Property Market – Page 195 – Digital Finance Analytics (DFA) Blog

How inflation is tied to the property market

Weak inflation has sent interest rates to historic lows, but new housing supply and APRA’s steps to rein in property investment will contain property prices according to an article in The Real Estate Conversation.

While many property owners around the country continue to enjoy strong capital growth, the national inflation rate dropped to 1% in the 12 months to June, according to the Australian Bureau of Statistics (ABS). For what it’s worth, this is below the Reserve Bank’s 2-3% target band and represents the weakest annual rate of inflation in 17 years.Such low inflation would typically mean the economy is weak and unemployment is high. But not in Australia, apparently. A number of commentators say that Australia’s unemployment rate (5.8% as per ABS) is at a stable level and that the economy is ticking along well, even though both company profits and wages are generally down. It’s a confusing mix of circumstances, for sure.

Adding to the complexity, low inflation has seemingly had little effect on the property market, which remains buoyant even after several years of high price growth in cities like Sydney and Melbourne. Prices aside, total housing credit has mostly been up this year (at least for owner-occupiers), and this usually means there are plenty of property buyers out and about and wanting to borrow money.

These buyers are often competing on a limited supply of homes, which is important because the supply-demand equation is central to our reading of the economy. One reason demand for property has so dramatically increased is because of the relatively cheap cost of home loans in recent years, which is due to record low interest rates – 1.5% as of August – implemented by the Reserve Bank (RBA).

The impact of rate cuts

Many media articles lead with the idea that RBA rate cuts are directly linked to the property market. Yet if you read past the headlines, it becomes clearer that the RBA is more concerned with low inflation.

“The RBA is trying to keep inflation at a certain level and the expected outcome from cutting interest rates is a lower dollar,” says BIS Shrapnel senior manager, Angie Zigomanis. “By lowering interest rates it means people will come here [to Australia] and the returns on their investments are lower, and the dollar starts falling on that basis because you’re competing for money.

“It means that the lower dollar starts stoking a lot of the import industries as well. It makes their products more competitive against exports.

“So rate cuts are part of a broader view to ward of inflationary pressures but also to lower the dollar to kick start some other industries that provide economic growth. The housing market is a bi-product [of this].”

Perception is reality

Much of this, of course, is about perception. In other words, high inflation means demand is seen to be strong, and this prompts businesses to invest more, consumers to spend and therefore price to go up.

There are several measures that help the government determine demand levels, like the consumer price index, which gives us that inflation rate figure. It simply measures the changing price consumers pay for goods and services. So in a high inflation environment, prices for the same goods and services are, well, much higher because the underlying demand is so strong.

Right now, CommSec says that price pressures are currently contained in Australia, largely due to greater competition in the market, including online sellers. This means consumers are the main beneficiaries of cheaper prices across all good and services – perhaps with the exception of property prices.

Find the balance

Over the past 20 years general price inflation has been low and stable, consistent with the inflation target since the early 1990s, according to an RBA paper published in 2015. However, such has been the level of property price growth that more recent prices have outstripped the rate of inflation in other parts of the economy, including inflation in the cost of new dwellings.

This has been a concern for the RBA because if property prices go up too high then most money will end up in housing and building instead of sustainable investment in industries, says Zigomanis.

This is why the Australian Prudential Regulation Authority (APRA) last year sought to limit the impact of property investors on the market by capping annual investor credit growth at 10%, which CoreLogic RP Data says has worked well to this point.

The Business Does Foreign Property Investors

Interesting segment from the ABC looking at foreign investors, with a focus on Chinese investors. They highlight a number of factors which suggests momentum from this sector may slow.

Loan availability is tightening, and as supply of units in Melbourne and Sydney rise, prices may slide, meaning that some already to committed to purchase off the plan apartments may not be able to complete.

One agent says only 20% of purchasers physically visit the property, and as banks have introduced tough new rules, and the states, surcharges; the market may slow significantly.

That said, some private lenders are filling the mortgage gap though at higher rates and demand still remains.

High Auction Clearances Again

CoreLogic says after recording the strongest year to date result last week, the capital city preliminary clearance rate this week has risen further, from 72.0 per cent to 74.9 per cent, based on preliminary results. The number of auctions held across the capitals this week was lower, with 1,517 held, compared to 1,610 over the previous week. Compared to the same week one year ago, auction activity currently is far more subdued, with almost 1,000 less capital city auctions. There were 2,512 auctions held over the corresponding week last year, with 76.9 per cent reported as successful. Of note this week, each of Melbourne, Sydney and Brisbane saw a rise in auction clearance rates, while across the remaining cities; week-on-week results show a fall in clearance rate.

Another Set of Good Auction Results

It may be a moot point whether home prices are rising or not, but the latest results from the APM PriceFinder team shows that nationally 76.3% of property for auction sold, compared with 68.6% last week, and 75.1% last year. However, the total number for sale was lower at 1,177, compared with 1,288 last week, and 1,989 last year.

Sydney led the way with 79.4% clearance from 393 listings, but there was more activity in Melbourne, with 676 listed, though 77.9% cleared. Both are higher that a year ago, when 74% cleared in Sydney and 71.7% in Melbourne.

ING Direct Cuts Mortgage Rates by 12 Basis Points

ING DIRECT will reduce its Orange Advantage variable home loan rates for existing and new customers by 0.12% p.a. effective Monday 15 August, 2016.

Owner occupier – Orange Advantage (100% offset) LVR of 80% or less with minimum borrowings of $150k:

3.67% p.a. (3.89% p.a. comparison rate)

Investor – Orange Advantage (100% offset) LVR of 80% or less with minimum borrowings of $150k:

4.12% p.a. (4.34% p.a. comparison rate)

All other variable home loan rates for new and existing customers will reduce by 0.10% p.a. effective from Monday 15 August, 2016.

Commercial variable loan rates will also reduce by 0.10% p.a. effective from Monday 15 August, 2016.

RBA Suggests House Price Growth Was Overstated

The latest statement on monetary policy, released by the RBA today, discusses the normal range of issues. However, one point of note is the apparent overstatement of the CoreLogic home price data in April and May.

A range of indicators suggest that conditions in the established housing market have eased this year from very strong conditions over recent years. Housing prices were little changed in the June quarter according to most published measures. In contrast, the headline CoreLogic measure of housing prices recorded very strong growth in April and May in a number of cities, to be more than 5 per cent higher over the June quarter.

Recent information suggests that the strong increases reported by CoreLogic were overstated as a result of methodological changes affecting growth rates for the June quarter.

Here is what CoreLogic told their customers.

As part of continual efforts to improve our analytics, filters which are applied to the CoreLogic hedonic index methodology were updated progressively through April.  Static price filters were previously applied to the hedonic index method which were designed to trim extreme transaction prices from the index calculation.  In April, after a periodic model review, CoreLogic revised the filtering method to be dynamic. 

The model recalibration should reduce index volatility and provide more accurate measurements of capital gains going forward.  Additionally, the price filter adjustment should alleviate seasonal changes that were historically evident in the index series during May and June. 

As a result of these changes, we recorded higher than normal intra-month volatility in the capital city index readings during April and May.  The combined capitals index rose 1.7% in April and 1.6% in May before reducing to 0.5% growth in June and, most recently, 0.8% in July.

The changes are part of a once off project aimed at improving the hedonic measurement of capital city home values.  The next major iteration of improvement will occur over the second half of 2016 as we migrate our indices to the new ASGS capital city boundaries.  This update will involve a revised back series of the hedonic index according to the new geography and we expect to release this to the market during Q4 2016.

The most recent data suggest that housing prices declined in most capital cities in July.

Other timely indicators of conditions in the established housing market continue to point to weaker conditions than last year. Auction clearance rates and the number of scheduled auctions are lower than a year ago and there has been a large decline in the number of transactions in the housing market, which is reflected in the turnover rate. In the private treaty market, the discount on vendor asking prices has been little changed of late, but the average number of days that a property is on the market has increased from the lows of last year.

Total housing loan approvals have been little changed in recent months. Meanwhile, housing credit growth has been steady in the first six months of the year but slower than in 2015, consistent with a relatively low level of turnover and the tightening of lending standards towards the end of 2015. The upswing in dwelling investment, particularly the construction of high-density dwellings, has continued, supported by low interest rates and earlier increases in housing prices. Residential building approvals are lower than their peak of mid 2015 but remain at high levels.

Indeed, building approvals have continued to exceed completions, resulting in the number of dwellings under construction or yet to be completed reaching historically high levels. The work in the pipeline is sufficient to underpin dwelling investment activity for the next couple of years.

Conditions in the rental market have continued to soften over the past year. The aggregate rental vacancy rate has drifted higher to be close to its longer-run average of around 3 per cent and rental inflation is around multi-decade lows, having eased across most capital cities. The Perth rental market is particularly weak, reflecting the slowing in population growth combined with ongoing additions to the housing supply.

Units Increasingly Driving The Market

From Corelogic.

Over recent years, the Australian Bureau of Statistics (ABS) has shown that as a proportion of overall dwelling approvals, attached dwellings (high/low rise apartments and townhouses) are increasing. As shown below, the proportion of attached dwellings, based on overall approvals has been trending upwards, and approximately half of all approvals are now for attached stock.

CoreLogic is seeing a similar trend in the proportion of units being advertised for sale. Across the combined capitals, over the four weeks ending 31 July, 2016, it was estimated that 36.2 per cent of dwellings available for sale were units, with houses accounting for 63.8 per cent of total housing stock available for sale.

Sydney and Melbourne, the two largest capital cities in terms of total volume of listings, are seeing the most prominent shift in the availability of stock for sale. In Sydney, over the most recent four week period, it was estimated that 45.3 per cent of stock available for sale were attached dwellings, up from 39.5 per cent last year and 38.3 per cent in 2014.

In Melbourne, almost half (48.9 per cent) of all dwellings currently advertised for sale are units, while one year ago 42.0 per cent of stock was units, and 40.3 per cent in 2014. Interestingly, units make up approximately 33 per cent of total dwelling stock across Melbourne, so the fact that almost half of advertised stock is for units could potentially be showing that investors are looking to cash out of the market, given the increasing fear of unit oversupply. Melbourne, along with Canberra, are two cities where there has been a notable upwards trend in unit listings and a downward trend in house listings.

Furthermore, capital growth for Melbourne houses has outpaced units on a rolling annual basis for the past 31 months and for Canberra, houses values have grown at a faster annual rate than units for the past 11 months.

When we look at the dwelling stock available for sale five years ago, it was a much different story. Units accounted for just 26.1 per cent of overall capital city dwelling stock available for sale. While in Sydney and Melbourne, units accounted for 35.0 per cent and 29.2 per cent of overall stock on the market, respectively.

Update On US Residential Mortgage Lending Practices

The Fed has released the latest Senior Loan Officer Survey on Bank Lending practices and discussed the responses from 71 domestic banks and 23 U.S. branches and agencies of foreign banks.

The FED says banks reported that demand for most types of Residential Real Estate loans strengthened over the second quarter.

Responses to a set of special annual questions on the approximate levels of lending standards suggested that banks’ lending standards banks continued to report in the July 2016, that on balance, domestic banks lending standards for all five categories (GSE-eligible mortgages, government-insured mortgages, jumbo mortgages, subprime mortgages, and HELOCs) remained tighter than the midpoints of the ranges observed since 2005. Of note, a major net fraction of banks reported that the current level of standards on subprime residential mortgage loans is tighter than the reference point.

The report also discusses commercial lending and consumer loans.

Regarding loans to businesses, the July survey results indicated that, on balance, banks tightened their standards on commercial and industrial (C&I) and commercial real estate (CRE) loans over the second quarter of 2016. The survey results indicated that demand for C&I loans was little
changed, while demand for CRE loans had strengthened during the second quarter on net.

Banks’ lending standards for all categories of C&I loans are currently easier than the midpoints of the ranges that have prevailed since 2005, except
for syndicated loans to below-investment-grade firms. However, banks also generally indicated that standards on all types of CRE loans are currently tighter than the midpoints of their respective ranges.

Banks indicated that changes in standards on consumer loans were mixed, while demand strengthened across all consumer loan types.

Bank of England Tightens IRB Mortgage Models

The UK Prudential Regulation Authority (PRA) proposes to set out a revised approach to IRB risk weights for residential mortgage portfolios and guidance as to how firms model probability of default (PD) and loss given default (LGD) for these exposures. The effect will be in some cases to lift the amount of capital held against mortgages.

This follows a review of the causes of variability of residential mortgage risk weights for firms with permission to use the IRB approach to calculate credit risk capital requirements which showed that first firms’ approaches to modelling PD vary. The majority of firms either use a highly point-in-time (PiT ) approach or a highly through-the-cycle (TtC) approach. In both cases a deficiency in risk capture was identified. Secondly, firms’ house price fall assumptions for UK residential mortgage LGD models vary widely.

So the PRA proposes that firms would be expected to adopt PD modelling approaches that avoid the deficiency in risk capture identified in the PiT and TtC models currently used by firms, and calibrate their models using a consistent and appropriate assumption for the level of model cyclicality.

The PRA also proposes to expect firms not to apply a house price fall assumption of less than 25% in their UK residential mortgage LGD models.

The PRA expects, in general, that these changes will result in firms having to recalibrate existing models rather than develop new ones. The PRA proposes that they will come into effect by 31 March 2019, though the PRA may on a case by case basis allow a longer period for firms to meet these expectations.

By way of background:

in December 2014, the Financial Policy Committee (FPC) raised concerns about excessive procyclicality and lack of comparability of UK banks’ residential mortgage risk weights in the 2014 UK stress test. The FPC mentioned in December 2015 that work was underway to try to investigate these issues, stating that in “the United Kingdom, the FPC and PRA Board are also considering ways of reducing the sensitivity of UK mortgage risk weights to economic conditions. The 2014 stress test demonstrated that the risk weights on some banks’ residential mortgage portfolios can increase significantly in stressed conditions”.

In implementing PiT models in the United Kingdom, firms’ residential mortgage models estimate a PD for the next year based upon the previous year’s default rate. This means that PDs are based only on very recent experience.

The PRA believes that for residential mortgages, this approach leads to capital requirements that are excessively procyclical. This is because under this approach mortgage assets, which are long term and cyclical, are calibrated based only on short term experience. This can lead to Pillar I capital requirements which are too low in an upturn and too high in a downturn, because a short term change in default rates leads directly to a change in the capital requirement for what is a long term asset. In turn this means that capital ratios may also appear too good in an upturn and too bad in a downturn.

A procyclical capital framework, where capital requirements are high in a downturn and low in an upturn, can encourage credit exuberance in a boom and deleveraging in a downturn. With major UK firms holding around £1 trillion of UK residential mortgage exposure, this is an asset class where excessive variability of capital requirements can be detrimental to financial stability.

TtC models, as implemented by UK firms, adopt a static approach whereby the PD does not vary with changes in the general economy. These models tend to use a relatively limited number of inputs, that do not change with time, to estimate average default rates for each borrower over an economic cycle. The borrower’s PD does not therefore change with economic conditions, and capital requirements vary much less than with PiT models.

In the UK firms use a form of TtC approach known as ‘variable scalar’ that use as inputs the PDs derived from relatively PiT models. Variable scalars then transform the average PiT PD for a portfolio into a static TtC PD, by using a multiplier, or scalar, that varies through time.

The PRA has found that, for residential mortgage portfolios, firms using TtC approaches, including variable scalar approaches, are unable to distinguish sufficiently between movements in default rates that result from cyclical factors (for example, factors that impact the economy in general) and those that result from non-cyclical reasons (for example, the specific performance of one borrower). These approaches only take account of a small number of risk drivers that do not change with time, and the PRA has found that this results in risks not being sufficiently captured. For example, if a particular portfolio deteriorates due to poor underwriting (rather than due to a downturn), then capital requirements calculated using variable scalar approaches may not increase as they should.

New Home Sales bounce back in June – HIA

The HIA New Home Sales Report, a survey of Australia’s largest volume builders, shows that total new home sales ended 2015/16 on a higher note, said the Housing Industry Association.

“The overall trend is still one of modest decline for New Home Sales, but a bounce of 8.2 per cent in June 2016 highlights the resilience of the national new home building sector,” commented HIA Chief Economist, Dr Harley Dale.

“The overall profile of HIA New Home Sales is signalling an orderly correction to national new home construction in the short term, as are other leading housing indicators,” noted Harley Dale.

“Below the national surface, the large geographical divergences between state housing markets have been a prominent feature of the current cycle – that will continue. The New Home Sales series highlights this fact. Comparing the June quarter this year to the same period last year, detached house sales are down very sharply in South Australia (-21.4 per cent) and in Western Australia (-27.5 per cent), yet sales are up by 17.0 per cent in Victoria and by 7.1 per cent in Queensland. New South Wales rounds off the detached house coverage provided by the New Home Sales report and sales are down by 7.3 per cent on an annual basis.”

The sale of detached houses bounced back by 7.2 per cent in the month of June 2016. ‘Multi-unit’ sales continued their recent recovery, growing by 11.5 per cent after a lift of 4.9 per cent in May. In the month of June 2016 detached house sales increased in all five mainland states with the largest increases occurring in Queensland (+14.9 per cent) and WA (+9.1 per cent). Detached house sales increased by 7.5 per cent in NSW, 3.7 per cent in South Australia, and 2.2 per cent in Victoria.