Digital Finance Analytics (DFA) Blog
"Intelligent Insight"
The preliminary data from Domain shows that yesterdays auction clearance volumes were down, to 413 nationally compared with 1,303 last week. However clearance rates are still sitting around 70%.
Brisbane cleared 60% of 87 scheduled, Adelaide cleared 68% of 45 scheduled, and Canberra cleared 63% of 31 listed.
The evidence is mounting that the property cycle is on the turn, and the question now is – will it be a gentle retreat or a blood bath? In this week’s edition of the Property Imperative we consider the evidence.
At the start of the week we got the latest auction clearance rates which showed the trend of lower volumes but high clearance rates continued. Momentum however is slowing. This long week, the number of auctions will be lower but Domains data shows a national clearance rate around 70%.
We released our latest Household Finance Confidence index to the end May, with a lower overall score of 100.6, down from 101.5 last month. This is firmly in the neutral zone, but households with mortgages are feeling the pinch and the index is set to go lower in the months ahead. Both property investors and owner occupiers are now more concerned about rising mortgage interest rates, and potentially falling property prices. Sentiment in the property sector is clearly a major influence on how households view their finances, but the real dampening force is falling real incomes. This is unlikely to correct any time soon, so we expect continued weakness in the index as we go through winter.
We also released our latest mortgage stress and default modelling. This analysis uses our core market model which combines information from our 52,000 household surveys, public data from the RBA, ABS and APRA; and private data from lenders and aggregators. Across the nation, more than 794,000 households are now in mortgage stress compared with 767,000 last month; with 30,000 of these in severe stress. This equates to 24.8% of households, up from 23.4% last month. We also estimate that nearly 55,000 households risk default in the next 12 months. Check out our good coverage in Reuters.
The main drivers are rising mortgage rates and living costs whilst real incomes continue to fall and underemployment is on the rise. This is a deadly combination and is touching households across the country, not just in the mortgage belts.
ABS data showed that overall lending flows fell 0.4% in April, to $32.8 billion. This is the first month following APRA’s latest intervention. Owner occupied loans fell 0.1% to $19.9 billion and investment lending fell 1% to $12.6 billion. Refinanced loans fell significantly, and the proportion of loans for investment purposes also fell. In addition, investment in new housing fell by 4.4 per cent in the March Quarter 2017 which brings the sector down from a record high investment in December 2016 and back to levels similar to those experienced at the start of 2016.
The number of new first home buyer loans decreased by 17.5% to 6,547 in April from 7,939 in March, though we still see more going direct to the investor sector.
According to a report from UBS, first time buyers are pretty much locked out of the property market. ‘Typical’ first home buyers are facing ~11 years to save; and ~40 years in Sydney! UBS already ‘called the top’ of housing, a key reason being that affordability is stretched, as the house price to income ratios surged to a record high of 6.5x, up sharply from 4.5x in 2012 (and more than doubling from 3x in 1996). While interest rates have fallen to a record low, the mortgage repayment share of income still lifted to a near decade high, and the key issue for first home buyers is the ‘deposit gap’ even before buying.
The March quarter edition of the Adelaide Bank/Real Estate Institute of Australia Housing Affordability Report also shows that whilst affordability improved across the country, the number of first home buyers decreased in all states and territories.
Then in a housing market update, ANZ Research said it expects “prices to slow sharply this year and next” and flagged the potential oversupply of apartments – particularly in Melbourne and Brisbane – as a key concern. The bank said. “Household debt is at record levels, which increases vulnerability to future shocks.
Bendigo announced that they have made a change to the accounting treatment of their Homesafe business with cash earnings now to exclude any unrealised income or losses and associated funding costs. Given Bendigo had a 6% long run home price growth assumption; in the current environment this looks like a smart move even though cash earning will be hit as a result.
There was a raft of further hikes in mortgage rates and changes in lending policy this week. For example, ING Direct eliminated interest-only repayments on new applications for its owner occupied fixed rate loans. On the other hand, the bank lowered rates on some principal and interest fixed rate loans. Several surveys have highlighted that households are considering moving to fixed rate mortgages to try and alleviate the pressure of ongoing lifts in variable rates.
Adelaide bank ditched their commercial low doc loans and Suncorp added 12 basis points to investor loans, but reduced some fixed rates for owner occupied loans and maintains its offer to first time buyers.
ANZ lifted variable interest-only home loan rates for investors and owner-occupiers by 30 basis points, whilst cutting five basis points off their variable interest rates for customers paying principal and interest on their home loans. This takes the bank’s standard variable rate for owner-occupiers to the lowest of major banks at 5.20%pa. So the competition for owner occupied loans is hotting up as pricing continues to be used to slow investment loan growth.
The RBA held the cash rate, and stressed the risks from high household debt once again. Also, on the economic front, the seasonally adjusted current account deficit fell $403 million (11 per cent) to $3,108 million in the March quarter 2017. This was not as good as expected. The pace of growth of the Australian economy slowed in the March quarter to 0.3 per cent and through the year, GDP grew 1.7 per cent. There were falls in exports and dwelling investment. The long term trend also highlights a slowing, so we need new growth engines if we are to keep the growth ball in the air! Household consumption just won’t do the job, and household savings fell in the quarter as they struggle to pay the bills.
So, it is clear the momentum in home lending is declining, and more households are struggling with high debts in a rising interest rate environment. It seems certain now, despite the banks targeting first time buyers, demand will slacken, and this will drive prices lower. Whilst the consensus view appears to be there will be an orderly decline, there are more risks now apparent which suggest prices may well fall further and faster than previously anticipated. We are indeed past the peak, so now its a question of how steep the downhill gradient becomes. Prepare for a bumpy ride!
In a housing market update this week, ANZ Research said it expects “prices to slow sharply this year and next” and flagged the potential oversupply of apartments – particularly in Melbourne and Brisbane – as a key concern.
“The twin issues of housing affordability and financial stability are front of mind for governments, the RBA and APRA,” the bank said. “Household debt is at record levels, which increases vulnerability to future shocks.”
According to ANZ, the residential construction cycle has lost momentum with approvals down about 20 per cent from their 2016 peak. The major bank expects another 5-10 per cent fall in the next 6-12 months.
“That said, the solid pipeline of work suggests that the level of residential construction activity will slow only gradually this year. There has been a slight rise in settlement risk which bears close monitoring,” ANZ said.
ANZ believes that the housing market will steadily cool going forward with a combination of further regulation and changes to government policy, tighter borrowing conditions and out-of-cycle mortgage rate increases all expected to weigh on the outlook for prices.
“We anticipate nationwide dwelling prices will rise by 4.5 per cent through 2017, before slowing further to 1.9 per cent 2018 and expect to see continued divergence across regions,” the group said.
While price growth in Sydney and Melbourne is expected to slow to well below historical averages, ANZ said these markets will remain positive as demand and population growth remain elevated.
“On the other hand, prices are expected to ease slightly through 2018 in Brisbane, given the significant volume of supply due to hit that market,” the bank said.
The NZ Reserve Bank has released its consultation paper on possible DTI restrictions. The 36+ page report is worth reading as it sets out the risks ensuring from high risk lending, leveraging experience from countries such as Ireland.
Interestingly they build a cost benefit analysis, trading off a reduction in the costs of a housing and financial crisis with a reduction in the near-term level of economic activity as a result of the DTI initiative and the cost to some potential homebuyers of having to delay their house purchase.
Submissions on this Consultation Paper are due by 18 August 2017.
In 2013, the Reserve Bank introduced macroprudential policy measures in the form of loan to-value ratio (LVR) restrictions to mitigate the risks to financial system stability posed by a growing proportion of residential mortgage loans with high LVRs (i.e. low deposit or low equity loans). This increase in borrower leverage had gone hand-in-hand with significant increases in house prices, particularly in Auckland. The Reserve Bank’s concern was the possibility of a sharp fall in house prices, in adverse economic circumstances where some borrowers had trouble servicing loans. Such an event had the potential to undermine bank asset quality given the limited equity held by some borrowers.
The Reserve Bank believes LVR restrictions have been effective in reducing the risk to financial system stability that can arise due to a build-up of highly-leveraged housing loans on bank balance sheets. However, LVRs relate mainly to one dimension of housing loan risk. The other key component of risk relates to the borrower’s capacity to service a loan, one measure of which is the debt-to-income ratio (DTI). All else equal, high DTI ratios increase the probability of loan defaults in the event of a sharp rise in interest rates or a negative shock to borrowers’ incomes. As a rule, borrowers with high DTIs will have less ability to deal with these events than those who borrow at more moderate DTIs. Even if they avoid default, their actions (e.g. selling properties because they are having difficulty servicing their mortgage) can increase the risk and potential severity of a housing related economic crisis.
While the full macroprudential framework will be reviewed in 2018, the Reserve Bank has elected to consult the public prior to the review. This consultation concerns the potential value of a policy instrument that could be used to limit the extent to which banks are able to provide loans to borrowers that are a high multiple of the borrower’s income (a DTI limit). A number of other countries have introduced DTI limits in recent years, often in association with LVR restrictions. In 2013, the Bank and the Minister of Finance agreed that direct, cyclical controls of this sort would not be imposed without the tool being listed in the Memorandum of Understanding on Macroprudential Policy (the MoU). Hence, cyclical DTI limits will only be possible in the future if an amended MoU is agreed.
The purpose of this consultation is for the Reserve Bank, Treasury and the Minister of Finance to gather feedback from the public on the prospect of including DTI limits in the Reserve Bank’s macroprudential toolkit.
Throughout the remainder of the document we have listed a number of questions, but feedback can cover other relevant issues. Information provided will be used by the Reserve Bank and Treasury in discussing the potential amendment of the MoU with the Minister of Finance. We present evidence that a DTI limit would reduce credit growth during the upswing and reduce the risk of a significant rise in mortgage defaults during a subsequent severe economic downturn. A DTI limit could also reduce the severity of the decline in house prices and economic growth in that severe downturn (since fewer households would be forced to sharply constrain their consumption or sell their house, even if they avoided actual default). The strongest evidence that these channels could materially worsen an economic downturn tends to come from countries that have experienced a housing crisis in recent history (including the UK and Ireland). The Reserve Bank believes that the use of DTI limits in appropriate circumstances would contribute to financial system resilience in several ways:
– By reducing household financial distress in adverse economic circumstances, including those involving a sharp fall in house prices;
– by reducing the magnitude of the economic downturn, which would otherwise serve to weaken bank loan portfolios (including in sectors broader than just housing); and
– by helping to constrain the credit-asset price cycle in a manner that most other macroprudential tools would not, thereby assisting in alleviating the build-up in risk accompanying such cycles.The policy would not eliminate the need for lenders and borrowers to undertake their own due diligence in determining that the scale and terms of a mortgage are suitable for a particular borrower. The focus would be systemic: on reducing the risk of the overall mortgage and housing markets becoming dysfunctional in a severe downturn, rather than attempting to protect individual borrowers. The consultation paper notes that DTIs on loans to New Zealand borrowers have risen sharply over the past 30 or so years, with further increases evident since 2014. This partly
reflects the downward trend in interest rates over the period. However, interest rates may rise in the future. While the Reserve Bank is continuing to work with banks to improve this data, the available data also show that average DTIs in New Zealand are quite high on an international basis, as are New Zealand house prices relative to incomes.Other policies (such as boosting required capital buffers for banks, or tightening LVR restrictions further) could be used to target the risks created by high-DTI lending. The Bank does not rule out these alternative policies (indeed, we are currently undertaking a broader review of capital requirements in New Zealand) but consider that they would not target our concerns around mortgage lending as directly or effectively. For example, while higher capital buffers would provide banks with more capacity to withstand elevated housing loan defaults, they would do little to mitigate the feedback effects between falling house prices, forced sales and economic stress.
The Reserve Bank has stated that it would not employ a DTI limit today if the tool was already in the MoU (especially given recent evidence of a cooling in the housing market and borrower activity), it believes a DTI instrument could be the best tool to employ if house prices prove resurgent and if the resurgence is accompanied by further substantial volumes of high DTI lending by the banking system. The Reserve Bank considers that the current global environment, with low interest rates expected in many countries over the next few years, tends to exacerbate the risk of asset price cycles arising from ‘search for yield’ behaviour, making the potential value of a DTI tool greater.
The exact nature of any limit applied would depend on the circumstances and further policy development. However, the Reserve Bank’s current thinking is that the policy would take a similar form to LVR restrictions. This would involve the use of a “speed limit”, under which banks would still be permitted to undertake a proportion of loans at DTIs above the chosen threshold. By adopting a speed limit approach, rather than imposing strict limits on DTI ratios, there would be less risk of moral hazard issues arising from a particular ratio being seen as “officially safe”. Exemptions similar to those available within the LVR restriction policy would also be likely to apply.
What type of property will be in strong demand in the future?
Now that’s a good question for property investors to ponder, because the way we live and where and how we live is evolving.
It wasn’t all that long ago that buying a house and land in the suburbs was considered an indisputable truism of property investing. Investing in a house on a large block was considered ‘safe as houses’ (pardon the pun), and still today you’ll hear investors talk about a property asset’s value being “all in the land”.
But what was accurate only a decade or two ago is now becoming less so, particularly when it comes to real estate. For instance, while it is true that a house will depreciate in value while the land appreciates, that doesn’t mean apartments and units make terrible investments.
That’s because apartments also have an articulable land value underneath them.
And in certain markets an apartment investment makes much more investment sense than a freestanding home. This is because demographics – or the composition of Australian households – is evolving.
More of us are now trading a backyard for a courtyard or balcony due to a range of factors, including shifting family dynamics, increasing divorce rates and a growing tendency towards single-person households.
This scratches at the surface of the many evolutions that investors must prepare for if they want to enjoy long-term success in real estate. These changes include:
- Our demographics are changing
In my mind our changing demographics will have more influence on the long-term performance of our property markets than the short-term influences of interest rates, bank lending policies or supply and demand.
It’s no secret that our nation is ageing, but the latest Australian Intergenerational Report reveals the significance and depth of this trend, forecasting that by 2055 the number of people aged over 65 will double.
Perhaps a bigger threat is that over the same time the ratio of people in the workforce compared to retirees will almost halve, from 4.5:1 to 2.7:1, as the baby boomers retire. In the 1970s, it was 7.5:1. This means the government will have to keep migration levels high to top up our workforce.
Another critical demographic trend is the Australian Bureau of Statistics forecast that lone-person households will see the most rapid increase of all household types — up by 65% in the next 25 years.
That means there will be about 3.4 million people living on their own, and most of these people will still want to live close to the big cities.
Let’s turn our attention back to that big house on the big block – the one that was as ‘safe as houses’.
In light of these demographic changes, how does that type of property stack up as likely to be in strong demand in the future?
- The economy is changing
The mining building boom is well and truly over, and we’re becoming less of a manufacturing country.
In the future our economy will be driven by services, IT and education, which means the economic centres of growth – which will translate to wages growth and the ability to pay more for properties – will be
in our capital cities and, in particular, locations close to the CBD in our three east coast capital cities.
Furthermore, with so many Australians exiting the workforce as baby boomers retire, the government will need to address the issue of skill shortages somehow, so, as I said, it’s likely that migration of skilled workers will only increase in the future.
- Our property markets are changing
Owing to the factors outlined above, the Australian property market is expected to experience increasing fragmentation, with the disparity between capital growth in cities and regional areas (and even within cities as the population grows) widening further.
Properties situated closer to the CBD, where robust economic activity, jobs and lifestyle amenities are easily accessible, will increase in value at a disproportionately higher rate than dwellings in the outer suburbs.
At the same time, there will be increased demand for apartments and townhouses as we’ll have more one- and two-person households edging out the stereotypical ‘husband, wife and two kids’ household structure.
What’s more, to cope with forecast population growth – which is tipped to almost double to around 40 million by 2055 – the Master Builders Association of Australia estimates we will need to build nine million new homes over the next 40 years.
This significant population growth will lead to a number of social issues and infrastructure challenges, and the consequential impact on Australia’s property market shouldn’t be underestimated.
Ultimately, there will always be a requirement for detached houses, but it’s becoming evident that there will also be increasing demand for medium-density and high-density apartments as retiring baby boomers trade their backyards for courtyards or balconies.
For property investors, the key to success is adopting a long-term view by seeking out properties that will be in continuous strong demand now, in the next decade, and 40 years from now.
Digital Finance Analytics has released mortgage stress and default modelling for Australian mortgage borrowers, to end May 2017. Across the nation, more than 794,000 households are now in mortgage stress (last month 767,000) with 30,000 of these in severe stress. This equates to 24.8% of households, up from 23.4% last month. We also estimate that nearly 55,000 households risk default in the next 12 months.
The main drivers are rising mortgage rates and living costs whilst real incomes continue to fall and underemployment is on the rise. This is a deadly combination and is touching households across the country, not just in the mortgage belts.
This analysis uses our core market model which combines information from our 52,000 household surveys, public data from the RBA, ABS and APRA; and private data from lenders and aggregators. The data is current to end May 2017.
We analyse household cash flow based on real incomes, outgoings and mortgage repayments. Households are “stressed” when income does not cover ongoing costs, rather than identifying a set proportion of income, (such as 30%) going on the mortgage.
Those households in mild stress have little leeway in their cash flows, whereas those in severe stress are unable to meet repayments from current income. In both cases, households manage this deficit by cutting back on spending, putting more on credit cards and seeking to refinance, restructure or sell their home. Those in severe stress are more likely to be seeking hardship assistance and are often forced to sell.
Martin North, Principal of Digital Finance Analytics said “Mortgage stress continues to rise as households experience rising living costs, higher mortgage rates and flat incomes. Risk of default is rising in areas of the country where underemployment, and unemployment are also rising. Expected future mortgage rate rises will add further pressure on households”.
“Stressed households are less likely to spend at the shops, which acts as a drag anchor on future growth. The number of households impacted are economically significant, especially as household debt continues to climb to new record levels. The latest housing debt to income ratio is at a record 188.7* so households will remain under pressure.”
“Analysis across our household segments highlights that stress is touching more affluent groups as well as those in traditional mortgage belts”.
*RBA E2 Household Finances – Selected Ratios Dec 2016.
Regional analysis shows that NSW has 216,836 (211,000 last month) households in stress, VIC 217,000 (209,000), QLD 145,970 (139,000) and WA 119,690 (109,000). The probability of default has also risen, with more than 10,000 in WA, 10,000 in QLD, 13,000 in VIC and 15,000 in NSW.
Probability of default extends the mortgage stress analysis by overlaying economic indicators such as employment, future wage growth and cpi changes. Regional analysis is included in the table below.
According to UBS, first time buyers are pretty much locked out of the property market. ‘Typical’ first home buyers are facing ~11 years to save; and ~40 years in Sydney!
Housing affordability is extreme as house price-income surged to a record 6.5x
UBS already ‘called the top’ of housing, with a key reason being that affordability is stretched, as the house price-income ratio surged to a record high of 6.5x, up sharply from 4.5x in 2012 (& >doubling from 3x in 1996). While interest rates have fallen to a record low, the mortgage repayment share of income still lifted to a near decade high, & the key issue for first home buyers (FHBs) is the ‘deposit gap’ even before buying.
‘Typical’ first home buyers facing ~11 years to save; and ~40 years in Sydney
UBS have now created a new and dynamic interactive model to estimate how long it would take a FHB to save a deposit to buy a home (click here for the model). The findings are confronting. We estimate a ‘base case’ scenario for a ‘typical’ FHB would take ~11 years to save for a home based on assumptions including: 1) a 10% deposit is required; 2) individual income is AWOTE of ~$80k per year; 3) saving rate is 5% of gross income (i.e. $4k per year); 4) home price today is $400k (~average FHB price); 5) home prices grow in line with household income ahead at 3% per year. However, given recent macroprudential tightening including for high-LVR loans, if we instead assume a 20% deposit is now required, then the time to save more than doubles (due to compounding) to ~24 years. Alternatively, saving a 10% deposit to buy at the average Sydney house price of $1.2mn would take an incredible ~40 years to save.
If house price vs income growth repeats, FHBs likely never can save enough Importantly, the key driver of time to save is house price growth vs income.
In the last 5 years, house price growth averaged 7%, but income only 4%. If this were to be repeated ahead, a FHB would likely never be able to save a 10% deposit – unless they were given (at least part of) the deposit (i.e. from the ‘bank of mum and dad’). Note that due to the frequent changes of Government policy on housing incentives/taxes (& other costs), our model purposely excludes these factors. However, they can be input to the model directly by the user by adjusting the required deposit or purchase price. For instance, the recent FHB super saver scheme potentially reduces the required time by up to several years (contributions are capped at $15k/year and $30k in total).
Confirming the Domain data we reported on Saturday, CoreLogic says the first week of winter saw auction volumes fall, with 2,545 homes taken to auction, compared to 2,885 the previous week.
The preliminary clearance rate across the combined capital cities was higher (73.9 per cent) compared with last week’s finalised result, which was the third lowest clearance rate so far this year (71.3 per cent). With auction clearance rates typically revising lower as more results flow through, the final clearance rate is likely to be lower than what was recorded last week. At the same time last year, both the combined capital city clearance rate and the number of auctions were lower, with 2,008 auctions held and 68.2 per cent reported as successful. The two largest auction markets, Melbourne and Sydney, saw their preliminary clearance rates rise compared with last weeks finalised results, with Sydney at 77.5 per cent and Melbourne at 75.4 per cent. Across the smaller capital city markets, week-on-week results show mixed results with clearance rates falling in Brisbane and Canberra.
The Turnbull government has taken planned restrictions to borrowing by self-managed superannuation funds off the agenda in the short-term in a move that may presage a weakening of the proposals.
Under a plan announced in April, debt on the books of SMSFs would be added to fund values when calculating the new $1.6 million limits for tax-free super pensions.
The move was designed to stop people effectively getting around the cap by using borrowings to reduce asset values and paying the debts off over time.
The initial consultation period for the move expired on May 3 but the government has opened discussions again with the superannuation industry.
A spokesperson for acting Financial Services and Revenue Minister Mathias Cormann said: “Following stakeholder feedback, the government will consult further with stakeholders on the proposal to add the outstanding balance of a limited recourse borrowing arrangement (LRBA) to a member’s total superannuation balance measure in conjunction with consultation on the non-arm’s length income integrity measure announced in the 2017-18 budget.”
The SMSF industry has kicked back on the moves, saying they may force some investors to sell properties because they won’t be able to make extra non-concessional contributions to their fund needed for debt repayments once it has hit the $1.6 million limit.
“Some self-managed funds may not be able to use limited recourse borrowing arrangements if they will be relying on non-concessional contributions to repay some or all of the loan interest and capital because the gross value of the asset(s) will take them over the $1.6 million total superannuation balance and they will be unable to make further non-concessional contributions to service the debt,” the SMSF owners alliance said in a submission on the issue to Treasury.
The opposition has not expressed a view on the legislation, saying instead it would like to ban SMSF’s borrowing altogether.
“Labor has previously stated that we will restore the general ban on direct borrowing by superannuation funds, as recommended by the 2014 Financial Systems Inquiry, to help cool an overheated housing market partly driven by wealthy Self-Managed Super Funds,” a spokesman for Labor’s shadow Financial Services Minister Katy Gallagher said in response to questions from The New Daily.
“This has seen an explosion in borrowing from $2.5 billion in 2012 to more than $24 billion today.”
Stephen Anthony, chief economist for Industry Super Australia, said there was an argument for leaving out existing arrangements from the changes.
“I’d be happy to see transition arrangements put in place and allowing the restrictions to apply to arrangements from here on in,” he said.
“But if the outcome of the consultation is just to water down what I see as a useful structural reform, I’d be very disappointed.”
The industry fears that introducing the new restrictions to existing arrangements would mean some SMSF owners would be forced to sell properties held in their funds because they would not be able to make loan repayments.
The explosion of SMSF property debt has been a concern for regulators, with the Murray inquiry into the financial system in 2014 recommending SMSF borrowing be banned, warning “further growth in superannuation funds’ direct borrowing would, over time, increase risk in the financial system”.
The Reserve Bank concurred.
The preliminary results from Domain are out and show continuation of trend with high clearance rates, but on lower volumes.
Sydney cleared 74.3% compared with 70.6% last week, with 445 sold. Melbourne cleared 75.9% compared with 73% last week, with 602 sold, and nationally, 74.2% or 1,139 sold compared with 70.1% 1,423.
Brisbane cleared 50% of 104 scheduled auctions, Adelaide 73% of 74 scheduled and Canberra 73% of 65 scheduled auctions.
