UK Property Investors Head For The Exit

The UK Property Investment Market could be a leading indicator of what is ahead for our market. But in the UK just 15% of all mortgages are for investment purposes (Buy-to-let), compared with ~35% in Australia.  Yet, in a down turn, the Bank of England says investment property owners are four times more likely to default than owner occupied owners when prices slide and they are more likely to hold interest only loans. Sounds familiar?

According to a report in The Economist,  “one in every 30 adults—and one in four MPs—is a landlord; rent from buy-to-let properties is estimated at up to £65bn ($87bn) a year. But yields on rental properties are falling and government policy has made life tougher for landlords. The age of the amateur landlord may be”.

Investing in the housing market has seemed like a one-way bet, with prices trending upwards in real terms for four decades, mainly because government after government has failed to loosen planning restrictions on building new houses. Now, however, there are signs that regulatory changes have begun to send the buy-to-let boom into reverse.

Yields on rental properties have fallen. House prices have risen faster than rents, in part because buy-to-letters have reduced the supply of housing available to prospective owner-occupiers while simultaneously increasing the supply of places to rent. Britain’s ratio of house prices to rents is now 50% above its long-run average. All this makes buy-to-let investment less lucrative. Data from the Bank of England suggest that yields in September were below 5%, their joint-lowest rate since records began in 2001, when they were above 7.5%.

One consequence of this could be a more stable financial system. Roughly 15% of mortgage debt is on buy-to-let properties. The Bank of England has warned that there are risks associated with this. One problem is that property investors buy when house prices are rising but sell when they are falling, making house prices more volatile. Buy-to-let landlords are also more likely to default than owner-occupiers. One reason is that doing so does not force them out of their home. Another is that buy-to-let mortgages are more likely to be interest-only (ie, where the principal is not repaid). That can be tax-efficient but it means that monthly repayments can jump sharply if interest rates rise. The Bank of England’s stress tests last month showed that the rate at which landlords’ loans turn sour could be four times greater than the rate for owner-occupiers’ loans. All things considered, the shrinking of the buy-to-let sector may come as a relief to regulators.

The future for buy-to-letters will not get much brighter. In January a tweak to the rules on capital-gains tax will increase the liabilities of landlords who register as businesses. Large institutional investors are moving on to buy-to-letters’ turf, hoping to benefit from their economies of scale to offer better-quality housing to tenants. It was good while it lasted, but the golden age for the amateur landlord may be over.

ATO to Scrutinise Rental Property Market

From The Real Estate Conversation.

The Australian Tax Office is ramping up scrutiny of the rental property market in a bid to stamp out tax rorts, reports The Australian.

In one of a series of interviews with The Australian about ATO priorities, tax commissioner Chris Jordan said the ATO will be looking closely at the practise of declaring rented properties vacant. He said the tax office will go so far as to monitor real estate agent, electricity and gas records to identify fraudulent claims.

Over the last few months, the Australian Taxation Office has already investigated 100,000 rental properties to ensure they are not involved in black-market activity or misclaiming of negative gearing.

The size of the rental market in Australia means it must be watched extremely closely for rorts, said Jordan.

Jordan told The Australian that ATO data shows deductions claimed for rental property exceed the rental income earned for privately owned rental properties in Australia.

“In the rental income space, there’s $40.1 billion of income and $43.6 billion of expenses,” he said.

With the 2016 census showing that 11 per cent of Australian properties, or 1.1 million homes, were unoccupied, rental income in Australia should be much higher, said Jordan.

Jordan said he is concerned about the growing amount of rental income disappearing into the cash economy.

“It appears that many landlords are not declaring their rental income, and many more are overstating their deductions,” he told The Australian.

The ATO is already using data-matching to check if properties are unoccupied. For example, Jordan said the ATO can match utility records, such as for electricity and gas, against the addresses of properties that owners claim are unoccupied.

The Australian reports that from next year, auditors will begin approaching real estate agents to request information about landlords.

Investor Loan Risk Is Accelerating

Traditionally in the Australian context loans to property investors have tended to perform better than loans to owner occupiers. This is because investors receive rental income streams to help pay for the mortgage costs, they are willing to carry the costs of the property against future capital gains, and many will be able to offset costs against tax, especially when negatively geared. In addition, occupancy rates in most states have been stellar.

But things are changing, as the costs of borrowing for investment purposes have risen (thanks to the banks’ out of cycle rises), while rental returns are flat, or falling and costs of managing the property are rising. The supply of investment property is rising, and occupancy rates are declining in a number of key markets.

So today, we look at the latest gross and net rental yields by using our Core Market Model.

First, we look at yields by type of property. Gross yield is the rental streams received compared with the value of the property; before costs. Net yield is calculated by subtracting the costs of the property, including interest costs on mortgages, management costs and other ongoing maintenance costs. We calculate the net yield before any tax offsets.

Across the nation, units overall are providing a slightly better net return than houses.

By state, VIC has the average worse net rental yield, followed by NSW, while TAS, NT and ACT have the highest net returns.

If we drill down into the regions in the states, we see some significant variations.

If we apply our core market segmentation, we find that more affluent households are getting better returns on average compared with the battlers and younger buyers. Perhaps experience counts.

We also see that Portfolio Investors, those with multiple properties, are on average getting better returns, whilst first time buyers are the least likely to get a positive net return. Again, experience seems to count.

Finally, in the ANZ data today, released as part of their results pack was this slide. It shows a trend which we have been observing too, that is delinquencies are rising faster among property investors (to the point where the same ratio ~0.7% applies to both investors and owner occupiers).

More, concerning, our forward modelling suggests that investors are likely to become a significant higher risk as rates rise, rental returns stall, and occupancy rates fall.  Just one more reason why we think the property investment party may be over.

Higher risks need to be factored into the banks’ modelling, especially as home price momentum is ebbing, so the value of these investment properties may start to fall.

Senior property investors can’t ‘sit on their hands’

From Nestegg.

The Citi report argued that the growing number of multi-property investors and falling yields were a worrying sign for senior investors who may have little time left in their working life to repay their debts. The report was compiled using Citi figures and data from Digital Finance Analytics (DFA).

“Tighter application of responsible lending laws mean that investors must now have a clear debt repayment plan, although for many prevailing interest-only (IO) borrowers this does not exist,” said the Citi analysts lead by Craig Williams and Brendan Sproules.

“The large level of debt outstanding by borrowers aged in their 50s and 60s means many investors will need to sell property to discharge their debts.”

They warned that as 28 per cent of wealthy senior investors were not asked about a capital repayment plan upon loan application and 32 per cent of them do not have a capital repayment plan, “as these cohorts begin to hit retirement age, their investment properties will need to be sold to repay the debt”.

According to Citi, mortgage debt is “one of the most important economic and social issues of our time”, due to the risk that highly indebted households pose to the economy.

Citi and DFA’s figures reported that ~35 per cent of mortgages are held by investors, ~40 per cent of mortgages are interest-only and the percentage of investors holding IO loans has grown to ~70 per cent.

Considering this, Citi said most wealthy seniors (53 per cent) preferred the repayment structure because it helped them get a bigger loan. For most stressed seniors (72 per cent), IO loans appealed because of the ability to make smaller repayments.

Multi-property investors growing

Additionally, the proportion of wealth seniors who own multiple investment properties has grown in the years since 2011.

In 2011, 22 per cent of wealthy senior investors own two or three properties, 72 per cent owned one, and just 1 per cent owned six or seven.

Conversely, in 2017, 18 per cent of this group owned six or seven properties, 7 per cent owned two or three, and 73 per cent owned one investment property.

Across all cohorts, the percentage of multi-property investors has grown and this has been “coinciding with the considerable rise in IO mortgages”.

At the same time, however, the gross rental yield in Sydney has fallen from 4.3 per cent in May 2013 to 2.80 per cent in May 2017 and the average standard variable rate for IO loans at the major banks has grown from 6.17 per cent to 6.26 per cent.

Marking these cash flow and investment fundamentals as “deteriorated”, Citi said: “Looking forward, investors are losing the ability to ride out the cycle.

“The most important question for the future direction of house prices is – What will these multi-investment property borrowers do when faced with increasing cash flow losses and flat or declining property prices?”

Given that the average age of wealthy seniors is 63 and the average IO debt is $236,400, according to their figures, Citi expressed concern that this cohort will not have enough time to repay the principal “without a significant hit to household cash flows”.

Further, this group could be additionally affected by the needs of the adult children they might have. Citi pointed to research showing that the ‘Bank of Mum and Dad’ can now be considered Australia’s fifth largest home loan lender.

The RBA backs them up

The Citi analysts are not alone in their concerns. The Reserve Bank of Australia recently flagged the “potential risk” in the growing number of property investors over the age of 60 with mortgage debt. The “significant increase” in the share of geared investors was considered particularly alarming.

The RBA conceded, however: “While this seemingly could increase risks, there are some mitigating factors.

“Although this age group is more indebted, the average retirement age has increased over time, so older investors are more likely to be working, increasing their capacity to withstand shortfalls in rental income or higher interest rates.”

Why Property Investors Are Less Bullish Now

Continuing our analysis of our households surveys to September 2017, today we look at the property investor segments (which account for one third of mortgage loans).  We already highlighted that investors have become less bullish about future home price growth:

For example, in 2015, 77% of portfolio investors were intending to transact, today this is down to 57%, and the trend in down. Solo investors are down from a high of 49% to 31%, and again is trending lower.

Now we look at what is causing this.

The underlying reason for Investors to transact has been changing, with the tax breaks (40%), and better returns than deposit account savings (35%) together now accounting for two-thirds of the motivation.  Appreciating property values has been squeezed (10%), as has access to low rate finance (5%).

Turning to the barriers which investors face, the difficulty in getting finance is on the rise (29%), along with concerns about rate rises (12%). Other factors, such as RBA warnings (3%), budget changes (1%) only registered a little but concerns about increased regulation rose (7%) . Around one third though already hold investment property (33%) and so will not be buying more in the next year. So, net demand is weakening.

The importance, when it comes to obtaining finance, of the price in the purchase decisions for investors is clear. Flexibility and loyalty to a specific lender count for naught.

Those investing via a SMSF exhibit somewhat similar drivers in terms of motivation to transact, with tax efficiency a strong motivator (37%), as well as appreciating property values (22%), and leverage ( 17%).

We see some changes in where SMSF Trustees get their advice, with more relying on internet forums or sites (23%), their own knowledge (20%) and a mortgage broker (16%).  Advice from real estate agents is on the rise, (14%), and is now similar to accountants (13%).

 The mix of property held in SMSF has not changed much, with 70% holding less that 40% of their investments in property.

Next time we look at first time buyers.

Wall Street landlords are chasing the American dream

From The Conversation.

Owning a family home in the suburbs has been a cornerstone of the American dream for many generations. But in 2008, when the United States’ housing bubble burst and a spate of mortgage foreclosures triggered the global financial crisis, that dream was vanquished, and such houses would instead become the sites of shattered lives.

In the aftermath of the crisis, hundreds of thousands of suburban homes were repossessed and sold at auction. With the market in shambles, prices were low. Tightened credit made it hard for individuals to buy – even for those whose credit was not destroyed by the crisis. Investors saw an opportunity, and began buying up houses.

Though house prices have recovered in many regions of the US, many of the people living in these homes are now renting – and their landlords are some of the biggest investment firms on Wall Street. Of course, small scale, mostly local investors have long owned and rented out individual houses. But it simply wasn’t feasible to manage large numbers of individual homes at a distance. As technology changed, it became much more practical for large corporations to manage individual homes spread across different regions.

With access to credit and funds unavailable to the average home buyer, large investors have been able to enter the landlord market in ways that have never been seen before. Blackstone – the world’s largest alternative investment firm – pioneered new rent-backed financial instruments in 2013, whereby rent checks are bundled up and sold as securities, similar to the way that mortgage payments are turned into financial products bought by investors.

Now, Blackstone’s rental company Invitation Homes looks set to merge with Starwood Waypoint Homes; a move that would create the nation’s largest landlord, with roughly 82,000 homes across the country. Another Wall Street backed firm, American Homes 4 Rent, owns a further 49,000 homes across 22 states.

Renting the American dream

Since 2010, the United States has seen a massive rise in the number of families renting the kind of single-family houses that have long been the desire of would-be homeowners chasing the American dream. While estimates vary, the inventory of single family homes being rented has grown by anywhere from three to seven million (35% to 67%) compared with pre-crisis levels. Single-family houses are now the most common form of rental property in the United States.

Overwhelmingly, the people living in these houses are families. Our ongoing research with Jake Wegmann of the University of Texas and Deirdre Pfeiffer of Arizona State University shows that almost half of Single Family Rented (SFR) households (49%) have at least one child under 18; a far greater percentage than rental properties with multiple units (roughly 25%) and owner-occupied homes (31%).

According to our own analysis of the American Community Survey, in 2015 an estimated 14.5m children in the United States lived in a rented single-family home. Demographically, single-family renters are more likely than owners to be people of colour, and to face moderate or severe housing cost burdens. The upshot of all this is that the 40m or so people living in SFR homes now form the basis of a new asset class of rental-backed securities.

Destination unknown

Scaling up portfolios consisting of thousands or tens of thousands of rental homes has made it possible for Wall Street firms to roll out financial instruments suited to “a rentership society”. Securitisation allows big investors to borrow against the value of the properties, to buy more properties and pay off old debt, and acts as a loan that tenants pay back with their rent checks.

Wall Street is no stranger to the housing business in America. But their involvement as landlords of single-family homes is new, and so are the financial instruments they have developed. The impact of Wall Street’s new role is unclear. While rehabilitating houses and helping to stabilise home values in the hardest-hit markets, they may also be crowding out first-time buyers, creating a lopsided market that shuts out would-be owner-occupiers.

Some Wall Street landlords have been singled out for poor repairs, problems with billing and collections and lacklustre customer service. There is also growing concern about the fact that renters of single-family homes have little protection, even in cities with some form of rent control. A report from the Federal Reserve Bank of Atlanta found that large corporate owners of houses are more likely than smaller landlords to evict tenants; some filed eviction notices on up to a third of their renters in just one year.

Here to stay

Wall Street landlords are also making new political allies, hinting they intend to stick around. The largest single-family rental companies have banded together to form a trade group, the National Rental Home Council, which promotes large-scale, single-family rental housing and advocates for public policies friendly to their interests. And it seems to be working.

In an unprecedented move, just after President Trump’s inauguration, the government-backed mortgage agency, Fannie Mae, agreed to underwrite Blackstone’s initial public offering of Invitation Homes stock, to the tune of a billion dollars. Blackstone’s CEO is Steve Schwarzman, one of the president’s most loyal backers. And Thomas Barrack – the recently departed leader of Colony Starwood Homes, which is preparing to merge with Invitation Homes – is a longtime friend of the mogul-turned-president.

Meanwhile, another government-backed agency, Freddie Mac, has announced that it too was supporting investment in single-family rentals, but with a focus on financing for mid-size investors and with an explicit goal of maintaining rental affordability. Non-partisan organisations like the Urban Institute have also suggested that government-backed financing opportunities could help single-family rental serve as a new affordable housing strategy.

All of these developments suggest that the downward trend in home ownership after the financial crisis could be here to stay. And while there is nothing wrong with renting – just as there is nothing inherently good about owning – the changes we are seeing in the single-family rental market bear ongoing scrutiny, to ensure that Wall Street’s demand for profit does not once again wreak havoc on Main Street.

Authors: Desiree Fields, Lecturer in Urban Geography, University of Sheffield; Alex Schafran, Lecturer in Urban Geography, University of Leeds; Zac Taylor, PhD Candidate in Geography, University of Leeds

Heritage Bank Halts Investment Lending

Heritage Bank has said it has temporarily stopped accepting new applications for investment home loans, to ensure they comply with regulatory limitations on growth.

Heritage has experienced a sharp increase in the proportion of investment lending in our new approvals recently.

That’s an outcome both of our attractive pricing structure and the actions other lenders in the investor market have taken to slow their growth.

We need to manage our investment lending portfolio carefully, to ensure we stay within the caps APRA has placed on growth in investor and interest only lending.

As a result, we’ve taken the decision to temporarily stop accepting applications for new investor lending, effective from Friday (1 September).

We will monitor our approvals and loan portfolio in coming weeks and review that decision as needed.

They also announced a tiered pricing structure, based on LVR bands for some products, reflecting the risks involved.

Heritage Bank is Australia’s largest customer-owned bank. In 1981 Toowoomba Permanent Building Society (est. 1875) and the Darling Downs Building Society (est. 1897) merged and became Heritage Building Society. In December 2011, Heritage Building Society officially changed its name to Heritage Bank to remain relevant and competitive.

Why investor-driven urban density is inevitably linked to disadvantage

From The Conversation.

The densification of Australian cities has been heralded as a boon for housing choice and diversity. The up-beat promotion of “the swing to urban living” by one of Australia’s leading developer lobby groups epitomises the rhetoric around this seismic shift in housing.

Glossy advertisements for luxury living in our city centres and suburbs adorn the property pages of our newspapers.

Brochures boast of breathtaking city views from uppers storeys and gush about amenity, lifestyle and “liveability” – often touting the benefits of adjacent public infrastructure investments (but please don’t mention “value sharing”).

Depictions of attractive younger people, occasionally clutching a smiling infant, are prominent as the image of all things new, urban and desirable.

Long gone are the days when the manifestations of property marketeers’ imaginations were restricted to images of low-density master-planned estates on the urban fringe. We hardly ever hear about these nowadays.

There’s truth in the claims that housing choice and diversity have indeed widened in the last few decades as a result. The statistics clearly show a much greater spread of dwelling options in our cities.

The rise and rise of the apartment block

Apartments now account for 28% of housing in Sydney and 15% in Melbourne. As the maps below show, most recent growth in apartment stock is clearly in and around the inner city. Yet even the more distant suburbs have had an increase in higher-density residential development.

Changes in the number of flats and apartments, 2011 to 2016, in Sydney (above) and Melbourne (below). Data: ABS Census 2011, 2016, Author provided
Data: ABS Census 2011, 2016, Author provided

For many, inner-city apartment living is clearly a preferred choice for the stage in their life when an upcoming, “vibrant” neighbourhood is attractive. High-density urban renewal has been a boon for hipsters and students alike.

But the issue of choice needs to be unpacked carefully. For many others, the “swing to urban living” is more of a necessity.

True, the surge in apartment building has put many properties onto the market to rent or buy that are clearly cheaper than houses in the same suburb. From that point of view, they have added to the affordability of these neighbourhoods.

However, affordable to whom is an open question. At A$850,000 and upwards for a standard two-bedder in Waterloo, South Sydney, and $500,000 or more in Melbourne’s Docklands for a similar property, these are not exactly a cheap option for anyone on a low income.

But other than in the prestige areas where higher-income downsizers and pied-à-terre owners can be enticed to buy in some comfort, much of what is being built is straightforward “investor grade product” – flats built to attract the burgeoning investment market.

It can be argued that the investor has always been a major target of apartment developers, even in the 1960s and 1970s when strata units became common, particularly in Sydney. But it is even more so today.

Despite the clamour to control overseas investors perceived to be flooding the market, the bulk of investors are home grown. We don’t need to rehearse the debates on the factors that have fuelled this splurge, but clearly the development industry has been savvy to the possibilities of this market.

In the last decade, backed by state planning authorities and politicians desperate to claim they have “solved” housing affordability by letting apartment building rip, developers have got involved on an unprecedented scale. The figures bear this out: in 2016, for the first time, Australia built more apartments than houses. The majority end up for rent.

Problematic products with too few protections

In the rush, we, the housing consumer, have been offered a motley range of new housing with a series of escalating problems. Leaving aside amateur management by owners’ bodies in charge of multi-million-dollar assets, problems of short-term holiday lettings and neighbour disputes, there are more serious concerns over build quality, defective materials and fire compliance.

The apartment market has been left wide open for poor-quality outcomes by building industry deregulation. This includes:

  • moves toward complying development approval for high-rise;
  • self-certification of building components;
  • complex design and non-traditional building methods;
  • relaxation of defect rectification requirements;
  • long chains of sub-contractors;
  • poor oversight by local planners and authorities; and
  • cheap or non-compliant fittings and finishes.

Plus there’s the rush to get buildings up and sold off. Not to mention fly-by-night “phoenix” developers who vanish as soon as the last flat is occupied, never to be found when the defects bills come in.

The lack of consumer protection in this market is astounding. The average toaster comes with more consumer protection – at least you can get your money back if the product fails.

‘Vertical slums’ in the making

These chickens will surely come home to roost in the lower end of the market, which will never attract the wealthy empty-nesters or cashed-up young professionals with the resources to ensure quality outcomes.

In Melbourne, space and design standards, including windowless bedrooms, have come under critical scrutiny, as has site cramming. Tall apartment blocks stand cheek-by-jowl in overdeveloped inner-city precincts.

At least New South Wales has State Environmental Planning Policy 65, which regulates space and amenity standards, and the BASIX environmental standard to prevent the more egregious practices.

But people are most likely to confront the problems of density in the many thousands of new units adorning precincts around suburban rail stations and town centres. These have been built under the uncertain logic of “transport-orientated development”, often replacing light industrial or secondary commercial development.

These developments attract a mixed community of lower-income renters. Many are recently arrived immigrants and marginal home buyers – often first-timers. Many have young children, as these units are the only option for young families to buy or rent in otherwise unaffordable markets. Overall, though, renters predominate.

What will be the trajectory of these blocks, once the gloss wears off and those who can move on do so? You only have to look at the previous generation of suburban walk-up blocks in these areas to find the answer.

Far from bastions of gentrification, the large multi-unit buildings in less prestigious locations will drift inexorably into the lower reaches of the private rental market.

Town centres like Liverpool, Fairfield, Auburn, Bankstown and Blacktown in Sydney point the way. The cracks in the density juggernaut are already showing in many of the more recently built blocks in these areas – literally, in many cases.

This inexorable logic of the market will create suburban concentrations of lower-income households on a scale hitherto experienced only in the legacy inner-city high-rise public housing estates.

With the latter being systematically cleared away, the formation of vertical slums of the future owned by the massed ranks of unaccountable, profit-driven investor landlords is a racing certainty. The consequences are all too easy to imagine.

The call for greater regulation of apartment, planning, design and construction is being heard in some quarters. The 2015 NSW Independent Review of the Building Professionals Act highlights these concerns.

But don’t hold your breath for rapid reform. No-one wants to kill the goose that’s laying so many golden eggs for the development industry and government alike – especially in inflated stamp-duty receipts.

The market has a habit of self-regulating on supply. Evidence of a marked downturn in apartment building is a clear sign of that. But don’t expect the market to self-regulate on quality, at least with the current highly fragmented, confusing (not least to builders and bureaucrats), under-resourced and largely unpoliced regulatory system.

The legacy of this entirely avoidable crisis is completely predictable, but will be for future generations to pick up

Author: Bill Randolph, Director, City Futures – Faculty Leadership, City Futures Research Centre, Urban Analytics and City Data, Infrastructure in the Built Environment, UNSW

The Rental Conundrum

The CPI data released by the ABS yesterday showed that over inflation remains low.

But within the series there is a striking contrast. The Housing Group category of data rose 0.3 per cent for the quarter, and 2.4 per cent for the year to June 2017 but rent rose only 0.2 per cent for the quarter, and 0.6 per cent for the year.

It is worth reflecting on this in the light of the out of cycle rate hikes which property investors are experiencing, as the banks improve their margins using the alibi of regulatory tightening. In fact recent hikes being applied not to new mortgages but to the entire book have meant a significant “bonus” to the banks.

First, lets be clear rental rates have more to do with income that property prices, and the fact that rental rates have hardly grown reflects the stagnation in wages. Vacancy rates are also rising.

Second, the fact is a greater proportion of property investors are now underwater on a net rental cash flow basis. But the situation varies by state.  This chart shows both gross yield (rental income) and net yield, (costs of mortgage repayments and other rental costs) on a cash flow basis and before tax.  VIC and NSW have on average negative net returns.

The net rental calculation is before any tax offsets. The distribution by state is even more interesting.

Investors seem ok with negative cash-flow returns because in many cases they just offset the losses against tax, and comfort themselves with the thought that the capital value of the property is still rising (in most eastern states at least).

However, the divergent movement of mortgage rates and net rental returns are a leading indicator of trouble ahead, especially if capital growth reverses.

Given flat incomes, we think rentals will not grow much at all for some time, and remember more new properties are coming on stream, so vacancy rates are likely to continue to rise!