The Real Estate Institute of Australia (REIA) has unleashed the hounds on Labor’s proposed reforms to negative gearing. The REIA’s campaign, Negative Gearing Affects Everyone, follows the lead of the Property Council, which describes the Australian housing market as a “house of cards”, with the REIA stressing how “fragile” the Australian economy is. You might be tempted to dismiss this as propaganda from people who exaggerate for a living, but evidence is mounting of instability close to the REIA’s home: the off-the-plan apartment sector.
An array of forces are converging to give the multi-unit house of cards a shove. Over the past couple of years apartment development has boomed. The Australian Bureau of Statistics shows building approvals for new flats, units and apartments reached a huge peak last year. It has stepped down in the most recent quarter, but is still very high.
You can see this development in the skylines of our cities, especially in Sydney, Melbourne, Brisbane and Canberra – and in the RLB Crane Index. RLB counts a total of almost 650 cranes engaged in construction in our capital cities, and says more than 80% of these are on residential projects.
This coming supply is reflected in CoreLogic’s projections for new units hitting the market. It estimates that sales for more than 92,000 new units will be settled in the next 12 months, only slightly less than last year’s total number of sales of new and established units. The year after, a further 139,000 new units sales are due to be settled, substantially more than total sales (new and established) last year.
But for all this supply, it appears there may be much less demand than anticipated, particularly from the foreign investors who did so much to stoketheboom. Evidence for this includes:
Over the last six months the Chinese government has tightened controls over currency exchange by its citizens. This has restricted their capacity to buy – and repay loans to buy – property in Australia and elsewhere. This in turn has led to…
Credit restrictions by Australian banks. Last month each of the Big Four banks restricted how much they’ll lend to foreign buyers (lower loan-to-valuation ratios), with Westpac withdrawing altogether. This month, Macquarie has pulled its horns in.
Foreign demand for new dwellings (as gauged by the NAB’s Quarterly Australian Residential Property Survey) was already down over the first quarter of the year, before the credit restrictions cut in. Now the media are reporting that Chinese demand for apartments has “fallen off dramatically”: Meriton says the number of Chinese buyers of its apartments halved in the last month.
As those cranes in the sky indicate, there’s a lot of people out there – foreign and local – who’ve paid deposits and entered into contracts to pay boom-era prices on completion of their units. When they go to the bank to borrow the balance, they may find that, between lower loan-to-valuation ratios and lower valuations, they are caught short. Some might make up the difference by selling another property, but many of those settlements projected by CoreLogic may not settle at all.
The result: deposits forfeited, unsold units dumped on the market – accelerating the bust – and possibly, at least for buyers who are actually in the jurisdiction, the threat of being sued by developers for the loss of the contracted higher price.
So what might policymakers do?
Faced with such a calamity, why won’t our politicians do something to shore up demand for all these newly constructed rental properties? Oh wait….
This is precisely what Labor’s proposed negative-gearing reform promises do, by allowing rental losses to be set against non-rental income only where the property is newly built. Under Treasurer Bowen, Australia’s dedicated army of negative gearers would be given new direction and purpose, switching from the established dwelling market into the new-built market deserted by foreign buyers. Furthermore, because no-one after the first purchaser can call a dwelling new (and hence get the same preferential treatment on their gearing), they may be inclined to hang on to their properties even as demand looks weak.
We should still expect such a reform to reduce total investor demand for housing, and hence reduce house prices overall. These are both good things. But it may also help cushion what might otherwise be a drastic and painful collapse in the new-build sector.
Both the REIA and the Coalition government talk about Australia’s “transitioning” economy. They should consider negative-gearing reform as a measure for transitioning out of our presently fragile, property-bubble-led economy.
Author: Chris Martin, Research Fellow, Housing Policy and Practice, UNSW Australia
With combined capital city weekly rents falling by -0.2% over the past year, we take a look at the capital city suburbs that have recorded the largest falls in weekly advertised rents over the past year.
The CoreLogic Monthly Rental Report for April 2016 showed that weekly rents have fallen by -0.5% for capital city houses over the past year and unit rents have increased by a record-low 1.2%. Substantial new housing supply, slowing population growth, weak wages growth and recently heightened level of purchasing by investors are all contributing to falls in rents. There is also currently a record high number of new units under construction, the last Census (2011) showed that units are more than twice as likely to be rented than houses. Given this, much of the new housing supply under construction is ultimately likely to end up as rental accommodation.
Annual change in weekly rents across the combined capital cities, houses vs. units
While for an investor falling rents are not ideal, particularly given home value growth is generally slowing, for renters it is great news because it means they can potentially reduce their housing costs or find superior accommodation for a similar cost.
With rental rates marginally lower over the past year across the combined capital cities, there are significant differences across individual suburbs. There are now many capital city suburbs where advertised rental rates are lower than they were 12 months ago and the table included in this report shows the 5 suburbs in each capital city that have seen the largest falls in the median advertised rental rate over the year.
Top 5 capital city suburbs for rental rate falls, 12 months to April 2016
For houses it is noticeable that some premium suburbs have seen the largest falls in advertised rental rates over the past year. Whether this is due to fewer executive rents as population growth slows or previous renters taking advantage of record-low interest rates to borrow to purchase is unknown. What is clear is that demand for rental houses is easing and in a number of suburbs rental prices have fallen dramatically.
A number of premium inner-city locations have made the list for units after seeing the median of advertised rental rates fall, in some cases dramatically over the past year. While the suburbs listed are often not the most significantly supplied rental markets, there are signs of weakening growth in many price inner-city unit markets.
With more rental supply set to enter the market over the coming years we expect that in order to keep tenants, landlords may have to reduce their rents. Although the cost of purchasing a house is becoming increasingly unaffordable it seems that the cost of renting is set to become more affordable over the coming years.
There has been much talk lately about loose lending standards in Australian banking.
We’ve had an exposition of lending practices in Western Sydney by hedge fund manager John Hempton and Jonathan Tepper from Variant Perception and we’ve had revelations of problems with offshore borrowers’ income verification at the major banks.
But, believe it or not, it is Australian lending standards which Paul Dales, Capital Economics’ chief economist for Australia and New Zealand, says will protect the local housing market from a US-style collapse in prices.
Dales says, “lending conditions during the good times have not been as loose as in America and Australian banks are better placed to cope with the bad times”.
But while a US-style collapse isn’t likely to happen, Dales says prices will stagnate for a couple of years before “house prices in Australia will fall outright in both 2019 and 2020”.
Dales says that it’s easy to say the “Australian housing market looks even more vulnerable to a large fall in prices than the US market did before prices there fell by 30% during the GFC” given the “350% rise in prices since 1990 eclipses the 140% rise in the US before its bubble burst”.
But again he says it’s lending standards which will hold Australian housing in good stead.
“The extent of the excess in Australia isn’t as large as lending standards aren’t as loose,” he says. “For example, just 9% of loans in Australia are being issued to borrowers with a deposit of less than 10%. At the peak of the US boom, it was 29%. And the outstanding value of mortgages that are similar to America’s subprime loans is 2% in Australia.
“In the US, the share peaked at 14%.”
No crash then.
It would have already happened, Dales says, if it was going to be in a similar vein to the US housing collapse. But prices are vulnerable given their elevated levels compared to incomes with the catalyst the RBA when it eventually raises rates.
But Dales, who was the first to call this easing cycle the RBA is currently undertaking back in 2015, says “that trigger won’t be pulled until 2018 at the earliest”.
The reason an RBA move is the smoking gun to knock house prices lower is because of Australia’s high debt levels which means, “interest payments are already absorbing a large share of household income even though interest rates are at a record low. As and when rates rise, that burden will grow and may be too much to bear for those borrowers without funds saved in offset mortgage accounts”.
Dales says interest-only borrowers are particularly vulnerable when it comes time to start repaying principal once rates rise.
Overall though, in the context of the rise in prices in the past 20 years, Dales’ expectation about the fall in prices is relatively mild and should overly trouble the economy, or economic outlook given RBA rate rise should be accompanied by an accelerated economic expansion.
“Overall, we doubt that national house prices will rise much over the next few years and, if interest rates rise in 2018, prices may fall by about 10% over 2019 and 2020,” he says.
“Any price fall will be smaller than the 30% drop in the US, though, mainly as the relative health of Australian banks will prevent a US-style spiral of large loan losses leading to a severe credit crunch and yet more losses.”
According to CoreLogic RP Data, the preliminary clearance rate across the combined capital cities rose this week, up from 69.5 per cent the previous week to 70.0 per cent. The level of activity across the capital city auction market was similar to the previous week, with 1,863 auctions held this week, compared to 1,876 last week. Auction activity remains well below the comparable week last year, however, when 2,599 capital city auctions were held and 79.1 per cent cleared. After ANZAC weekend last year, there were five consecutive weeks of more than 2,200 auctions held across the combined capitals; however the same activity hasn’t been replicated this year.
Macquarie is the latest lender to tighten lending criteria on post codes where there are a number of new high rise apartments being built. In a note to brokers, they say that effective now, the LVR ceiling will be dialed back to 70%. Latest approval data shows that at least 200,000 units will flow into the market in coming months, at a time when demand may be slowing, thanks to tighter lending criteria and a reduction in foreign investor loans. Often people will be buying off the plan, and committing to a price, months before the property is built. Macquarie is also tightening a number of other lending criteria. Below are some of the hot spots which we have mapped for Melbourne, Sydney, Brisbane, Gold Coast and Cains.
Investors seeking exposure to real estate should consider listed as well as direct given the returns, diversification and volatility of the asset classes are very similar over the long term, according to AMP Capital.
Don’t tell me it’s not real estate, a white paper written by AMP Capital Co-Head of Global Listed Real Estate James Maydew, demonstrates the correlation between listed and direct real estate increases significantly as the investment horizon lengthens. The daily liquidity of listed real estate, however, means it behaves more like equities if they only invest in the short term.
Mr Maydew said: “Real estate, both listed and direct, is a long-term investment by the very nature of leases that are contractually committed to and the longevity of the physical assets. The two asset classes are essentially the same over five years and beyond as the returns are driven by the underlying real estate cash flows they have in common. For investors who want to maximise risk adjusted returns, an asset allocation between both listed and direct should be utilised at different points in the cycle. Listed real estate can also be a useful proxy for direct for investors who want to get set in real estate but who are struggling to deploy their capital given global competition for quality assets.”
The paper also highlights how listed real estate can be used by investors as a harbinger of what the direct market is likely to do. Analysis of whether real estate investment trusts (REITs) are trading at a premium or discount to net asset value (NAV) has proven to be an accurate predictor of how the direct market will move in the coming year.
Mr Maydew explained: “Put very simply, if a REIT trades at a premium to its NAV, the market believes its assets will appreciate above levels indicated by market pricing of the underlying direct real estate. If we look at listed real estate in the US since 1988, whenever prices have been at a premium to NAV, direct real estate appreciated 96 per cent of the time in the following 12 months.”
Globally, listed real estate is currently trading at a discount to NAV. The biggest discounts are in Asia, with the US and the UK markets also trading at a discount. Australian REITs are trading at a slight premium, with larger premiums ascribed to Continental Europe and the Japanese REIT market.
Mr Maydew added: “In individual markets where listed real estate is trading at a discount to NAV, the best management teams are taking advantage of strong pricing in direct real estate markets, selling on-core assets and utilising the proceeds to either de-lever balance sheets or shrink their equity base by returning capital to investors.”
Don’t tell me it’s not real estate is the first of a series of AMP Capital whitepapers on listed real estate. Mr Maydew noted: “More global investors are allocating to listed real estate and they are hungry for knowledge and insights about the asset class. We intend to release a number of white papers this year on the sector more broadly as well as a range of diverse individual investment themes such as senior living REITs, shopping malls and the impact of disruptive technology on real estate.”
With about one out of four developments bought by foreigners, it is possible that sales of new residential properties to offshore buyers could be much higher than what local banks estimate, according to ratings agency Fitch Ratings. This could raise risk for banks and the economy.
Fitch Ratings’ Andrea Jaehne claims that there was an increase in foreign buyers since 2010, with data from the Foreign Investment Review Board showing an eightfold increase in approvals up to 2015. It is difficult to know the true number of properties sold offshore because there is no required approval for foreigners buying apartments off the plan.
“The condition is they have to market the property into the local market, but often you find them selling it off in Hong Kong, Singapore, and Shanghai,” Jaehne said in a Sydney conference yesterday. “We don’t have a full picture of who is buying this property.”
Foreign buying in some pockets of Sydney and Melbourne is believed to be much higher than the 25 per cent conservative estimate of most banks, with up to 80 per cent of some apartment developments sold directly to offshore buyers.
Regulators and banks have responded to concerns about foreign buyers pushing up property prices by restricting lending for investment properties. This led to dwindling Chinese investors, despite the fact that around 250,000 new apartments are set to hit the market over the next two years.
“Vendors aren’t as confident as they were 12 months ago,” said analyst Cameron Kusher from CoreLogic RP Data. “The rate of price growth is slowing, and people are holding out until the election is done, and then after that, they’ll hold out until spring.”
As a result, Fitch has issued a rare downgrade of five residential mortgage-backed bonds.
There are a number of barriers which might stop investors from transacting. Last time the prospect of potential budget changes registered, whereas this time the proportion of investor households who cited this as a reason to avoid transacting dissipated. We see a similar trend relating to changes in regulation. On the other hand, there was a rise in those unable to get funding – from below 5% last year to more than 15% this year, reflecting tighter underwriting requirement. So not everyone can get what they want. Results of the election are in the “Other” category, and hardly registered. Investors seem to assume no change in government. High home prices appear to be less of a barrier now.
Looking at solo investors – those who only have one or two investment properties, the prospect of better returns than other investment vehicles is the strongest driver, and the recent cash rate cut has underscored this even more. We see evidence of older investors turning to property instead of bank term deposits (and we see a switch from term deposits to call savings accounts as part of the picture), because of the very low interest rates on offer.
Households who are portfolio investors maintain a basket of investment properties. There are 193,000 households in this group (up by 2,000 from the previous survey). The median number of properties held by these households is eight. Some have more than 20!
In addition, we continue to see a rise in those investing via a SMSF (we have yet to detect an impact on the $1.6m cap which was announced in the budget, which of course is only applicable to those in draw down mode, and even then is still tax efficient).
Households looking to invest via a SMSF seems to be getting information from a mortgage broker (24%) or internet sources (22%). Financial Planners (7%) lag behind Accountants (14%) and Real Estate Agents (11%).
Finally, we still find that those who do investment via SMSF do not tend to put all their super savings into property.
Next time we will look at the latest data relating to first time buyers.
The results from the just updated Digital Finance Analytics Household Surveys shows that after a few wobbly months, demand for property has strengthened. The latest results supplement those found in the Property Imperative Report, which is still available on request. According to the results, lower interest rates, the removal of the negative gearing “risk”, no budget changes, and lower returns from alternative investments all lead to the same conclusion – buy property. We also note that property price rise expectations have risen for some. Over the next few days we will discuss our segment specific findings – looking especially at investors and first time buyers. Today, however we summarise the main trends.
In response to the question, are you expecting to transact in the next 12 months, we see a larger proportion of investors and refinancers expect to be active. Solo investors showed the largest movement compared with the February 2016 data.
More than half of households expect property prices to continue to rise in the next 12 months. Uptraders increased their expectations, compared with February, others were a little less bullish. But a fair degree of optimism reigns.
Looking at borrowing requirements, we see that demand for more credit remains strong – the 7% growth rate in credit will likely continue. Demand is strongest among investors, but we also see a spike in the refinance sector. This is driven by finance availability, lower and discounted rates and capital extraction.
First time buyers are saving the hardest, but uptraders also saving.
Looking at the barriers to purchase, we see that the availability of finance is now impacting more than 12% of households wishing to transact. This reflects tighter underwriting criteria now in play. Fear of unemployment has fallen as a factor, whilst the expectation of future rate rises has diminished significantly. High prices are still a significant factor.
Finally in this overview, we see that the propensity to use a mortgage brokers remains strong among investors, refinancers and first time buyers.
Next time we will look in more detail at our segment specific analysis. You can read about our segmentation methodology here.
According to CoreLogic RP Data, the recent boom in unit construction has seen record-high levels of unit approvals and construction culminating in a substantial volume of new unit stock, much of which will settle over the next 24 months.
CoreLogic’s new settlement risk report looks at the number of units due to settle over the next 6, 12, 18 and 24 months. This is based on the expected completion of new developments coupled with the number of units being built in these developments.
The first table highlights the number of unit sales over the 12 months to April 2016, the average number of annual unit sales over the five years to April 2016 and the anticipated number of unit completions over the 12 month to April 2017 and 24 months to April 2018. Across the combined capital cities there are 92,102 new units set for completion over the next 12 months with that figure rising to 231,129 over the next 24 months.
Number of expected unit settlement, data to April
Looking at the expected new unit supply, Sydney and Melbourne predictably have the greatest increases in stock over the next two years. If you compare the volume of stock expected to settle over the next 12 and 24 months to the average number of unit sales annually over the past five years, you can see a big disconnect, particularly in the four largest capital cities. The historic sales figures include sales of both existing and new units keeping in mind that new stock, usually accounts for a smaller slice of total sales than resales of existing stock.
The large volume of new stock, coupled with an ever-growing supply of existing stock which resells means that historic high levels of unit settlements are due to occur over the next two years in most cities. In fact, in Melbourne and Brisbane even a recurrence of the peak year for sales over the next two years wouldn’t represent enough demand to cater for all of the new units set to settle over the coming 24 months.
The second table highlights the SA3 regions nationally that have the highest number of anticipated unit settlements over the next 24 months. Given the much higher number of unit settlements in Sydney and Melbourne, these cities dominate this list with eight and 12 of the regions listed respectively. In Queensland, three regions from Brisbane and one from the Gold Coast are listed while one Perth region is also listed.
SA3 regions nationally with the most expected unit completions over
24 months to Apr-18
If we compare the capital cities, it becomes evident that most of the stock in Melbourne, Brisbane and Perth is located in inner-city (within 10km radius of the city). Taking a look at Sydney, the new unit supply is more geographically diverse. Yes, there are a lot of new units in inner city areas but there are also plenty in outer areas like Parramatta, Strathfield, Auburn and Kogarah-Rockdale. In some respects this spreads some of the risk around the city rather than other cities where new supply is much more centralised.
The large volume of new unit settlements over the next two years does raise some potential concerns, namely:
In many regions, capital growth for units has been substantially lower than that for houses. Many off-the-plan unit buyers would have expected a level of capital growth between contract and settlement.
Mortgage lenders have recently tightened their lending criteria and subsequently some people who have committed to purchasing off-the-plan units may not be able to borrow as much as they could at the time of signing the contract.
Units are much more likely to be owned by investors. Not only have lenders recently tightened mortgage criteria, they have also increased mortgage rates for investors.
Many of the units are coming up for settlement in similar locations and will compete with existing unit stock. With so much stock coming on-line at once there is an increasing concern as to whether settlement valuations will actually meet the contract price of these units.
To compound the situation, three of the four largest banks have announced they will no longer be lending to home buyers from overseas which could result in a larger number of contracts not progressing through to settlement, considering a larger proportion of off-the-plan unit sales are to overseas buyers.
