Home prices are more to do with sentiment that fundamental economics, and this week we saw new data, so are home prices on their way down?
Welcome to the Property Imperative weekly to the 25 November 2017. Watch the video, or read the transcript.
We start this week’s digest of finance and property news noting that Auction clearance rates continue to drift lower, especially in Sydney and home prices are easing back as the supply/demand equation changes.
CommSec said the average floor size of an Australian home (houses and apartments) has fallen to a 20-year low, with the typical new home now 189.8 square metres, down 2.7 per cent over the past year and the smallest since 1997. Though Australians continue to build some of the biggest houses in the world, an increasing proportion of Australians – especially in Sydney, Melbourne and Brisbane – also want smaller homes like apartments, semi-detached homes and town houses. Generation Y, Millennials, couples and small families want to live closer to work, cafes, restaurants, shopping and airports and are giving up living space for better proximity to the desirable amenities. CBA also make the point that since 2014 the number of people per dwelling has been falling. Lower interest rates and the increased supply of cheaper apartments (compared with houses) have prompted older couples to down-size. More Generation Y have been looking to move out of home and take ownership of accommodation more appropriate to their needs.
Also on the supply/demand property equation was an important study from the ANU. The Government view is high home prices is ultimately driven by lack of supply, relative to demand, including from migration. So the solution is to build more (flick pass to the States!). It has nothing to do with excessive debt, nor does the fact the average number of people per home is falling signify anything. And tax policy is not the problem. But the working paper “Regional housing supply and demandin Australia” from the ANU Center for Social Research and Methods, blows a mighty hole in that mantra. They suggest that demand factors (availability of loans, tax concessions etc.) have a significant impact, while demand and supply equilibrium varies significantly across different regions, with some hot spots, and some where vacant property exists (yet prices remain high, because of these demand factors). Significantly, much of the surplus is in areas where high-rise development has been strong. We think this may signal further downward pressure on prices in areas like Central Sydney, Melbourne and Brisbane as well as Townsville and Cairns. On the other hand, there is a shortage of property in Adelaide, and some outer suburban areas.
Wayne Byers, APRA Chairman spoke at the Australian Securitisation Forum 2017. Household debt is high, and continues to rise he said. He identified three mortgage related risks. First, the trend in non-performing housing loans is upward, despite a relatively benign environment for lenders. In fact the overall rate of non-performing housing loans is drifting up towards post-crisis highs, without any sign of crisis and when rates are ultra low.
Second, while the upward trend in low Net Income Surplus (NIS) lending appears to have moderated over the past few quarters, a reasonable proportion of new borrowers have limited surplus funds each month to cover unanticipated expenses, or put aside as savings.
Third, there is only a slight moderation in the proportion of borrowers being granted loans that represent more than six times their income. As a rule of thumb, an LTI of six times will require a borrower to commit 50 per cent of their net income to repayments if interest rates returned to their long term average of a little more than 7 per cent. High LTI lending in Australia is well north of what has been permitted in other jurisdictions grappling with high house prices and low interest rates, such as the UK and Ireland.
So, APRA finally acknowledge there are risks in the system and is finally looking at LTI. Better late than never…! LVR is not enough. He also called on the finance industry to “devote more effort to the collection of realistic living expense estimates from borrowers” and give “greater thought” to the appropriate use and construct of benchmarks”.
Another BIS series, trends in home prices, updated this week, shows Australia is near the top in terms of growth, relative to other western countries, including UK, USA, Canada and New Zealand. There is an important lesson in this data. If prices do crash it can take significant time to recover. Home prices in Ireland, which peaked in 2007, 10 years later are still well below the peak – a salutatory warning. USA prices have now just passed their pre-GFC peak and the UK achieved this in 2014! The fallout from home price falls cast a long shadow. The fall in prices took on average 5 years from their peak to the subsequent trough. A warning that if Australian prices slide, they could do so for many years.
The IMF issued a warning this week, based on their latest Australian visit. They warn that growth will be modest, more effort is required to contain housing risks – including macroprudential, and a structural reform agenda is required to lift productivity and growth. They say near-term risks to growth have become more balanced, but large external shocks, including their interaction with the domestic housing market, are an important downside risk. The housing market is expected to cool, but imbalances—lower housing affordability and household debt vulnerabilities—are unlikely to be corrected soon. Declines in household debt-to-income ratios would need to be driven by strong nominal income growth and amortization. They are however, stuck on the supply-side policy mantra as the most effective approach to achieving housing affordability in the longer term.
The RBA had a good trot this week, with Head of Financial Stability Jonathan Kearns, saying the Bank has responsibility to promote the stability of the financial system as a whole so carefully monitors property markets because poor commercial property lending and the large stock of residential property debt means risks to financial stability and household resilience. The high valuation of commercial property increases the potential for a sharp correction and so the risks from commercial property lending. The high level of household mortgage borrowing also brings risks, both for lenders and households. He also discussed the impact of purchases and financing by foreigner investors and banks. Nationally, purchases by foreign buyers are equivalent to around 10-15 per cent of new construction, or about 5 per cent of total housing sales. He said, these purchases by foreign buyers do not, on the whole, reduce the supply of dwellings available to local residents and in fact may actually contribute to expansion of the housing stock – though such purchases by foreign buyers, particularly for investment purposes, are a more recent phenomenon and so their impact on the housing cycle is less clear.
Marion Kohler, Head of Domestic Markets Department, RBA, explored more from their mortgage Securitisation Dataset. There were two insights. First the LVR distribution is highest at 80% (which is skewed because of the securitisation rules), but her claim “on average, securitised loans appear to be no riskier than the broader population of mortgages, was unproven. Second there was some interesting commentary on mortgage rates, with interest-only loans now significantly higher. There is now a greater proportion of principal-and-interest loans with an interest rate below 4 per cent, due to the lower rates applied to owner-occupier loans, and there has reportedly been increased competition for these types of loans. She did not discuss the critical Loan to Income ratios, which should be available in the data!
Finally, RBA Governor Philip Lowe spoke at the Australian Business Economists Annual Dinner. Essentially, the conundrum of low inflation and wage growth, despite better employment means the cash rate will stay lower for longer, though the next move is likely up. High household debt is less about risks to the banking system and more about medium term financial stability, especially as rates rise. Household spending will remain muted. GDP is forecast to be higher because the fall in mining investment has ended, even if other business investment is still low. He also highlighted the bank keeps overestimating future consumption growth. Finally, he said that it is important to be clear that the RBA does not have a target for housing prices. But a return to more sustainable growth in housing prices does reduce the medium-term risks.
A report by Bloomberg says the party is finally winding down for Australia’s housing market. How severe the hangover is will determine the economy’s fate for years to come. After five years of surging prices, the market value of the nation’s homes has ballooned to A$7.3 trillion — or more than four times gross domestic product. Not even the U.S. and U.K. markets achieved such heights at their peaks a decade ago before prices spiralled lower and dragged their economies with them. The report cited UBS economists’ declaration that “Australia’s world-record housing boom is officially over, and the cooling may be happening a bit more quickly than even we expected.”
The risk is that it leaves the Australian economy extremely exposed, and a minor shock could become far more significant,” said Daniel Blake, an economist at Morgan Stanley in Sydney. While the RBA is satisfied that lenders have adequate buffers to cope with any downturn, banks may find it harder to value their collateral in a falling market as investors look to consolidate their portfolios of multiple homes.
Now reflect on this, more than half of all dividends in Australia come from the banks. Data from the latest Janus Henderson Global Dividend Index reveals that Australia’s banks pay $6 out of every $11 of the country’s dividends each year but dividends are growing slowly given already high payout ratios. Leading is Commonwealth Bank which raised its per share payout 3.7 per cent on the back of steady profit growth, but National Australia, Westpac and ANZ all held their dividends flat. CBA and Westpac were identified in the report as the world’s fourth and sixth biggest dividend payers respectively, with Chinese and Taiwanese technology and manufacturing companies taking the top three place. Much of the dividends in Australia comes from mortgage lending.
Standing back, home prices have been rising thanks to high local and foreign demand, and from investors who believe in yet higher prices ahead. But now the evidence is mounting that sentiment is changing, demand is easing (and as lending standards get tightened) and low wage growth in rising and living costs bite. Our household surveys picked this up a few weeks back, and now there is also more awareness of the risks from higher rates ahead.
So we think prices are set to slide further, with Sydney leading the way. Brisbane will follow, but there may be a little more momentum in Melbourne. All the economic data points in the same direction, and our modelling suggests a fall of 20% or more is possible, over the medium term. If we are lucky, the easing will be gentle, but could last for perhaps 5 years, but there is also a risk of a bigger fall sooner. This would create a negative feedback loop which would reduce growth and hit the banks hard. No wonder then many with vested interests in property still want to talk the market up, but the fundamentals don’t lie. It’s not now a question of if, but when, and how far home prices will fall.
That’s the Property Imperative weekly to 25 November 2017. If you found this useful, do leave a comment below, subscribe to receive future updates and check back again next week. Thanks for taking the time to watch. See you next time.
The party is finally winding down for Australia’s housing market. How severe the hangover is will determine the economy’s fate for years to come.
After five years of surging prices, the market value of the nation’s homes has ballooned to A$7.3 trillion ($5.6 trillion) — or more than four times gross domestic product. Not even the U.S. and U.K. markets achieved such heights at their peaks a decade ago before prices spiraled lower and dragged their economies with them.
So far, the Reserve Bank of Australia has relied on banking regulators to apply the brakes with lending curbs. It reckons the financial system is well-placed to withstand any shocks, but isn’t so confident on consumers. That puts it out of step with developed-world peers that are incrementally tightening policy, with Governor Philip Lowe this week making clear local interest rates aren’t going anywhere soon.
To be sure, there are key dynamics that differentiate Australia’s housing boom with those that soured in recent years around the world. Aussie banks can claim against other income and assets or chase individuals into bankruptcy if borrowers default. Tax deductions for interest paid on investment loans also support demand, as does a rich pipeline of demand from Asian buyers, especially Chinese.
But with prices in major cities like Sydney finally leveling off and a wave of new apartments about to hit markets in Brisbane and Melbourne, it’s worth taking a look at housing’s out-sized influence on Australia’s economy.
The weight of Australian homes on the economy is heavier than policy makers would like. On one hand, the dizzy valuations reflect a desirable location and strong population growth. But they also reflect the massive liabilities that are now tied to these assets. “The risk is that it leaves the Australian economy extremely exposed, and a minor shock could become far more significant,” said Daniel Blake, an economist at Morgan Stanley in Sydney.
The increasing treatment of housing as a financial commodity has seen borrowers rush into a byzantine maze of mortgage-related products. That’s made banks very profitable, but very exposed. While the RBA is satisfied that lenders have adequate buffers to cope with any downturn, banks may find it harder to value their collateral in a falling market as investors look to consolidate their portfolios of multiple homes, said Blake.
Aussie households have racked up record private debts and aren’t getting the pay rises to help service them. That’s a core concern for the RBA and frequently cited as a deterrent for hiking interest rates. Macquarie Bank has said such debt levels mean any hikes will have triple the impact on consumers than tightening cycles in the mid-1990s. With retail sales looking grim and wage growth near record lows, debt will likely vex policy makers for years.
Soaring prices have seen home ownership among young Aussies fall to the lowest level on record, squeezing out all but the wealthiest buyers. Fueled by cheap money, a lack of supply and a tax system that favors property investors, Sydney has vaulted past London and New York to rank as the world’s second-most expensive housing market.
While cranes dot the Sydney skyline for miles, the central bank remains confident that population growth will eventually fill all those new apartments. Its worries about a Melbourne glut have eased off recently, with the main concern in the Brisbane market, where peak completion is expected this year, capping a three-year period in which the number of apartments has increased by more than a third. Overseas buyers comprise up to 15 percent of new dwelling purchases nationwide, according to the RBA.
“Australia’s world-record housing boom is officially over,” UBS Group AG economists declared at the start of this month. “The cooling may be happening a bit more quickly than even we expected.”
The latest BIS data series on home prices trends has been published to Q2 2017. Here is a selected range, which shows Australia is near the top in terms of trend growth, relative to other western countries, including UK, USA, Canada and New Zealand.
Norway and Sweden are slightly higher. The fastest rate of growth is in South Africa, which has reached a heady 700!
There is an important lesson in this data. If prices do crash it can take significant time to recover. Look at home prices in Ireland (the yellow solid line), which peaked in 2007, and 10 years later is still well below the peak – a salutatory warning. USA prices have now just passed their pre-GFC peak and the UK achieved this in 2014!
The fallout from home price falls cast a long shadow. Importantly, the fall in prices took on average 5 years from their peak to the subsequent trough. A warning that if Australian prices start to slide, they could do so for many years.
For many years, the BIS has promoted analysis of the long-term movements in residential property prices that are particularly important for financial stability research and policy. A data set of long historical time series of nominal residential property prices in 13 advanced economies was presented for the first time in 1994. Interest in this data set has steadily increased among researchers as well as policymakers and private sector practitioners.
The research data set on long series on residential property prices presented here currently includes quarterly time series for 18 advanced economies going back as far as 1970 or 1971 or even earlier, and quarterly time series for five emerging market economies with starting dates between 1966 and 1991. This work has been undertaken by the BIS in close coordination with national authorities with the aim of providing the most accurate data whenever possible. However, these long series are imperfect. They have been constructed from a variety of sources, including central banks, national statistical offices, research institutes, private companies and academic studies. The methodologies they employ, and the types of geographical areas and dwellings they cover, are likewise varied. Although significant efforts have been made recently to harmonise and improve the comparability of house price indices across countries, the discrepancies in the compilation methods are quite large and may hamper the usability of the data set.
The recent accidents with regards to MP’s citizenship seems to have opened the door wider on a potential inquiry into banking. That may happen, but in my view it misses the point.
The clear and present danger which we are now facing relates to housing. We have been tracking the building risks in the sector for many years, and finally even the regulators have gotten the message, see ASIC, APRA and RBA. Our regulators have failed us and the proposal from Murray’s FSI for an audit of their effectiveness fell on deaf ears. The Council of Financial Regulators suffers from group think.
The myopic approach from Government (Federal and State) means we have no long term planning, no joined up thinking and ad hoc “fixes” as for example in the QLD election campaign and a deliberate failure to address the fundamentals.
Worse, our banks are super-sized building societies, with some lenders holding up to 70% of their loan book exposed to the property sector. This means they are less willing to lend to productive businesses who can create real growth. Banks underestimate their portfolio risks. Defaults are rising even now at current low rates and the trajectory is higher. Yet more than half of dividends in Australia come from the banks.
There are so many stakeholders with vested interests, it is no surprise we just muddle through. Weird when you think that based on the size of our island continent, per capital we have more land than almost anyone. Lending will continue to grow at three times income/cpi.
It seems to me we have two potential circuit breakers.
The first is we wait for the inevitable home price crash – by at least 20% leading to misery for households and banks. Remember 10 years after the GFC, Ireland is still wrestling with the property falls there. Almost certainly there would be an inquiry post the apocalypse which will happen 2-3 years after rates start to rise if the GFC is an analogue.
The second option is a proper root and branch review now. Bite the bullet to look at the whole housing box and dice, to include regulation, taxation, planning, lending and the rest. Put aside political infighting, and get the strategy right. That way we might just escape the inevitable crunch, or at least mitigate the impact.
If you want an inquiry, best pick the right horse. Or we just keep doing the same, just do not expect a different outcome.
Further confirmation today that Sydney is leading the property market lower, based on the preliminary auction results from CoreLogic.
The combined capital cities returned a preliminary auction clearance rate of 65.4 per cent this week across 3,335 auctions making it the third busiest week for auctions so far this year, increasing from 62.8 per cent across 2,907 auctions last week. This time last year, 2,987 homes were taken to auction and a clearance rate of 74.4 per cent was recorded.
The final clearance rate has remained below 65 per cent for the last 4 weeks and it’s likely that this will be the case again on Thursday when the final results are released. One of the biggest contributors to the softer auction market conditions is Sydney, where the final clearance rate has remained below 60 per cent since the last week of October, while Melbourne has slipped below 70 per cent for the second week in a row.
RBA Head of Financial Stability Jonathan Kearns, spoke at Aus-China Property Developers, Investors & Financiers today. He said the Bank has responsibility to promote the stability of the financial system as a whole so carefully monitors property markets because poor commercial property lending and the large stock of residential property debt means risks to financial stability and household resilience.
The high valuation of commercial property increases the potential for a sharp correction and so the risks from commercial property lending. The high level of household mortgage borrowing also brings risks, both for lenders and households.
He also discussed the impact of purchases and financing by foreigner investors and banks. Nationally, purchases by foreign buyers are equivalent to around 10-15 per cent of new construction, or about 5 per cent of total housing sales. But he said, these purchases by foreign buyers do not, on the whole, reduce the supply of dwellings available to local residents and in fact may actually contribute to expansion of the housing stock. However, these purchases by foreign buyers, particularly for investment purposes, are a more recent phenomenon and so their impact on the housing cycle is less clear.
Property and Financial Stability
The property market is important for financial stability for a number of reasons. In the past, banks have experienced substantial losses on their commercial property lending because of its large cycles. Residential property is also important for financial stability because residential mortgages account for a very large share of banks’ lending in Australia. Because of the high value of households’ mortgage debt and housing assets, the property market also has implications for the resilience of households’ balance sheets. Today, I will outline the connection of financial stability with commercial property, and then with residential property.
Internationally, banks experienced substantial losses on their commercial property lending in the financial crisis. In Australia the performance of commercial property lending also deteriorated, but losses were relatively moderate.
Graph 1
However, Australia does have its own history in the early 1990s of large losses on commercial property lending, resulting in individual lenders needing to be rescued and threatening the stability of the financial system. In five years, Australian banks experienced losses of around 10 per cent of their loans, concentrated in their commercial property lending.
This was a classic boom-bust or ‘hog cycle’ story. The second half of the 1980s saw buoyant economic conditions, strong growth in commercial property prices and a large increase in commercial property construction.
A ready supply of credit fuelled the boom. Following bank deregulation and the entry of foreign banks into the domestic market in the mid 1980s, the domestic banks competed to hold on to their market share. Lending standards were lowered and business credit grew by around 25 per cent each year in the second half of the 1980s. With the economy overheating, monetary policy was tightened. Increased interest payments and the economy falling into recession resulted in rising losses on business lending. Office prices halved from their peak as construction initiated in the late 1980s added to supply in an already falling market. Losses mounted at banks with two having to be rescued, and one major bank needing to raise capital.
As notable as this episode seems, it follows a script that had played out before domestically and has since internationally. There are several aspects to commercial property lending that make it inherently risky, and typically more risky than residential mortgage lending. A large share of banks’ commercial property lending is for construction and development, including for large apartment buildings. Construction and development loans tend to be riskier because the property isn’t yet earning rent, things can go wrong in the often complex construction phase, and market conditions can change in the several years or more it takes to complete large projects. Losses can also be greater on lending for commercial property than for residential property because borrowers with a limited liability company structure have less incentive to repay than individual residential mortgage borrowers who face full recourse.
Adding to the risk is that the availability of finance for commercial property has tended to be pro-cyclical. A booming property market has often led to an easing of both lending standards and borrowers’ collateral constraints just as demand for funding is rising. Relative to residential property, the greater ability for funding to come from outside established lenders adds to this cyclicality. Commercial property lending can be syndicated and large individual projects make it easier for new banks to enter the market at a relatively low cost. This cyclicality of lending can accentuate the cycles in commercial property construction and prices.
Foreign investors may add to the cyclicality of the commercial property market if they tend to enter the market when prices have been rising and there are more properties for sale. Alternatively, if foreign investors’ decisions are largely influenced by conditions in their home country rather than the domestic market they may actually moderate the domestic property cycle. Foreign banks direct links to domestic banks tend to be small, so their impact on the domestic financial system is likely to be indirect through an amplification of the credit cycle and property market.
Historically, residential property lending has been less risky for banks than commercial property lending. Indeed, the stress test conducted by APRA indicated that Australian banks have sufficient capital to survive a deep recession and a collapse in the housing market. However, the sheer size of mortgage lending on Australian banks’ books means that residential loan performance is critical to banks’ health and so the stability of the broader financial system. Housing debt is also important for the resilience of the household sector in Australia. The ratio of household debt to income is high in Australia relative to other advanced economies, and has edged higher since the financial crisis.
In Australia, unlike many other countries, individual households also borrow to directly purchase investment properties, which may add to risk. More than one-in-ten tax payers owns an investment property. Most of these are geared, so much so that the majority do not earn positive income for their owners. While these borrowers generally start with smaller loans, and most of the debt is held by high-income households, they have less incentive to pay down their mortgage ahead of schedule because of the tax benefits of debt and so tend to retain higher mortgage balances over the lifetime of the loan.
Despite the high level of mortgage borrowing, various factors mitigate the risks to the financial system. Housing debt is mostly well secured. Limits on the maximum loan-to-valuation for mortgage lending and house price appreciation over time mean that existing borrowers generally have a large amount of equity in their homes. In addition, the ability of Australian borrowers to make excess payments on their mortgage, and that this is a tax effective way for owner occupiers to save, means that borrowers tend to accumulate large pre-payments (‘mortgage buffers’). Close to two-thirds of loans have such pre-payments, which collectively amount to two and half years of scheduled mortgage repayments at current interest rates.
As with commercial property, foreign buyers of residential property could amplify cycles or transmit foreign shocks. Non-residents purchasing Australian real estate as an investment may choose between different countries based on expected returns, which can increase the correlation of the Australian market with other countries. Changes in economic and regulatory conditions in foreign buyers’ home countries can also be transmitted to their demand for Australian property. But if purchases of residential property by foreign buyers mainly depend on conditions in their home country, their participation could actually have a moderating impact on the Australian housing cycle.
Having explained why we take a significant interest in the property market from a financial stability perspective, I would now like to provide an update on recent developments in the commercial and residential property markets and the role that international investors, finance and developers have played.
Commercial Property
One part of the commercial property sector that the Reserve Bank has been watching closely is loans for the development of residential property. The surge in apartments recently completed and under construction in the major cities raises the risk of price falls. The construction of new apartments has been largest relative to the existing stock in Brisbane and inner-city Melbourne, though it is largest in absolute numbers in Sydney.
Prices for other types of commercial property have risen sharply with a strong increase in demand from international investors seeking the relatively high yields available on Australian commercial property. Exceptionally low long-term interest rates globally have pushed up valuations for property and other assets, all the more so because relatively strong and stable global economic growth in the past few years has reduced investors’ perception of the current risks. While there has not been a surge in construction, the run up in commercial property prices raises the risk of a sharp correction, for example if there is a change in sentiment or a pick-up in long term interest rates.
Graph 2
Commercial office markets have been strongest in Sydney and Melbourne with low vacancy rates and rising prices. In contrast, conditions have been weaker in Perth where vacancy rates increased sharply with the downturn in the state economy from the decline in mining investment.
Conditions in retail property markets have also been relatively subdued across Australia. In part, this reflects strong competition in the retail sector from new entrants and online retailers. However, banks have continued to grow their lending for new retail developments and refurbishments with an increased focus on entertainment, hospitality, services and mixed residential.
Overall, Australian banks have tightened their lending conditions for commercial property in recent years. Restrained lending by Australian banks has provided an opportunity for new entrants into the market. Asian banks have grown their commercial property lending sharply, more than doubling their market share in just two years, although it remains relatively small. This strong growth in commercial property lending by Asian banks is reminiscent of European banks’ growth in the lead up to the financial crisis. However, whereas Australian banks eased their lending standards in that pre-crisis period in order to compete, this time Australian banks do not appear to have eased lending standards.
Graph 3
Residential Property
The Australian residential property market has been strong in the post-financial crisis period as interest rates have been kept low to support economic activity and to boost low inflation. Since 2009, national housing prices have risen by around two thirds and growth of housing credit has outpaced that of incomes. By 2014, concerns grew about the risks from an increase in riskier types of lending, including interest-only loans and investor lending at high loan-to-valuation ratios as well as rising household indebtedness. In response to these concerns, the Australian Securities and Investments Commission (ASIC) increased its scrutiny of lending practices and APRA implemented several macro prudential measures in late 2014 and then again in early 2017, on both occasions after consultation with the Council of Financial Regulators, which the Governor of the Reserve Bank chairs. There are several aspects to these regulatory measures. For each authorised deposit-taking institution (ADI), the growth of investor housing lending has been capped at 10 per cent. Interest-only loans can be no more than 30 per cent of new mortgage lending. In addition, APRA has been monitoring high loan-to-valuation mortgage lending and instructed lenders to pay closer attention to loan serviceability criteria, such as the interest rate buffer applied to the current low mortgage rates and borrowers’ expenses.
These measures have played a role in reducing the build up in risks from household borrowing. Lenders responded to the restrictions by increasing their interest rates for interest-only loans and investor lending. In response, the share of new loans that are interest-only has been falling, and overall investor credit growth has remained below the 10 per cent threshold. Many existing borrowers have also switched their interest-only loans to principal-and-interest loans and there has been a decline in the share of new loans at high loan-to-valuation ratios.
While riskier types of lending have moderated, and investor credit growth has slowed, the pace of overall housing credit growth has been fairly stable this year as borrowing by owner-occupiers has picked up. Conditions in the housing market have eased, particularly in Sydney where prices had experienced strong growth and are particularly high, possibly giving lending restrictions greater impact in Sydney. In Melbourne, conditions remain stronger than in other capital cities. On the other side of the country, and at the other end of the spectrum in terms of housing market conditions, the Perth housing market remains weak. Prices have fallen gradually over the past two to three years, with rents also falling as the rental vacancy rate has increased to its highest level since 1990.
The strong demand driving housing price growth reflected not only low interest rates but also strong population growth. With rising demand and prices, dwelling investment increased strongly. A notable feature of the recent dwelling construction cycle has been the marked increase in the share of higher density construction, a helpful response to the shortage of well-located land in Australia’s large cities. Approvals for new higher density dwellings went from being less than half those of detached dwellings less than a decade ago to being almost on par in recent years. But the longer time to build higher-density dwellings than detached houses increases the risk that a large number of new dwellings could be completed just as the housing market turns down, so amplifying the housing cycle.
Graph 4
This surge in apartment construction has been largest in Sydney, but has also been notable in Melbourne. While the number of apartments being built in Brisbane has been smaller compared to its population, it has been greater relative to the existing stock of apartments. Peak apartment completion in Brisbane is expected to occur this year, capping a three-year period in which the number of apartments has increased by over one-third from the stock in 2015. Perth has also seen strong growth in a relatively small stock of apartments.
This change in the composition of the housing stock is resulting in a rebalancing of relative prices, with prices for detached dwellings growing faster than those for apartments in the major cities over the past five years. In the weaker housing markets of Brisbane and Perth, this has seen apartments experience small price falls in recent years. To date, despite valuations for some apartments at settlement being lower than the purchase price off the plan there have not been widespread reports of higher rates of settlement failure or any notable increase in arrears or losses for banks.
Purchases by foreign buyers have received considerable focus in recent years. Non-residents are able to purchase newly constructed dwellings in Australia, while temporary residents, such as those in Australia for work or study, are able to purchase an existing dwelling for their primary residence. It has been hard to get a firm estimate of how large these purchases are, but drawing on a range of sources, it seems that, nationally, purchases by foreign buyers are equivalent to around 10-15 per cent of new construction, or about 5 per cent of total housing sales. The share of new construction purchases is highest in Melbourne and Sydney. It is also higher for apartments, but it is still only perhaps around one-quarter of newly built apartments. Many foreign buyers come from China, seemingly around three-quarters. Purchases of new properties by foreign buyers have eased over the past year, reportedly because of stricter enforcement of Chinese capital controls and tighter access to finance for foreign buyers.
Purchases by foreign buyers do not, on the whole, reduce the supply of dwellings available to local residents and in fact may actually contribute to expansion of the housing stock. Foreign buyers in Australia for work or study would have been renting if they did not purchase. Other foreign buyers rent the property as an investment and so contribute to the rental stock. Also, there are some new developments that only proceed because they get high pre-sales from foreign buyers.
The strength of the Australian property market, and the participation by foreign buyers, has also enticed some foreign developers to Australia for specific projects, but overall they remain a small part of the market. Foreign banks also have a very small role in residential property lending in Australia.
Given their significance for financial stability, the Reserve Bank carefully monitors property markets. History has taught us that commercial property lending can result in substantial losses for banks. And the large stock of residential property debt means that it too is important for financial stability and household resilience.
The high valuation of commercial property, which is common to many other assets, increases the potential for a sharp correction and so the risks from commercial property lending. The high level of household mortgage borrowing also brings risks, both for lenders and households.
Purchases and financing by foreigner investors and banks have been prominent in the current commercial property cycle. We have seen this before and are well aware of the impact this can have on the cycle. The increased purchases of dwellings by foreign buyers, particularly for investment purposes, are a more recent phenomenon and so their impact on the housing cycle is less clear.
APRA has investigated commercial property lending standards to ensure these are not eroded, while measures by APRA and ASIC aim to reduce the riskiness of new residential lending. And the Reserve Bank, with its mandate for overall financial stability, will continue to closely monitor risks from property markets and lending.
Interesting research from CommSec, who commissioned the ABS to look at trends in the size of Australian homes. They says the average floor size of an Australian home (houses and apartments) has fallen to a 20-year low, the average new home is 189.8 square metres, down 2.7 per cent over the past year and the smallest since 1997.
Australians continue to build some of the biggest houses in the world. But an increasing proportion of Australians – especially in Sydney, Melbourne and Brisbane – also want smaller homes like apartments, semi-detached homes and town houses. As a result, the average home size continues to fall – now at 20-year lows.
Generation Y, Millennials, couples and small families want to live closer to work, cafes, restaurants, shopping and airports and are giving up living space for better proximity to the desirable amenities.
So consolidation is occurring in the eastern states. Older free-standing houses are making way for apartments. And while building completions hit record highs in the year to March, approvals to build homes are rising again.
It is important to note that there are differences in house size across Australia. In the past year the average size of houses built in both South Australia and Western Australia has lifted. In fact South Australia built the biggest homes on records going back 30 years. And on average Western Australian houses built in 2016/17 were just short of record highs for the state.
Clearly the changes in housing demand and supply, and the differences across the country, have major implications for builders, developers, investors, building material companies, financiers and all levels of Government.
OCCUPANCY RATES
Since the first Census was conducted in 1911, and up to 2006, the number of persons per dwelling consistently fell. In 1911 there was an average of 4.5 people in every home. But by 2006 this ratio had almost halved to around 2.4 people in every home. Not only were more homes being built but other factors like families with fewer children, more divorces fewer marriages taking place had resulted in smaller families.
From 2006 to 2013, the number of people per dwelling rose. At face value, the modest increase in average household size may not seem significant. But it was the first increase in household size – and as a consequence, the average number of people in Australian homes – in at least a century.
Children were staying home longer with their parents – no doubt the cost of homes and rising rents being key influences. With the ageing population, more generations were choosing to stick together in the one dwelling – a trend that is a consequence of the increased size and quality of homes. New migrants also chose to stay with family or friends. And given the increased preference to attend universities and colleges, Generation Y was forced to share accommodation and save longer to buy a home.
But according to quarterly ABS data, since 2014 the number of people per dwelling has again been falling. Lower interest rates and the increased supply of cheaper apartments (compared with houses) have prompted older couples to down-size. More Generation Y have been looking to move out of home and take ownership of accommodation more appropriate to their needs.
In part, the decline in household size explains some of the lift in home building. Higher population growth – especially in NSW and Victoria – also explains the lift in home building. The question is whether household size continues to fall over the next few years or whether higher home prices acts to stall demand, again prompting greater co-habitation of dwellings.
STATE DATA
Victorians are building the biggest houses in Australia. In 2016/17 the average floor area of houses built in Victoria was 242.8m², ahead of Western Australia (242.5m²), NSW (230.0m²) and Queensland (227.3m²).
The smallest new houses built were in Tasmania (195.5m²) and the ACT (197.0m²).
In 2016/27 the biggest apartments could be found in the Northern Territory (154.5m²). However, the data may be distorted by the small number of completions in the year (1,173).
Of the states, South Australia built the biggest apartments in 2016/17 with the average floor area at 152.3m², ahead of Victoria (131.0m²) and Tasmania (129.8m²).
Of all homes built in 2016/17, the average floor area was biggest in Western Australia (214.3m²), then South Australia (201m²). In Western Australia over 69 per cent of homes built were free-standing houses, and in South Australia houses were 73.2 per cent of the total. By comparison, only 43.6 per cent of homes built in NSW were free-standing or detached houses.
The preliminary auction results from Domain are in. The trend looks like it is continuing to ease compared with last year, though a little up from last week so far. Melbourne is sitting on 72.1% stronger than last weekend.
Brisbane cleared 33% of 136 listed, Adelaide 62% of 98 listed and Canberra 69% of 96 listed.
A really mixed bag of news this week, with stronger business and employment data, lower mortgage defaults and yet weak wage growth, and more evidence of the pressure on households. We pick over the coals and try to make sense of what’s going on.
Welcome to the Property Imperative Weekly to 18 November 2017. Watch the video or read the transcript.
We start with some good news.
The latest National Australia Business (NAB) survey — a composite indicator that measures trading activity, profitability and employment — surged by a massive 7 points to +21, leaving it at the highest level since the survey began in 1997. On this measure, Australian businesses have not had it so good in at least two decades. There were enormous increases recorded in trading and profitability, suggesting that demand was rampant during October. However, beware, this included a massive unexplained jump in manufacturing and the survey’s lead indicators softened over the month, which, along with an unchanged reading on business confidence, raises questions as to whether the bounce in the conditions index can be sustained.
Deputy Governor Guy Debelle spoke at the UBS Australasia Conference on “Business Investment in Australia“. He argued that investment has been strong over the last decade, thanks to the mining sector. This is now easing back, and the question is will the non-mining sector start firing or not? Even if it does, they have huge boots to fill!
Luci Ellis RBA Assistant Governor (Economic) delivered the Stan Kelly Lecture on “Where is the Growth Going to Come From?“. An excellent question given the fading mining boom, and geared up households! But we really got few answers. Australia’s population is growing faster than in almost any other OECD economy. That has remained true over the past couple of years. The rate of natural increase is higher than many other countries, but most of the difference is the large contribution from immigration. Of course, just adding more people and growing the economy to keep pace wouldn’t boost our living standards. Next, employment participation has been rising recently. The increase has been concentrated amongst women and older workers and is linked with the increase in health and education employment. Finally, productivity can improve, especially if innovation can be leveraged, although she noted the rate of technology adoption has slowed down since the turn of the century. We wonder if this has something to do with the sluggish and underpowered NBN rollout currently underway.
The monthly trend unemployment rate remained at 5.5 per cent in October 2017, according to figures released by the Australian Bureau of Statistics. While the trend is down, it was not as strong as some analysts were expecting. The seasonally adjusted unemployment rate decreased by 0.1 percentage points to 5.4 per cent and the labour force participation rate decreased to 65.1 per cent.
The ABS released their analysis of individual state accounts to Jun 2017. This includes an estimate of average gross household disposable income per capita. The variations across states are significant and interesting. Of note is the astronomical value, and trajectory of individuals in the ACT, at more than $90,000. We saw a decline in gross incomes in WA (one reason why mortgage defaults are rising there) at around $50,000. NSW was also around $50,000 while VIC was around $45,000 and TAS was $40,000.
Wages rose 0.5 per cent in the September quarter 2017 and 2.0 per cent over the year, according to the ABS. This was below consensus expectation, and continues the slow grind in household income, for many falling below the costs of living. Those in the public sector continue to do better than those in the private sector. In original terms, wage growth to the September quarter 2017 ranged from 1.2 per cent for the Mining industry to 2.7 per cent for Health Care and Arts and recreation services. Western Australia recorded the lowest growth through the year of 1.3 per cent and Victoria, Queensland and Tasmania the highest of 2.2 per cent.
The legislation to tighten some aspects of investment property, and levy a charge on vacant foreign owned property has been passed in the Senate. The legislation prevents property investors from claiming travel expenses when travelling between properties, as well as tightening depreciation on plant and equipment tax deductions. Foreign owners will be charged a fee if they leave their properties vacant for at least six months in a 12-month period, in an attempt to release more property to ease supply. The latest Census showed that there are 200,000 more vacant homes across Australia than there were ten years ago.
Turning to the mortgage industry, Fitch Ratings says Australia’s RBMS mortgage arrears fell to 1.02% in 3Q17, a 15bp decrease from the previous quarter; consistent with the nine-year long seasonal trend where 30+ days arrears have eased in the third quarter. They say the curing of third-quarter arrears was helped by borrowers using tax return receipts to make repayments. The 30+ days arrears were 4bp lower than in 3Q16, reflecting Australia’s improved economic environment and lower standard variable interest rates for owner-occupied lending. They said the gap between investor lending and owner-occupied rates has widened, as banks respond to regulatory investment and interest-only limits on new loan origination. Historically, investors paid a 25bp-30bp premium over owner-occupied loans, but this widened to 60bp in September 2017.
S&P Global Ratings said RMBS Mortgage arrears fell to 1.08% in September across Australian down from 1.10% in August 2017. They say mortgage arrears rose in both the Northern Territory and the ACT during September but fell elsewhere. The ACT mortgage arrears it is only at a low 0.64%, compared with Western Australia who has the highest arrears of 2.21%. However, while outstanding loan repayments on 30-to-60-day arrears also declined in most states between January and September, 90-day+ arrears rose in Western Australia and Queensland. This is the same as we saw recently in the bank reporting season. S&P expects arrears to rise over the coming months, as they “traditionally start to increase in November and continue through to March.”
There was more evidence of poor mortgage lending practice this week, following the recent UBS “Liar Loans” research study. A liar loan is a loan that is approved on the basis of unverified and possibly false information about income, assets or capacity to repay. This is important because mortgage delinquency and default may rise due to excessive risk taking in mortgage lending combined with deteriorating economic conditions; or due to falling income and rising unemployment during a housing downturn.
Connective remained brokers of their obligations, and pointed to findings from the 2016 Veda Cybercrime and Fraud Report, which recorded a 27 per cent year-on-year increase in falsifying personal information. “Falsified documentation — particularly documents that verify a customer’s income — is the most common type of fraud that a mortgage broker is likely to encounter,” the aggregator said. Back in June, Equifax informed brokers at a Pepper Money roadshow that 13 per cent of frauds reported were targeting home loans and there has been a 25 per cent year-on-year increase in frauds originating from the broker channel.
In the same vein, NAB has said it has commenced a remediation program for some of its customers, after a review identified their home loan may not have been established in accordance with NAB’s policies. NAB identified around 2,300 home loans since 2013 that may have been submitted without accurate customer information and/or documentation, or correct information in relation to NAB’s Introducer Program. As a result of NAB’s review, 20 bankers in New South Wales and Victoria had their employments terminated, or are no longer employed by NAB, and an additional 32 bankers had consequences applied including the reduction of remuneration. NAB has commenced writing to these customers – many of whom live overseas – asking them to participate in a detailed review of their loan, which may include verification of documents submitted at the time of their home loan application. Affected customers may be offered compensation as appropriate.
More evidence of the risks in the system came when The Reserve Bank in New Zealand said that Westpac New Zealand has had its minimum regulatory capital requirements increased after it failed to comply with regulatory obligations relating to its status as an internal models bank. Internal models banks are accredited by the Reserve Bank to use approved risk models to calculate how much regulatory capital they need to hold. Westpac used a number of models that had not been approved by the Reserve Bank, and materially failed to meet requirements around model governance, processes and documentation.
Still talking of risks, there was an interesting paper from the Federal Reserve Bank of Cleveland “Three Myths about Peer-to-Peer Loans” which suggested these platforms, which have experienced phenomenal growth in the past decade, resemble predatory loans in terms of the segment of the consumer market they serve and their impact on consumers’ finances and have a negative effect on individual borrowers’ financial stability. This is of course what triggered the 2007 financial crisis. There is no specific regulation in the US on the borrower side. Given that P2P lenders are not regulated or supervised for antipredatory laws, lawmakers and regulators may need to revisit their position on online lending marketplaces.
It seems that eventually mortgage rates will rise in Australia, as global forces exert external pressure on the RBA, and as the RBA tries to normalise rates (at say 2% higher than today). Timing is, of course, not certain. But it is worth considering the potential impact. While our mortgage stress analysis takes a cash flow view of household finances, our modelling can look at the problem another way. One algorithm we have developed is a rate sensitivity calculation, which takes a household’s mortgage outstanding, at current rates, and increments the interest rate to the point where household affordability “breaks”. We use data from our household survey to drive the analysis.
So we start with the average across the country. We find that around 10% of households would run into affordability issues with less a 0.5% hike in mortgage rates, and around another 8% would be hit if rates rose 0.5%, and a larger number would be added to the “in pain” pile, giving us a total of around 25% of households across the country in difficulty if rates went 1% higher. [Note that the calculation does not phase the rate increases in]. Around 40% of households would be fine even if rates when more than 7% higher. At a state level we found that around 40% of households in NSW would have a problem, compared with 27% in VIC and 24% in WA. We can also take the analysis further, to a regional view across the states. This reveals that the worst impacted areas would be, in order, Greater Sydney, Central Coast, Curtain and Greater Melbourne. These are all areas where home prices relative to income are significantly extended, thus households are highly leveraged.
CoreLogic said Mortgage clearance rates have continued to track below 70 per cent since June the year; this is a considerably softer trend than what was seen over the same period last year when clearance rates were tracking around the mid 70 per cent range for most of the second half 2016. Results across each of the individual markets were varied this week, with Canberra recording the highest preliminary auction clearance rate of 72.9 per cent, while in Brisbane only 45.7 per cent of auctions cleared.
So to, two important reports.
According to the eighth edition of the Credit Suisse Research Institute’s Global Wealth Report, in the year to mid-2017, total global wealth rose at a rate of 6.4%, the fastest pace since 2012 and reached USD 280 trillion. But wealth distribution has become more uneven. This reflected widespread gains in equity markets matched by similar rises in non-financial assets (home prices), which moved above the pre-crisis year 2007’s level. Household wealth in Australia grew at an average annual growth rate of 12%, with about half the rise due to exchange-rate appreciation against the US dollar. Australia’s wealth per adult in 2017 is USD 402,600, the second highest in the world after Switzerland.
However, the composition of household wealth in Australia is heavily skewed towards non-financial assets, which average USD 303,200, and form 60% of gross assets. The high level of real assets partly reflects a large endowment of land and natural resources relative to population, but also results from high property prices in the largest cities.
Finally, Industry Super Australia, published an excellent discussion paper on “Assisting Housing Affordability” which endeavours to identify the underlying causes of affordability issues, and considers some useful policy responses in the current and historical context. They rightly consider both supply and demand related issues.
They call out specifically the impact of incoming migration, especially around university suburbs in the major centres as one major factor.
More broadly, they articulate the problem facing many, in that access to affordable housing – a basic need – is now more difficult than ever and the issue is affecting household spending decisions:
Key workers like police officers, teachers and nurses can’t afford to live near the communities they serve.
Children are staying at home for longer, marrying later and taking longer to save for a home deposit.
Many older Australians are locked into big houses that no longer suit their needs while a greater number of near retirees are renting or paying off a mortgage.
Commuters spend too much time on congested roads and trains which are now the norm in certain Australian cities.
More Australians are renting.
The report is worth reading because it knits together the complex web of issues, and confirms the complexity which is housing affordability, and that there are no simple single point solutions.
And that’s the point. Sure, employment looks strong, but the nature of that employment is favouring lower wage occupations. Business confidence is strong, because business profits are up, but this is not translating into higher wages. As a result, wealth distribution is becoming more skewed, as home prices and stock prices rise. But the risks remain. Property is overvalued, and we lack joined up thinking to address the fundamental structural issues which exist. So meantime we muddle on, hoping that wage growth will start to rise before home prices fall too far and mortgage rates rise. Don’t look down, we are walking a tightrope!
So that’s the Property Imperative weekly to 18th November 2017. If you found this useful, do leave a comment below, subscribe to receive future updates, and check back next time. Thanks for watching.
Brisbane cleared 59% of the 119 scheduled auctions, Adelaide 61% of 106 and Canberra 67% of 99 scheduled.
Welcome to the Property Imperative weekly to the 25 November 2017. Watch the video, or read the transcript.
Norway and Sweden are slightly higher. The fastest rate of growth is in South Africa, which has reached a heady 700!
The clear and present danger which we are now facing relates to housing. We have been tracking the building risks in the sector for many years, and finally even the regulators have gotten the message, see ASIC, APRA and RBA. Our regulators have failed us and the proposal from Murray’s FSI for an audit of their effectiveness fell on deaf ears. The Council of Financial Regulators suffers from group think.
Brisbane cleared 33% of 136 listed, Adelaide 62% of 98 listed and Canberra 69% of 96 listed.
Welcome to the Property Imperative Weekly to 18 November 2017. Watch the video or read the transcript.
