Social Trends – Page 132 – Digital Finance Analytics (DFA) Blog

What Australia can learn from overseas about the future of rental housing

When we talk about rental housing in Australia, we often make comparisons with renting overseas. Faced with insecure tenancies and unaffordable home ownership, we sometimes try to envisage European-style tenancies being imported here.

And, over the past year, there has been a surge of enthusiasm for developing a sector of large-scale institutional landlords, modelled on the UK’s build-to-rent sector or “multi-family” housing in the US.

Our review of the private rental sectors of ten countries in Australasia, Europe and North America identified innovations in rental housing policies and markets Australia might try to emulate – and avoid. International comparisons also give a different perspective on aspects of Australia’s own rental housing institutions that might otherwise be taken for granted.

Not everyone in Europe rents

In nine of the ten countries we reviewed, private rental is the second-largest tenure after owner-occupation. Only in Germany do more households rent privately than own their housing. Most of the European countries we reviewed have higher rates of home ownership than Australia.

In most of the European and North American countries in our study, single people and lower-income households and apartments are heavily represented in the private rental sector. Higher-income households, families with kids, and detached houses are represented much more in owner-occupation. It’s less uneven in Australia: more houses, kids and higher-income households are in private rental.

Two key potential implications follow from this.

First, it suggests a high degree of integration between the Australian private rental and owner-occupier sectors, and that policy settings and market conditions applying to one will be transmitted readily to the other.

So, policies that give preferential treatment to owner-occupied housing will also induce purchase of housing for rental, and rental housing investor activity will directly affect prices and accessibility in the owner-occupied sector.

It also heightens the prospect of investment in both sectors falling simultaneously, with little established institutional capacity for countercyclical investment that makes necessary increases in ongoing supply.

A second implication relates to equality. Australian households of similar composition and similar incomes differ in their housing tenure – and, considering the traditional value placed on owner-occupation, this may not be by choice.

This suggests housing tenure may figure strongly in the subjective experience of inequality. It raises the question of whether housing is a primary driver of inequality, and not the outcome of difference or inequality in other aspects of life.

The rise of large corporate landlords

In almost all of the countries we reviewed, the ownership of private rental housing is dominated by individuals with relatively small holdings. Only in Sweden are housing companies the dominant type of landlord.

However, most countries also have a sector of large corporate landlords. In some countries, these landlords are very large. For example, America’s five largest corporate landlords own about 420,000 properties in total. Germany’s largest landlord, Vonovia, has more than 330,000 properties alone.

These landlords’ origins vary. Germany’s arose from massive sell-offs of municipal housing and industry-related housing in the early 2000s.

In the US, multi-family (apartment) landlords have been around for decades. And in the aftermath of the global financial crisis, they have been joined by a new sector of single-family (detached house) landlords that have rapidly acquired large portfolios from bulk purchases of foreclosed, formerly owner-occupied homes.

In these countries and elsewhere, the rise of largest corporate landlords has been controversial. Germany’s have a poor record of relations with tenants – to the extent of being the subject of popular protests in the 2000s – and their practice of characterising repairs as improvements to justify rent increases.

American housing advocates have voiced concern about “the rise of the corporate landlord” – especially in the single-family sector, where there’s some evidence that they more readily terminate tenancies.

These landlords also don’t build much housing. They are most active in renovating (for higher rents), merging with one another, and – especially in the US – developing innovative financial instruments such as “rental-backed securities”.

“Institutional landlords” are now a standing item on the Australian housing policy agenda. Considering the activities of large corporate landlords internationally, we should get specific about the sort of institutional landlords we really want, how we will get them, and how we will ensure they deliver desired housing outcomes.

Policymakers and housing advocates have, for years, looked to the community housing sector as the prime candidate for this role. They envisage its transformation into an affordable housing industry that works across the sector toward a wide range of policy outcomes in housing supply, affordability, security, social housing renewal and community development.

With interest in the prospect of build-to-rent and multifamily housing rising in the property development and finance sectors, there is a risk that affordable housing policy may be colonised by for-profit interests.

The development of a for-profit large corporate landlord sector may be desirable for greater professionalisation and efficiencies in the management of tenancies and properties. However, this should not come at the expense of a mission-oriented affordable housing industry that makes a distinctive contribution to housing outcomes.

Bringing it home

Looking at the policy settings in the ten countries, we found some surprising results and strange bedfellows.

For example, Germany – which has had a remarkably long period of stable house prices – has negative gearing provisions and tax exemptions for capital gains, much like Australia. But, in Australia, these policies are blamed for driving speculation and booming prices.

And while the UK taxes landlords more heavily than most other countries, it has the fastest-growing private rental sector of the countries we reviewed.

However, these challenging findings should not be taken to diminish the explanatory power or effectiveness of these settings in each country’s housing policy. Rather, they show the necessity of considering taxation and other policy settings in interaction with each other and in wider systemic contexts.

So, for example, Germany’s conservative housing finance practices, and regulation of rents, may mean the speculative potential of negative gearing and tax-free capital gains isn’t activated there.

Strategy in Australia for its private rental sector should join consideration of finance, taxation, supply and demand-side subsidies and regulation with the objective of making private rental housing outcomes competitive with other sectors.

Author: Chris Martin, Research Fellow, City Housing, UNSW

Bank of Mum and Dad Now A “Top 10” Lender

The latest Digital Finance Analytics analysis shows that the number and value of loans made to First Time Buyers by the “Bank of Mum and Dad” has increased, to a total estimated at more than $20 billion, which places it among the top 10 mortgage lenders in Australia.

We use data from our household surveys to examine how First Time Buyers are becoming ever more reliant on getting cash from parents to make up the deposit for a mortgage to facilitate a property purchase.

Savings for a deposit is very difficult, at a time when many lenders are requiring a larger deposit as loan to value rules are tightened. The rise of the important of the Bank of Mum and Dad is a response to rising home prices, against flat incomes, and the equity growth which those already in the market have enjoyed. This enables an inter-generational cash switch, which those fortunate First Time Buyers with wealthy parents can enjoy. In turn, this enables them also to gain from the more generous First Home Owner Grants which are also available. Those who do not have wealthy parents are at a significant disadvantage.

Whilst help comes in a number of ways, from a loan to a gift, or ongoing help with mortgage repayments or other expenses, where a cash injection is involved, the average is around $88,000. It does vary across the states.

We see a spike in owner occupied First Time Buyers accessing the Bank of Mum and Dad, while the number of investor First Time Buyers has fallen away.

But overall, around 55% of First Time Buyers are getting assistance from parents, with around 23,000 in the last quarter.

There are risks attached to this strategy, for both parents and buyers, but for many it is the only way to get access to the expensive and over-valued property market at the moment. Of course if prices fall from current levels, both parents and their children will be adversely impacted in an inter-generational financial embrace.

Treasury memo misses the real impact of Labor’s negative gearing policy

From The Conversation.

Labor MPs might be rubbing their hands together with glee at a Treasury memo that shows the federal opposition’s negative gearing policy will have a “small” impact on the property market. But insights from behavioural public policy, as highlighted by the 2017 Economics Nobel laureate – Richard Thaler and his colleague Cass Sunstein, tell us that how people respond to this policy will be more about how the government frames it.

The Treasury memo showed the Labor policy of limiting negative gearing to existing homeowners will have a limited impact as the changes are unlikely to encourage investors to sell quickly. Also, owner-occupiers dominate the housing market and the costs of selling are high.

However, this assumes that people are forward-looking, well-informed, good with numbers and perfectly responsive to new information. Behavioural economics shows us that people do not always think so deeply and logically about their choices.

How any changes to negative gearing are sold to us – as a loss or gain, as a one-off or ongoing, in terms of short versus long term costs and benefits – will impact how Australians react.

Most of us aren’t whizzes with mathematics. As Nobel prize winner Herbert Simon has shown, in place of complex mathematical algorithms we use heuristics. These are simple rules of thumb that draw on our intuitions, experience and gut feel.

Heuristics and biases

One common example of a heuristic is the availability heuristic. This is when we make decisions based on easily available information such as recent events and highly emotive experiences. Our brains work better with narratives and stories than with facts and figures.

Nobel economics laureates George Akerlof and Robert Shiller have applied a similar insight to analyse people’s perceptions of housing market fluctuations. They noted that we hear lots of stories about how house prices are on an upward trend. Via the availability heuristic, we easily remember these emotionally engaging stories, much better than we can remember the dry facts about the history of house price instability and housing market crashes.

This leads us to overestimate the chances of continuing house price rises, and to underestimate the chances of a fall, driving unsustainable house price increases – as witnessed, for example, in the American sub-prime property markets before the global financial crisis.

While heuristics can help us to decide quickly, they sometimes lead us into systematic mistakes – “behavioural biases”. This does not mean that we’re all hopelessly irrational. But for negative gearing it matters how a potential change is framed, and how that fits into our heuristics and biases.

Most economists (including those at Treasury) assume that one dollar is a perfect substitute for any other dollar. Whether we save A$100 via a tax break, win A$100 from a scratch card or earn A$100 from working overtime, it makes no difference.

Contrary to this view, behavioural economics has shown that the way we treat money is different depending on the contexts in which we earn and spend it. We have different “mental accounts” for consumption, wealth, regular income and windfalls. We are more likely to splurge money we’ve won from a scratch card than money we’ve earnt doing overtime.

This is another reason why framing is important. How the government frames a negative gearing change will determine the mental account to which we assign it, and therefore how we respond.

If negative gearing changes are considered a one-off hit – the opposite of a scratch card windfall – then property owners won’t worry so much. On the other hand, if the change to negative gearing is seen as an ongoing drain on our incomes, then they will worry a lot.

Another factor that will come into play is loss aversion – people are much more likely to worry about losses than gains. Evidence from behavioural experiments shows that home-owners over-estimate the value of their properties. This makes them reluctant to sell at reduced prices in a falling market.

It also means that Australians will resist negative gearing changes if these are framed as a loss, creating political pressures for a policy u-turn. It is difficult to predict how people might respond, but behavioural economics shows that any ructions might be avoided if the negative gearing change is framed as a gain.

For instance, Treasury predicts that the additional revenue raised from restricting negative gearing could be up to A$3.9 billion. Therefore, the negative gearing changes could cover more than 80% of federal government expenditure on veterans and their families.

In the long and short term

Treasury’s modelling notes there might be downward pressure on house prices in the short term from changing negative gearing, but that this will be small overall.

But a range of models and experiments have shown that people are disproportionately focused on tangible, short-term outcomes. For example, most of us find it hard to persuade ourselves to go the gym: the short-term costs are inconvenience and discomfort and the benefits seem intangible and distant. This is called “present bias”.

Recent work in behavioural economics confirms that framing (alongside a range of other socio-psychological influences) has a strong impact on our choices. Framing will determine how we perceive the policy, which mental account we will use to process it and how the various heuristics and biases identified by economics and psychologists will play out.

In the debates around negative gearing policy changes, these behavioural insights have not been highlighted. So perhaps Treasury could have added some psychology, alongside the economics, in arguing that house price falls are likely to be limited.

Author: Michelle Baddeley , Research Professor at the Institute for Choice, University of South Australia

More Evidence of Poor Mortgage Lending Practice

The Australian Financial Review is reporting that New ‘liar loans’ data reveal borrowers more stretched than some lenders suspect.

One in five property borrowers are exaggerating their income and nearly half understating their spending, triggering new concerns about underwriting standards and vulnerability to sharp economic corrections, according to new analysis of loan applications by online property lender Tic:Toc Home Loans.

The number of ‘liar loans’ exceeds original estimates by investment bank UBS that last year found about 30 per cent of home loans, or $500 billion worth of loans could be affected.

Tic:Toc Home Loans’ founder and chief executive, Anthony Baum, said loan applications are representative of larger lenders in terms of location, borrower and loan size, which range from about $60,000 to $1.3 million.

Mr Baum, a senior banker for nearly 30 years, said in many cases applicants did not have to over-state their income for the required loan.

“Our portfolio looks like other organisations,” he said.

Analysis of their applications reveals about 20 per cent overstate their income, typically by about 30 per cent, and 50 per cent state their expenses are lower than the Household Expenditure Measure, also by about 30 per cent.

Property market experts claim the latest analysis, although based on a smaller sample than UBS’s survey, are credible and consistent with independent analysis of the lending standards.

“They do not surprise me,” said Richard Holden, professor economics at University of NSW Business School, who argues the potential problems are compounded by more than one-in-three loans being interest only.

Martin North, principal of Digital Finance Analytics, an independent consultancy, also backed the latest ‘liar loan’ numbers.

Mr North said standards had slipped because of lenders’ readiness to “jump over backwards” to increase business and commission incentives for mortgage brokers rewarding bigger loans.

“Not all lenders are the same but these numbers do not surprise me at all,” he said.

Mr North said there was strong evidence that salaries are overstated by between 15 and 20 per cent by borrowers using a range of tactics, such as over-stating bonuses or, for variable income earners, using peak rather than average income.

Household Financial Confidence Trudges South In December

The latest edition of the Digital Finance Analytics Household Financial Security Confidence Index, to December 2017 shows another fall, down from 96.1 last month to 95.7 this time, and remains below the neutral measure of 100.

The trend continues to drift south as flat incomes, big debt and now falling home prices all impact.

Analysis of households by their property owning status reveals that property investors are in particular turning sour, as flat net rental incomes, and rising interest rates hit many, at a time when property capital growth is stalling. Owner occupied households are faring a little better, thanks to a range of ultra cheap mortgage rates on offer at the moment, but they are also concerned about price momentum. Those without property interests remain the least confident, as the costs of renting outstrip income growth, and more are slipping into rental stress.

Looking across the states, they all slipped a little, with NSW now well behind VIC (we think the Victorian market is about 6 months behind Sydney, so will drift lower ahead). WA has not improved this time, suggesting that those talking up the market in the west may be over optimistic.

Across the age groups, young households are most concerned about their financial position, but every age group shows a small fall this month – perhaps thanks to the Christmas binge (though we think credit card debt will not rise that much this year) and retail stats may be lower than expected.

Looking in detail at the scorecard, which shows the elements which drive the index; job security is pretty stable, but savings are being raided by many to support their finances, while rates on bank deposits continue to drift lower. Households are becoming increasingly uncomfortable with the level of debt they hold (they should at a ratio of 2:1, debt to income). Income continues to fall in real terms and costs of living are rising (child care costs and rising fuel costs are concerning many). We also see a slide in net worth, as home prices, especially in the Sydney region decline. This despite high stock market prices at the moment.

We cannot see any circuit breakers in the mix ahead, so we expect the falling trend to continue into autumn.

By way of background, these results are derived from our household surveys, averaged across Australia. We have 52,000 households in our sample at any one time. We include detailed questions covering various aspects of a household’s financial footprint. The index measures how households are feeling about their financial health. To calculate the index we ask questions which cover a number of different dimensions. We start by asking households how confident they are feeling about their job security, whether their real income has risen or fallen in the past year, their view on their costs of living over the same period, whether they have increased their loans and other outstanding debts including credit cards and whether they are saving more than last year. Finally we ask about their overall change in net worth over the past 12 months – by net worth we mean net assets less outstanding debts.

We will update the results again next month.

Property, debt stress prompts clients to take tax risks

SMSF and accounting professionals alike are increasingly finding that clients are willing to take risky moves with their property portfolios, in an effort to reduce their mortgage stress. From SMSF Adviser.

These patterns are surfacing as instances of mortgage stress continue to climb significantly in Australian households. Research house Digital Finance Analytics (DFA) has released its mortgage stress and default analysis for December 2017, showing about 29.7 per cent of households — 921,000 — are under “mortgage stress.”

About 24,000 households are under “severe mortgage stress”, up by 3,000 from November 2017.

DFA principal Martin North believes the risk of default for Australians has increased for 2018, with an estimated 54,000 households currently at risk of 30-day debt defaults in the next 12 months.

Several accountants and financial advisers have told Accountants Daily that their clients, including high-net-worth property investors, are increasingly looking to take on more risk to sustain their levels of debt.

Director at Verante Financial Planning, and chair of the SMSF Association’s NSW state chapter, Liam Shorte, said he’s seen evidence of investors asking accountants to increase their reportable income to increase their borrowing capacity, usually where they need to refinance. Historically, clients have sought advice on how to minimise their reportable income for tax purposes.

He also told sister publication Accountants Daily that more clients are asking their parents to do a “family pledge,” or guarantee about 20 per cent of a loan to help reduce debt while refinancing.

For Lielette Calleja, director at bookkeeping firm All That Counts, mortgage stress is most pronounced with small business owners, and doesn’t necessarily only affect those at the lower end of the earning scale.

“I would have to say that small business owners are heavily affected. Your income is not always consistent, as opposed to being a PAYG. Mortgage stress is across the board I don’t believe it discriminates as it’s relative to each type of borrower. Property investors and high-net-worth individuals tend to be asset rich but lack cash flow until their development is complete and/or sold/leased out,” Ms Calleja told Accountants Daily.

Further, Ms Calleja is finding clients are modifying their behaviours and expenses to adjust to a new normal in household debt levels.

“Families that are not in a position to refinance are resorting to taking their kids out of private schools and foregoing luxury holidays, even simple things like making your own lunch instead of buying is becoming the Aussie way,” she said.

“Small business owners are coming to the conclusion that having good financials consistently all year round is critical in keeping their mortgage stress levels at bay,” she added.

Households Under The Mortgage Stress Gun In December

Digital Finance Analytics has released the December mortgage stress and default analysis update. Across Australia, more than 921,000 households are estimated to be now in mortgage stress (last month 913,000). This equates to 29.7% of households. In addition, more than 24,000 of these in severe stress, up 3,000 from last month. We estimate that more than 52,000 households risk 30-day default in the next 12 months, similar to last month. We expect bank portfolio losses to be around 2.8 basis points, though with losses in WA rising to 4.9 basis points. Households in NSW are showing the most significant rise in stress, thanks to larger mortgages relative to income, while income growth is slow.

Martin North, Principal of Digital Finance Analytics said “the number of households impacted are economically significant, especially as household debt continues to climb to new record levels. Mortgage lending is still growing at three times income. This is not sustainable”. The latest household debt to income ratio is now at a record 199.7.[1]

Risks in the system continue to rise, and while recent strengthening of lending standards will help protect new borrowers, there are many households currently holding loans which would not now be approved. This is a significant sleeping problem and the risks in the system are higher than many recognise.

Our analysis uses the DFA 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 December 2017. We analyse household cash flow based on real incomes, outgoings and mortgage repayments, rather than using an arbitrary 30% of income.

Households are defined as “stressed” when net income (or cash flow) does not cover ongoing costs. 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.

The forces which are lifting mortgage stress levels remain largely the same. In cash flow terms, we see households having to cope with rising living costs whilst real incomes continue to fall and underemployment remains high. Households have larger mortgages, thanks to the strong rise in home prices, especially in the main eastern state centres, but now there are signs prices are slipping. While mortgage rates remain quite low for owner occupied borrowers, those with interest only loans or investment loans have seen significant rises. We expect some upward pressure on real mortgage rates in the next year as international funding pressures mount, a potential for local rate rises and margin pressure on the banks.

Probability of default extends our mortgage stress analysis by overlaying economic indicators such as employment, future wage growth and cpi changes. Our Core Market Model also examines the potential of portfolio risk of loss in basis point and value terms. Losses are likely to be higher among more affluent households.

Stress by The Numbers.

Regional analysis shows that NSW has 258,572 households in stress (251,576 last month), VIC 254,485 (253,248 last month), QLD 156,097 (157,019 last month) and WA 121,934 (123,849 last month). The probability of default rose, with around 9,800 in WA, around 9,500 in QLD, 13,000 in VIC and 14,000 in NSW.

The largest financial losses relating to bank write-offs reside in NSW ($1.3 billion) from Owner Occupied borrowers) and VIC ($957 million) from Owner Occupied Borrowers, which equates to 2.1 and 2.7 basis points respectively. Losses are likely to be highest in WA at 4.9 basis points, which equates to $682 million from Owner Occupied borrowers.

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Note that the detailed results from our surveys and analysis are made available to our paying clients.

[1] RBA E2 Household Finances – Selected Ratios September 2017

Some Segments Are More Likely To Buy, But Is It Enough?

Now, in our review of the results from our household surveys, we look at owner occupied purchasers. We start with “want to buys” – households who would like to purchase but cannot. High home prices are the strongest barrier (31%), followed by availability of finance (27%), rising costs of living (17%) and concerns about interest rate rises (16%). Unemployment is not currently a major concern.

Turning to first time buyers, around 30% are buying for a place to live, while 17% are eying the potential capital gains (down from 31% a year ago). 15% are motivated by tax breaks, and 11% by the availability of first home owner grants (FHOG), up from 1% a year ago. Greater security is also another factor (12%).

Turning to first time buyer barriers, the most significant challenge is problems with finance availability at 24.5% (compared with 11% a year ago), and house prices 41.1% (compared with 45.5% a year ago). Finding a place to buy is a little easier, down from 24% a year ago to 16% now.

Looking at the type of property they expect to purchase, we see a rise in city edge units, and suburban units, as more purchase an apartment not a house. 17% are not sure what to buy, compared with 22% a year ago.

Those seeking to refinance are driven a desire to reduce monthly payments (42%), 17% to withdraw capital, 18% for a better interest rate and 14% to lock in a fixed rate. Poor lender service is not a significant driver of refinancing.

Those seeking to sell and move down the market are seeking to release capital for retirement (41%), up from a year ago, 30% moving for great living convenience, and 10% because of illness or death of a spouse. Interestingly, the attraction of putting funds into an investment property has reduced from 23% a year ago to 16% now.

Finally, those seeking to trade up, 32% are doing so to get more space, 38% for investment purposes down from 43% a year ago, 17% for life style change and 13% for job change.

So the surveys highlight the lower appetite for investment property, the barriers limiting access to funds, and the desire to extract capital before prices fall much further.

Putting all this together, we think home prices are likely to fall further, as investor appetite continue to dissipate, and whilst there will be some first time buyer substitution, it will not be sufficient to keep prices high. Sydney, Brisbane and Melbourne markets are most likely to see a fall though 2018. There is a risk of a more sustained fall if more property investors decide to cut their losses and try to lock in paper profits.