentially too complacent.  There are large institutional positions that are predicated on a continuation of the low volatility regime remaining in place. He had expected that volatility would move higher structurally in the past and this has turned out to be wrong. But He thinks there is a higher probability of being proven correct this time. In other words, rising rates will reduce asset prices, and the question is – have investors and other holders of assets – including property – been lulled into a false sense of security?

All the indicators are that rates will rise – you can watch our blog on this. Rising rates of course are bad news for households with large mortgages, exacerbated by the possibility of weaker ability to service loans thanks to fraud, and poor lending practice. We discussed this, especially in the context of interest only loans, and the problems of loan resets on the ABC’s 7:30 programme on Monday.  We expect mortgage stress to continue to rise.

There was more discussion this week on Housing Affordability. The Conversation ran a piece showed that zoning is not the cause of poor affordability, and neither is supply of property. Indeed planning reform they say is not a housing affordability strategy.  Australia needs a more realistic assessment of the housing problem. We can clearly generate significant dwelling approvals and dwellings in the right economic circumstances. Yet there is little evidence this new supply improves affordability for lower-income households. Three years after the peak of the WA housing boom, these households are no better off in terms of affordability. In part, this may reflect that fact that significant numbers of new homes appear not to house anyone at all. A recent CBA report estimated that 17% of dwellings built in the four years to 2016 remained unoccupied. If we are serious about delivering greater affordability for lower-income Australians, then policy needs to deliver housing supply directly to such households. This will include more affordable supply in the private rental sector, ideally through investment driven by large institutions such as super funds. And for those who cannot afford to rent in this sector, investment in the community housing sector is needed. In capital city markets, new housing built for sale to either home buyers or landlords is simply not going to deliver affordable housing options unless a portion is reserved for those on low or moderate incomes.

But they did not discuss the elephant in the room – booming credit. We discussed the relative strength of different drivers associated with home price rises in a separate, and well visited blog post, Popping The Housing Affordability Myth. But in summary, the truth is banks have pretty unlimited capacity to create more loans from thin air – FIAT – let it be. It is not linked to deposits, as claimed in classic economic theory.  The only limit on the amount of credit is people’s ability to service the loans – eventually. With that in mind, we built a scenario model, based on our core market model, which allows us to test the relationship between home prices, and a series of drivers, including population, migration, planning restrictions, the cash rate, income, tax incentives and credit.

We found the greatest of these is credit policy, which has for years allowed banks to magic money from thin air, to lend to borrowers, to drive up home prices, to inflate the banks’ balance sheet, to lend more to drive prices higher – repeat ad nauseam! Totally unproductive, and in fact it sucks the air out of the real economy and money directly out of punters wages, but make bankers and their shareholders richer. One final point, the GDP calculation we use in Australia is flattered by housing growth (triggered by credit growth). The second driver of GDP growth is population growth.  But in real terms neither of these are really creating true economic growth. To solve the property equation, and the economic future of the country, we have to address credit. But then again, I refer to the fact that most economists still think credit is unimportant in macroeconomic terms! The alternative is to continue to let credit grow well above wages, and lift the already heavy debt burden even higher. Current settings are doing just that, as more households have come to believe the only way is to borrow ever more. But, that is, ultimately unsustainable, and this why there will be an economic correction in Australia, and quite soon. At that point the poor mortgage underwriting chickens will come home to roost. And next time we will discuss in more detail how these scenarios are likely to play out. But already we know enough to show it will not end well.

Affordable housing policy failure still being fuelled by flawed analysis

From The Conversation.

Australia has a housing affordability problem. There’s no doubt about that. Unfortunately, one of the reasons the problem has become so entrenched is that the policy conversation appears increasingly confused. It’s time to debunk some policy clichés that keep re-emerging.

Is ‘zoning’ to blame?

It can be tempting to frame the housing affordability problem as all about inadequate new supply. According to this argument, the “demand side” drivers – such as low interest rates and tax incentives for property investment – have combined with population growth in the capital cities to fuel house prices, and new housing construction simply hasn’t kept up.

“Zoning” is often blamed. There is little hard evidence, though, to show systematic regulatory constraint.

Supply is at record highs, and in the right places

Australia’s new housing supply per capita is actually very strong by international standards. Over the past decade, supply of new units and apartments has been flowing in job-rich metropolitan areas with dense populations, which are also higher-value locations.

According to the cliché, this supply response should have cooled prices. Yet dwelling price inflation has surged even in metropolitan areas where new housing supply has exceeded population growth.

The fallacies of ‘filtering’

One of the great hopes underpinning the supply cliché is that new housing stock improves affordability even if these homes are not affordable for lower-income groups. This faith is based on a theory called “filtering” whereby older housing moves down to the affordable end of the market over time.

The empirical data on filtering are thin. Indeed, the academic literature has historically cast doubt on the theory. However, some commentators continue to claim that American rental housing markets provide evidence that “filtering” can occur in practice.

But whatever might happen in the US, in Australia there’s still no evidence to suggest new housing supply has filtered across the housing stock to expand affordable housing opportunities for low-income Australians, or that it will do so any time soon.

Prominent economists continue to produce data that suggest the potential impact of new supply on price is minimal. The shortage of affordable housing opportunities for low-income households in Australia remains persistent. And the evidence indicates that low-income working households in our cities consistently face housing costs well above accepted affordability levels regardless of the quality of the housing they live in.

Sustaining supply in a cooling market?

Some commentators cite cooling house prices as evidence that the supply response is taking effect. Whether or not that is so (above and beyond demand-side factors like higher interest rates for investor loans), expect the pipeline to start slowing down. Private sector development is driven by profit and risk and, as we have seen over many years, is characterised by speculative booms and busts.

Developers can turn off the new supply tap much more quickly than they can turn it on. Falling prices, weak consumer sentiment and economic uncertainty mean many developers will not follow through on building approvals until the market recovers.

This means that high levels of supply output are rarely sustained. Recent housing data in Western Australia provide a case in point. WA recorded rising completions in 2014, 2015 and 2016. But 2017 completion figures are expected to show a drop of around a third as prices have shaded off since the end of the mining boom.

Put simply, the market on its own will never solve Australia’s housing affordability problem. Expecting developers to keep building in order to reduce house prices is pure fantasy.

Planning reform is not an affordable housing strategy

We’ve written before about the political appeal of calling for planning reform instead of real solutions to housing affordability pressures. In fact, Australian states have embarked on more than a decade of planning reforms.

They have aimed to: standardise and simplify planning rules; promote mixed use and higher-density housing near train stations; and overcome local political opposition to development through the use of independent expert panels.

Housing targets for both urban infill and new greenfield areas have been a feature of metropolitan plans to drive dwelling approval rates since at least 2000.

These reforms have been effective in overcoming regulatory constraints. The scale of the recent supply response shows clearly that zoning and development assessment processes are not inhibiting residential development approvals in cities like Sydney and Melbourne.

But trying to accommodate Australia’s population growth in towers around railway stations will fail as an affordable housing strategy – even if “zoning” and height rules were completely scrapped.

Rather than narrow deregulation agendas, bigger picture reforms are needed. Aligning infrastructure funding with metropolitan and regional decentralisation is a critical long-term strategy. Reforms to deliver affordable housing in communities supported by new infrastructure are long overdue.

A bigger affordable housing sector is needed

Australia needs a more realistic assessment of the housing problem. We can clearly generate significant dwelling approvals and dwellings in the right economic circumstances. Yet there is little evidence this new supply improves affordability for lower-income households. Three years after the peak of the WA housing boom, these households are no better off in terms of affordability.

In part, this may reflect that fact that significant numbers of new homes appear not to house anyone at all. A recent CBA report estimated that 17% of dwellings built in the four years to 2016 remained unoccupied.

If we are serious about delivering greater affordability for lower-income Australians, then policy needs to deliver housing supply directly to such households. This will include more affordable supply in the private rental sector, ideally through investment driven by large institutions such as super funds. And for those who cannot afford to rent in this sector, investment in the community housing sector is needed.

In capital city markets, new housing built for sale to either home buyers or landlords is simply not going to deliver affordable housing options unless a portion is reserved for those on low or moderate incomes.

Authors: Nicole Gurran, Professor of Urban and Regional Planning, University of Sydney; Bill Randolph, Director, City Futures Research Centre, Faculty of the Built Environment, UNSW; Peter Phibbs, Director, Henry Halloran Trust, University of Sydney; Rachel Ong, Professor of Economics, School of Economics and Finance, Curtin University; Steven Rowley, Director, Australian Housing and Urban Research Institute, Curtin Research Centre, Curtin University

Government Policy Contributes to Affordability Problems – HIA

“The current housing affordability crisis is the product of two decades of policy neglect,” HIA Managing Director Shane Goodwin said today.

“It is the core issue that HIA has championed fixing, and is responsible for the affordability challenge facing Australian cities.

“For too long governments have chosen quick fix options to the very long term problem of housing affordability. Australia needs brave and bold policies that go to the heart of the affordability problem,” Mr Goodwin said.

“We need to resume the discussion around tax especially where it cascades applies to land and housing and put an end to upfront taxes that are keeping so many first home buyers out of the market.

“We need to get serious about planning reform, these things are the keys to solving housing affordability which have largely been overlooked by State and Federal Governments.

“We need all tiers of government back at the table, driving these discussions and implementing change.

“HIA has said for a long time now that the problem of housing affordability in simple terms, comes down to supply and demand – more land needs to be freed up, and the punitive taxes like stamp duty that come with buying a home need to be done away with.

“State governments should take on policies like fixing planning rules to allow more homes to be built in inner and middle-ring suburbs of our largest cities, and continue to support the supply of new land around
our cities to achieve the right balance of housing supply.

“It is pleasing that today’s Grattan industry report mirrors HIA call for reform, but HIA cautions against any changes to migration.

“The problem of housing affordability is one of supply and demand – houses will not get built if the population doesn’t grow, and the main driver of population growth in Australia is migration.

“Migration issues aside, HIA is urging State and Federal Governments to get moving on reform, rather than sticking to the current politically safe and largely ineffective measures of dealing with housing affordability,” Mr Goodwin concluded.

A good point, but we also observe that availability of low cost credit, and weak lending standards has also driven affordability lower. This must also be addressed, or else more supply just means bigger debts, and more trouble for households. Time for some joined up thinking!

Migration and Housing Affordability

From The Conversation.

So much of Australia’s history and success is built on immigration. Migrants have benefited incumbent Australians by raising incomes, increasing innovation, contributing to government budgets, smoothing over population ageing and diversifying our social fabric. But it is also true that immigration is affecting house prices and rents.

Australian governments are squandering the gains from migration with poor housing and infrastructure policies. Our new report, Housing affordability: re-imagining the Australian dream, shows what’s at stake. Unless the states reform their planning systems to allow more housing to be built, the Commonwealth should consider tapping the brakes on Australia’s migrant intake.

Immigration has increased housing demand

Australia’s migration policy is its de-facto population policy. The population is growing by about 350,000 a year. More than half of this is due to immigration.

Since 2005, net overseas migration – which includes the increase in temporary migrants – has averaged 200,000 people per year, up from 100,000 in the previous decade. It is predicted to be around 240,000 per year over the next few years.

Immigrants are more likely to move to Australia’s big cities than existing residents, which increases demand for scarce urban housing. In 2011, 86% of immigrants lived in major cities, compared to 65% of the Australian-born population.

Chart 1. Migration has jumped, and so have capital city populations

Grattan Institute, Author provided

Not surprisingly, several studies have found that migration increases house prices, especially when there are constraints on building enough new homes.

The pick-up in immigration coincides with Australia’s most recent housing price boom. Sydney and Melbourne are taking more migrants than ever. Australian house prices have increased 50% in the past five years, and by 70% in Sydney.

Chart 2: Net overseas migration into NSW and Victoria is at record levels

Grattan Institute (Data source: ABS 3101.0 – Australian Demographic Statistics), Author provided

Of course immigration isn’t the only factor driving up house prices and rents. Housing also costs more because incomes rose, interest rates fell and banks made it easier to get a loan. But adding 2 million migrants in the past decade has clearly increased how many new homes are needed.

We haven’t built enough homes

Housing demand from immigration shouldn’t lead to higher prices if enough dwellings are built quickly and at low cost. In post-war Australia, record rates of home building matched rapid population growth. House prices barely moved.

But over the last decade, home building did not keep pace with increases in demand, and prices rose. Through the 1990s, Australian cities built about 800 new homes for every extra 1,000 people. They built half as many over the past eight years.

We estimate somewhere between 450 and 550 new homes are needed for each 1,000 new residents, after accounting for demolitions. And because more families are breaking up and the population is ageing, more homes are needed to accommodate households with fewer members.

The imbalance between demand and supply has consequences. Younger and poorer households are paying more for housing, and owning a home depends more on who your parents are, a big change from the early 1980s.

Chart 3: Housing construction lagged population in the last decade, but has picked up

Grattan Institute, Author provided

Only in the past couple of years has construction started to match population growth, especially in Sydney. It’s no coincidence that Sydney house prices have finally moderated in the past six months.

But the backlog of a decade of undersupply remains. Development at today’s record rates is the bare minimum needed to meet record population growth built into Sydney’s and Melbourne’s housing supply targets over the next 40 years.

Chart 4: Strong housing construction will need to be maintained to meet city plan housing targets

Grattan Institute

So what should governments do?

Building more housing will improve affordability the most – but slowly. Even at current record construction rates, new housing increases the stock of dwellings by only 2% each year. But building an extra 50,000 homes a year nationwide for a decade would lead to national house prices between 5% and 20% lower than otherwise. Do it for longer and prices will fall even further.

State governments need to fix planning rules to allow more housing to be built in inner and middle-ring suburbs. More small-scale urban infill projects should be allowed without council planning approval. And state governments should allow denser development “as of right” along key transport corridors. The Commonwealth can help with financial incentives for these reforms.

But the politics of planning in our major cities is fraught. Most people in established middle suburbs already own their houses. Prospective residents who don’t already live there can’t vote in council elections, and their interests are largely unrepresented.

If we want to maintain current migration levels, along with their economic, social and budgetary benefits, we need to do better at planning to allow more housing to be built.

What does this mean for the migrant intake?

The Australian government should develop a population policy, as the Productivity Commission recommended. It should articulate the appropriate level of migration given its economic, budgetary and social benefits and costs. This should include how it affects the Australian community living with the reality of land use planning policy – and contrasting this with the effect of optimal planning policy.

If planning and infrastructure policies don’t improve, the government should consider cutting the migration intake. This would reduce demand for housing, but would also reduce the incomes of existing residents.

The best policy is probably to continue with Australia’s demand-driven, relatively high-skill migration and to build enough homes for the growing population. But Australia is in a world of third-best policy: rapid migration and restricted housing supply are imposing big costs on people who don’t already own their homes. If the states are not going to reform planning rules to increase the number of homes built, then the Australian government should consider whether reducing migration is the lesser evil.

Any reduction should be modest and targeted at the parts of the migration program that provide the smallest benefit to Australian residents and migrants themselves. Balancing these interests is difficult, because each part of the program has different economic, social and budgetary costs and benefits.

Cutting back family reunion visas would have substantial social costs. Limiting skilled migration would hurt the economy and many businesses. Restricting growth in international students would reduce universities’ incomes.

There are also broader costs to cutting the migrant intake. It would hit the Commonwealth budget in the short term. Most migrants are of working age and pay full rates of personal income tax. And many temporary migrants, such as 457 visa holders, can’t draw on a range of government services and benefits, including welfare and Medicare. More importantly, cutting back on younger, skilled migrants is likely to hurt the budget and the economy in the long term.

But there is no point denying that housing affordability is worse because of a combination of rapid immigration and poor planning policy. Rather than tackling these issues, much of the debate has focused on policies that are unlikely to make a real difference. Unless governments own up to the real problems, and start explaining the policy changes that will make a real difference, Australia’s housing affordability woes are likely to get worse.

Authors; John Daley, Chief Executive Officer, Grattan Institute; Brendan Coates, Fellow, Grattan Institute; Trent Wiltshire, Associate, Grattan Institute

The Better Affordability Silver Lining To The Home Price Clouds

The HIA Housing Affordability Index saw a small improvement of 0.2 per cent during the December 2017 quarter indicating that affordability challenges have eased thanks to softer home prices in Sydney where they are now slightly lower than they were a year ago. This makes home purchase a little more accessible, particularly for First Home Buyers. [DFA Editors note: though offset by tighter lending criteria now].

The HIA Affordability Index is produced quarterly and measures the mortgage repayment burden as a proportion of typical earnings in each market. A higher index result signifies a more favourable affordability

Shane Garrett, HIA Senior Economist said

Softer home prices in Sydney contributed to improved housing affordability during the final quarter of 2017.

Affordability conditions in Sydney are still more challenging than any other city. After Sydney, Melbourne has the second highest mortgage repayment burden.

It is often overlooked that affordability conditions are favourable in the markets outside of Sydney and Melbourne. Housing prices are more affordable in the other six capital cities today than has typically been the case over the past 20 years – primarily due to very low interest rates. Housing affordability is still a very acute problem.

To win the affordability battle, governments need to make tough decisions on reducing the tax burden on new home building, speeding up the planning process and releasing new residential land in a more timely fashion.

To Buy, Or Not To Buy, That IS indeed the Question

We get a steady flow of questions from those who read our research, or follow our posts, but one question, more than any other we get asked is –  Should I Buy Property Now? Many cite the real estate industry claims that now is a great time to buy – but is it really? Today we are going to explore this question, but with a caveat. This is NOT financial advice, and is simply my opinion, based our own research and surveys. Your mileage may vary. The market is different across states and locations.

Watch the video or read the transcript.

But it is an important question given that home prices appear to have reached something of a peak, and may be sliding in some areas; housing is Australia is unaffordable, as the recent Demographia report showed; banks are tightening their lending standards under regulatory pressure; net rental streams are looking pretty stressed; many households are under severe financial pressure, and mortgage interest rates are likely to rise.

In fact, we have a generation of home buyers and prospective home buyers who have only ever seen home values rise, and if you are in the property owning system, is has become a significant source of wealth creation, amplified if you are a property investor, and assisted by ultra-low interest rates, tax breaks and other incentives.  But will the good times continue to roll? Not necessarily.

So to decide if now is a good time to buy, consider these questions.

First, why do you want to buy a property? Up until recently, our surveys have shown the number one reason to buy was capital appreciation and wealth building, with finding somewhere to live a poor second. But now, if you are wanting to buy to grow wealth, we say be careful, as the market dynamics are changing, and its likely prices will slide. Also there may be changes to negative gearing under a Labor government, and property investment mortgage rates are likely to rise, while rental streams are not, so more investment properties, on a cash flow basis will be under water. At the moment there are much better returns from the buoyant stock market, though of course that may change. Remember that prices crashed by 40% in Ireland, 35% in the USA and 25% in UK after the GFC. Prices can go down as well as up. Property is not a one-way bet!

But, if you are seeking to buy, for somewhere to live, and capital growth is less important to you, then it may still be a good time to transact. Prices are already down, and many sellers are accepting deeper discounts off the asking price to make a deal. In addition, if you are a first time buyer, there are state incentives and really low mortgage rates available. But remember you are still buying into a highly unaffordable market, and the capital value of your property may fall. This could turn into a paper loss, and indeed should you need to sell, a real financial hit. The way a mortgage works is you put in a deposit, and the bank lends the rest. But in a falling market, it is your deposit which is eroded. After the GFC many households in the northern hemisphere ended up in negative equity, meaning the value of their mortgage was larger than the market value of their property. As a result, people were stuck living in their properties unable to move, hoping the market would rise again. In fact, it did over the next 10 years, so now many are no longer in negative equity. But it can be a long and winding road.

Next, if you do decide to buy, do the work. First look around at property available, and recent sales, to get a sense of the market. Also look in different areas, and even different states. Often locations a little further from public transport are cheaper – but then is the trade-off worth it? Also compare new builds with existing property. Often newly constructed homes carry a premium, which just like a new car, on first use falls away. On the other hand, there are some desperate builders out there, with big projects, and few buyers, especially in the high-rise belts of Brisbane, Melbourne and Sydney, so they may do a deal. We are seeing a steady stream of people who sign up for off the plan builds, but then when it comes to getting a mortgage, they cannot find one, so cannot complete. So read the small print on these contracts. Ask yourself, what happens if you cannot complete the transaction.

It is also harder to add any value to a new property, whereas an older one may offer more potential for investment and upgrade, and this can be a way of helping to preserve value. There is an old adage – buy the worst property on the best street. This is still true, with caveats – you should check the condition of the property so you know what you are up for.

Also, do the work when it comes to a mortgage. Our research shows you can often get better mortgage rates from some of the smaller customer owned lender, as opposed to the big four by going direct to them. So shop around. Whilst using a broker may help, again we find that some of the best rates are found by borrowers who do the work themselves. Many brokers will do the right thing, and really help, but there is a risk that the commission and ownership structure of broker firms may mean they do not have access to the best rates, and they may not always be working in your best interests, so be careful.

There is more work to do also, on affordability. A lender will make an offer of a mortgage, based on your financial details as contained in the application, and supporting evidence. Remember lenders want to make a loan – it is the only game in town in terms of their profitability – but there is evidence that some lenders will offer a bigger loan, by using more aggressive living expenses, and income assumptions. That said, the industry is getting more conservative, with lower allowable loan to value ratios, and some income categories now reduced.

Just because the lender says you can have a loan, does not mean you should get the loan. The lender is looking at risk of loss from their perspective, not yours. If you have a large deposit, then the bank can assume that capital is available on default to recover their mortgage. Remember in Australia, you cannot just walk away and return the keys, the liability stays with you. So, ask the lender, not just about repayments at current interest rates, but also what happens if they rise. A good rule of thumb is catering for a 3% rise in rates. Get the lender to tell you what the revised repayments would be at this higher rate, and ask yourself if you could still make the repayments. This is important, as incomes are not growing in real terms and mortgage rates may well rise. If you cannot make the repayments at 3% high, get a smaller loan, and buy a smaller place.

You may need to build your own cash flow to test what is affordable – again do not rely on the bank for this – remember they are concerned about risk of loss to their shareholders, not to you.  ASIC’s MoneySmart Budget Planner is a good starting point. Also, remember to include the transaction and stamp duty costs in your calculations.

Another area is the deposit you will need. These days you are likely to need a bigger deposit. 20% would be a good target, as this then avoids having to pay for expensive Lenders Mortgage Insurance. Above that, you will need this facility – which to be clear, protects the bank, not you!

More prospective borrowers are turning to the Bank of Mum and Dad, for help, but there are also risks attached to this arrangement – see our earlier Video Blog on the Bank of Mum and Dad. Some buyers are clubbing together to purchase, but there are risks attached to these arrangements too.

Finally, if you do buy, work on the assumption you will need to hold the property for some time – say a minimum of 3-5 years. The old trick of flicking after a year or so will not work if, as we expect prices fall. Remember too that there are additional costs to owning a property from council rates, running costs – such as electricity – and maintenance costs. Owning property is an expensive business.   Make sure these costs are included in your cash flows.

So what’s the bottom line?  If you are wanting to buy to put shelter over your family’s head, and can afford the mortgage, and are willing to accept a risk of loss of capital, then do the work, and it might be the right thing to do.  A capital gain is by no means certain in the current climate!

But, if you are looking at property as a wealth building tool, I think you might do better to hold off, as prices are likely to slide, and the costs of an investment mortgage are on the rise. At very least look in areas around Hobart and Adelaide where value is better at the moment.

In fact, though, the only reason I can see to transact in this case is to lock in a negative gearing arrangement now, before the next Federal election. But then, that seems to me to be a long bow, and our modelling suggests that the removal of negative gearing will have only a minor impact on the market. There are a bunch of other more compelling reasons to think the market will fall.

So in summary, whatever type of borrower you are, do the work and be very careful. Prices may rise, but they can also certainly fall, and a mortgage could just be a noose around your neck.

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Housing Affordability and Employment – The Property Imperative Weekly 27 Jan 2018

Housing in Australia is severely unaffordable, and despite the growth in jobs, unemployment in some centres is rising. We look at the evidence. Welcome the Property Imperative Weekly to 27th January 2018.

Thanks to checking out this week’s edition of our property and finance digest.   Watch the video or read the transcript.

Today we start with employment data. CommSec looked at employment across regions over the last year. Despite the boom in jobs, the regional variations are quite stark, with some areas showing higher rates of unemployment, and difficult economic conditions. Unemployment has increased in several Queensland regional centres in recent years. Queensland’s coastal regional centres such as Bundaberg, Gympie, Bundaberg and Hervey Bay, known more broadly as Wide Bay (average 9.0 per cent), together with Townsville (albeit lower at 8.5 per cent) have elevated jobless rates. Unemployment also increased along the suburban fringes and city ‘spines’ such as Ipswich (8.1 per cent) in Brisbane and the western suburbs of Melbourne (9.0 per cent). In Western Australia, Mandurah, south of Perth, experienced a significant decline in the jobless rate to an average of 7.0 per cent in December from 11.2 per cent a year ago. Higher income metropolitan areas, especially in Sydney’s coastal suburbs, dominate the regions with the lowest unemployment rates. However, the corridor between Broken Hill and Dubbo has Australia’s lowest regional unemployment rate at 2.9 per cent, benefitting from agricultural, tourism and mining-related jobs growth. You will find there is a strong correlation with mortgage stress, as we will discuss next week.

The Victorian Government has reaffirmed their intent to shortly accept applications for its shared equity scheme known as HomesVic from up to 400 applicants. We do not think such schemes help affordability, they simply lift prices higher, but looks good politically.  This was first announced in March 2017. The $50-million pilot initiative aims to make it easier for first-home buyers to enter the market by reducing the size of their loan, hence reducing the amount they need to save for a deposit. The initiative targets single first-home buyers earning an annual income of less than $75,000 and couples earning less than $95,000. Eligible applicants must buy in so-called “priority areas” which include 85 Melbourne suburbs, seven fringe towns and 130 regional towns and suburbs. In Melbourne, the list includes suburbs around Box Hill, Broadmeadows, Dandenong, Epping, Fishermen’s Bend, Footscray, Fountain Gate, Frankston, LaTrobe, Monash, Pakenham, Parkville, Ringwood, Sunshine and Werribee. Regional centres on the list include Ballarat, Bendigo, Castlemaine, Geelong, La Trobe, Mildura, Seymour, Shepparton, Wangaratta, Warrnambool and Wodonga. The state government said the locations were chosen in growth areas where there was a high demand for housing and access to employment and public transport. Some of these locations are where mortgage stress, on our modelling is highest – we will release the January results next week. The scheme is not available in most of Melbourne’s bayside suburbs, the leafy inner eastern suburbs or some pockets of the inner north.

Overseas, the US Mortgage Rates continue to rise, heading back to the worst levels in more than 9 months.  Rates have risen an eighth of a percentage point since last week, a quarter of a point from 2 weeks ago, and 3/8ths of a point since mid-December.  That makes this the worst run since the abrupt spike following 2016’s presidential election. While this doesn’t necessarily mean that rates will continue a linear trend higher in the coming months, the trajectory is up, reflecting movements in the capital markets, and putting more pressure on funding costs globally.

The Bank for International Settlements (BIS) has published an important reportStructural changes in banking after the crisis“. The report highlights a “new normal” world of lower bank profitability, and warns that banks may be tempted to take more risks, and leverage harder in an attempt to bolster profitability. This however, should be resisted. They also underscore the issues of banking concentration and the asset growth, two issues which are highly relevant to Australia. The report says that in some countries the 2007 banking crisis brought about the end of a period of fast and excessive growth in domestic banking sectors.  Worth noting the substantial growth in Australia, relative to some other markets and of particular note has been the dramatic expansion of the Chinese banking system, which grew from about 230% to 310% of GDP over 2010–16 to become the largest in the world, accounting for 27% of aggregate bank assets.

Back home, an ASIC review of financial advice provided by the five biggest vertically integrated financial institutions (the big four banks and AMP) has identified areas where improvements are needed to the management of conflicts of interest. 68% of clients’ funds were invested in in-house products. ASIC also examined a sample of files to test whether advice to switch to in-house products satisfied the ‘best interests’ requirements. ASIC found that in 75% of the advice files reviewed the advisers did not demonstrate compliance with the duty to act in the best interests of their clients. Further, 10% of the advice reviewed was likely to leave the customer in a significantly worse financial position. This highlights the problems in vertically integrated firms, something which the Productivity Commission is also looking at. The real problem is commission related remuneration, and cultural norms which put interest of customers well down the list of priorities.

The Financial Services Royal Commission has called for submissions, demonstrating poor behaviour and misconduct. It will hold an initial public hearing in Melbourne on Monday 12 February 2018. The not-for-profit consumer organisation, the Consumer Action Law Centre (CALC) said the number of Aussie households facing mortgage stress has “soared” nearly 20 per cent in the last six months, and argued that lenders are to blame. Referencing Digital Finance Analytics’ prediction that homes facing mortgage stress will top 1 million by 2019, CALC said older Australians are at particular risk. The organisation explained: “Irresponsible mortgage lending can have severe consequences, including the loss of the security of a home. “Consumer Action’s experience is that older people are at significant risk, particularly where they agree to mortgage or refinance their home for the benefit of third parties. This can be family members or someone who holds their trust.” Continuing, CALC said a “common situation” features adult children persuading an older relative to enter into a loan contract as the borrower, assuring them that they will execute all the repayments. “[However] the lack of appropriate inquiries into the suitability of a loan only comes to light when the adult child defaults on loan repayments and the bank commences proceedings for possession of the loan in order to discharge the debt,” CALC said. We think poor lending practice should be on the Commissions Agenda, and we will be making our own submission shortly.

The latest 14th edition of the Annual Demographia International Housing Affordability Survey: 2018, continues to demonstrate the fact that we have major issues here in Australia. There are no affordable or moderately affordable markets in Australia. NONE! Sydney is second worst globally in terms of affordability after Hong Kong, with Melbourne, Sunshine Coast, Gold Coast, Geelong, Adelaide, Brisbane, Hobart, Perth, Cains and Canberra all near the top of the list. You can watch our separate video where we discuss the findings and listen to our discussion with Ben Fordham on 2GB.  When this report comes out each year, we get the normal responses from industry, such as Australia is different or the calculations are flawed. I would simply say, the trends over time show the relative collapse in affordability, and actually the metrics are well researched.

Fitch Ratings published its Global Home Prices report. They say price growth is expected to slow in most markets and risks are growing as the prospect of gradually rising mortgage rates comes into view this year. Their data on Australia makes interesting reading. Fitch expects Sydney and Melbourne HPI to stabilise in 2018, due to low interest rates, falling rental yields, increasing supply, limited investment alternatives and growing dwelling completions, partially offset by high population growth. Fitch expects the increase in FTB to be temporary; low income growth, tighter underwriting and rising living costs will maintain pressure on affordability for FTB. As mortgage rates are currently low, any material rate rise will weigh further on mortgage affordability and serviceability. The rising cost of living and sluggish wage growth are likely to increase pressure on recent borrowers who have little disposable income. Fitch expects mortgage lending growth to slow to around 4% in 2018, based on continued record low interest rates and stable unemployment. This will once again be offset by continued underemployment, reduced investor demand and tougher lending practices.

Finally, the latest weekly data from CoreLogic underscores the weakness in the property market. First prices are drifting lower, with Sydney down 0.4% in the past week and Melbourne down 0.1%.  The indicator of mortgage activity is also down, suggesting demand is easing as lending rules tighten. But then we always have a decline over the summer break. The question is, are we seeing a temporary blip, over the holiday season, or something more structural? We think the latter is more likely, but time will tell.

So that’s the Property Imperative Weekly to 27th January 2018. If you found this useful, do like the post, add a comment and subscribe to receive future editions. Many thanks for taking the time to watch.






The Housing Affordability Crisis In Australia

Our latest Video Blog discusses the Demographia Housing Affordability Report with specific reference to Australia.

The latest 14th edition of the Annual Demographia International Housing Affordability Survey: 2018, using 3Q 2017 data continues to demonstrate the fact that we have major issues here. There are no affordable or moderately affordable markets in Australia. NONE!

Discussing Housing Affordability

We discussed the latest Demographia report and housing affordability on 2GB today, with Ben Fordham. There are no affordable or moderately affordable markets in Australia. NONE! We have a structural problem.

Housing Unaffordable In Australia – Demographia

Housing Unaffordable In Australia – Demographia

The latest 14th edition of the Annual Demographia International Housing Affordability Survey: 2018, using 3Q 2017 data continues to demonstrate the fact that we have  major issue in Australia. There are no affordable or moderately affordable markets in Australia. NONE!

The major markets of Australia (6.6), New Zealand (8.8) and China (19.4) are severely unaffordable. By international standards houses are big in both Australia and New Zealand but relatively unaffordable.

Using a standard methodology across geographies, the study benchmarks affordability of middle income housing, using an index on average prices and incomes – formally, Median Multiple: Median house price divided by median household income.

Sydney is second worst in terms of affordability after Hong Kong, with Melbourne, Sunshine Coats, Gold Coast, Geelong, Adelaide, Brisbane, Hobart, Perth, Cains and Canberra all near the top of the list.  [Click on the graphic to see it larger].

In recent decades, house prices have escalated far above household incomes in many parts of the world. In some metropolitan markets house prices have doubled, tripled or even quadrupled relative to household incomes. Typically, the housing markets rated “severely unaffordable” have more
restrictive land use policy, usually “urban containment.”

Sydney is again Australia’s least affordable market, with a Median Multiple of 12.9, and ranks second worst overall, trailing Hong Kong. Sydney’s housing affordability has worsened by the equivalent of 6.6 years in pre-tax median household income since 2001. This is a more than doubling of the Median Multiple. In contrast, Sydney’s housing affordability worsen less than one-fourth as much between 1981 and 2001.

At 12.9 Sydney’s Median Multiple is the poorest major housing affordability ever recorded by the Survey outside Hong Kong. Additionally, the UBS Global Real Estate Bubble Index rates Sydney as having the world’s fourth worst housing bubble risk (tied with Vancouver).

Melbourne has a Median Multiple of 9.9 and is the fifth least affordable major housing market internationally. Only Hong Kong, Sydney, Vancouver, and San Jose are less affordable than Melbourne. Melbourne’s Median Multiple has deteriorated from 6.3 in 2001 and under 3.0 in the early 1980s. Just since 2001, median house prices have increased the equivalent of more than three years in pre-tax median household income.

Adelaide has a severely unaffordable 6.6 Median Multiple and is the 16th least affordable of the 92 major markets. Brisbane has a Median Multiple is 6.2 and is ranked 18th least affordable, while Perth, with a Median Multiple of 5.9 is the 21st least affordable major housing market in Australia.

The report argues that:

The key to both housing affordability and an affordable standard of living is a competitive market that produces housing (including the cost of associated land) at production costs, including competitive profit margins.

None of that currently exists in Australia, with land prices sky high, linked to lack of supply (strange given the size of the country!) as well as the financialisation of property and the massive investment sector.

In contrast with well functioning housing markets, virtually all the severely unaffordable major housing markets covered in the Demographia International Housing Affordability Survey have restrictive land use regulation, overwhelmingly urban containment. A typical strategy for limiting or prohibiting new housing on the urban fringe an “urban growth boundary,” (UGB) which leads to (and is intended to lead to) an abrupt gap in land values.

Australia is perhaps the least densely populated major country in the world, but state governments there have contrived to drive land prices in major urban areas to very high levels, with the result that in that country housing in major state capitals has become severely unaffordable.