Social Trends – Page 173 – Digital Finance Analytics (DFA) Blog

Household Incomes And Property Segmentation

In the current discussions about macroprudential, stimulated by the RBA comments last week and likely to be stoked further as the RBA appears before the Senate Banking Committee on Thursday, many are claiming that household balance sheets and incomes are supporting the growth in house prices, and so no intervention is needed. The chair of the Banking Committee Sam Dastyari is “concerned about the unanticipated consequences of the Reserve Banks’s view-change on the sustainability of the housing boom and whether it needed to interfere with bank lending”.

The debate has shifted to first time buyers, and not wishing to put further barriers in the way of the small number able to enter the market at prices which are already too high. They may be missing the point. First, the increase in household wealth is directly linked to the rise in house prices (a weird piece of feedback here, as prices rise, households are more wealthy, so can accommodate higher prices – spot the chicken and egg problem?). In addition, wealth is growing thanks to stock market movements (though down recently) driven partly by the US and European low rates and printing money strategies. This will reverse as rates are moved to more normal levels later. Superannuation, the third element is of course savings for retirement, so cannot be touched normally (there are exceptions, and no, first time buyers should not be allowed to use their super to get into the property market). More first time buyer incentives won’t help.

But, we have been looking at household incomes, after inflation, at a segment level. We segment based on property ownership, and you can read about the DFA segments here. On average, across all households, income growth is falling behind inflation. This is the ABS data from June 2014. In the past few months, real income is going backwards, before we consider rising costs of living.

However, at a segment level, the situation is even more interesting, and diverse. Those wanting to buy, but unable to enter the market are seeing their incomes falling sharply, inflation adjusted, making the prospect of buying a house more unlikely. We are seeing the number of households in this group rising steadily, see our Property Imperative Report.

First time buyers, those who have, or are purchasing for the first time, are also seeing income falling in real terms, more sharply than the average. This is why we are predicting a higher proportion of first time buyers will get into mortgage stress, especially if interest rates are increased. This is one reason why loan to income ratios for this group are high.

Then looking at holders, their incomes are moving closer to the average. Holders have no plans to change their property, many have mortgages.

Refinancers, are hoping to lock in lower rates, though we note the forward rates are now higher than they were, which may suggest the lowest deals are evaporating. One of the prime motivations for switching in this segment is to reduce outgoings, not surprising when we see incomes falling faster than the average in real terms.

Now, looking at Up Traders, we find their incomes are rising more quickly than the average. Up Traders have been active recently. They have the capacity to service larger loans. They will be purchasing primarily for owner occupation.

Down Traders have incomes rising more quickly, thanks to investment income, and there still about one million households looking to sell and move into a smaller property, releasing capital in the process. They are also active property investors, directing some of their released capital in this direction, either direct, or via super funds.

Investors also have incomes which are rising faster than the average, so no surprise they are active in the market, seeking yields higher than deposits, and taking advantage of negative gearing. We continue to see a small but growing number of investors using super funds for the transaction.

So, the segmental analysis highlights how complex the market is, and that there are no easy fixes. Any rise in interest rates would hit first time buyers very hard. Demand from investors (the foreign investment discussions is only a sideshow in my view) will be sustained, with the current policy settings. Raising interest rates will not help much on this front, because interest will be set against income. So macroprudential controls on investment loans makes more sense.

One option would be to differentially increase the capital buffers the banks hold for investment loans, making their pricing less aggressive, and the banks more willing to lend to suitable owner occupiers and businesses, which is what we need. Trimming demand for investment properties may help to control prices.

The bottom line though is that many years of poor policy are coming home to roost, on both the supply and demand side. A number of settings need to be changed, as discussed before.

My Recent Thoughts On House Prices

I did an interview for the ABC, on the RBA Financial Stability Review. Here is the transcript, courtesy of the ABC. The link to the interview, and my longer interview can be found at the ABC site.

By way of context, a quick reminder of current house price trends from the Economist:

CHRIS UHLMANN: The Reserve Bank (RBA) has given its strongest warning yet that a dangerous property price bubble in Sydney and Melbourne could destabilise the economy.

It’s now ramping up talks with other regulators to introduce lending controls to head off the risk of a damaging correction in prices.

With more I’m joined by our business editor, Peter Ryan.

And Peter, these warning have been around for the past year. Is the Reserve Bank starting on the back foot?

PETER RYAN: Well, this was certainly very strong language from the RBA yesterday that investment in Australian property is now becoming “unbalanced” and that the speculation increases the potential for current stellar prices to fall.

Now the RBA is now worried about the broader impact of any correction or a hard landing and how that would hurt not just the speculators but average Australians whose biggest single investment is usually the family home.

The property analyst Martin North says unless the RBA intervenes with tighter controls, there could be a correction in the range of 20 to 25 per cent and that some borrowers could find themselves overwhelmed in debt – in other words facing negative equity.

MARTIN NORTH: Property prices have been high for a long period of time so this is not just a little bubble. This is a long term systemic issue.

So what’s been happening is it’s been sucking a lot of money from people’s pockets out to pay the mortgage, right? Secondly, people have been committing to buy at the top of the market and so if prices were to move down, a lot of people who’ve bought relatively recently would be out of the money and that’s very significant.

A lot of those are investors – and investors will change their tune quite quickly, you know, particularly if capital growth is no longer in the sector. So yeah, this is a very unstable situation.

Also, the banks have a huge exposure to property, probably one of the highest exposures in the world and that means that whatever happens to the property market is going to impact not only individuals but also the banks as well.

PETER RYAN: If there was a correction and those property speculators decided to sell while they could and the market was flooded with properties, what impact would that have on the general market?

MARTIN NORTH: We will probably see a downward swing and that downward swing would gain quite a lot of momentum. I wouldn’t be surprised to see prices slipping by 20 to 25 per cent. It will probably self-correct a little bit beyond that but it’s that, it’s that sort of slide down and then up which is the problem.

PETER RYAN: And that of course is a huge problem for borrowers who bought at the top of the market, borrowed too much and are now over their heads in debt.

MARTIN NORTH: The real issue there of course is all the people will find that they’re in negative equity at a point. In other words, they can’t then sell. So we could find the situation where people are trying to sell, are being forced to sell. That will tend to drive prices further down, probably languish for quite some time because we have to correct back to long term averages between income and property prices in my view.

So this is more like I think the early signs of some of the things that happened in the US prior to the GFC.

CHRIS UHLMANN: Property analyst Martin North.

So Peter, can we expect to see action on lending controls from the Reserve Bank?

PETER RYAN: Well, the RBA governor Glenn Stevens is speaking in Melbourne later today and as always his comments will be scrutinised on perhaps when and how the RBA might intervene to prevent any property bubble bursting.

CHRIS UHLMANN: Business editor Peter Ryan, thank you.

Australian Population Now 23.4m And Ageing

The ABS just released their preliminary demographic statistics to end March 2014. Australia’s total population increased by 388,400 people to reach 23.4 million by the end of March 2014, with a growth rate of 1.7 per cent, a continuation of the average annual growth rate for the past three years. Natural increase contributed 156,900 people to Australia’s population in the year to 31 March 2014, consisting of 306,500 births and 149,600 deaths. Net overseas migration contributed 231,500 to the population over the same period, accounting for 60 per cent of Australia’s total growth.

All states and territories recorded positive population growth in the year ended 31 March 2014. Western Australia continued to record the fastest growth rate of all states and territories at 2.5%. Tasmania recorded the slowest growth rate at 0.3%. New South Wales and Victoria continued to experience high population growth going against the trend of slowing annual growth around Australia – the population of New South Wales and Victoria grew by 114,500 and 108,800 respectively. Net overseas migration (NOM) was the main contributor to both New South Wales and Victoria’s population growth, accounting for 67 and 57 per cent of the states’ growth respectively. The NOM contribution to Victoria’s growth is below the Australian rate of 60 per cent, which highlights the recent increase in net interstate migration to the state. We’re also seeing fewer people moving to Queensland and Western Australia. Queensland recorded one of its lowest annual gains on record, slowing by 65 per cent in five years. Meanwhile, New South Wales recorded its lowest annual interstate loss in nearly 30 years and Victoria recorded its highest annual gain on record.
There is a significant skew towards older Australians, as can be seen by the relative movement from 1971, by age bands. In fact in absolute numbers, those under 20 years grew the slowest whilst those aged 40-69 grew the fastest. This has a profound impact on the community, with those planning to retire well ahead of new workers ready to join the workforce – yet youth unemployment is very high, as we discussed recently.

We can also look at the splits in percentage terms, which shows again these trends. In 1971, the fiftieth point was 27 years, today it is 38 years, and rising.

Mortgage Stress Coming To A Household Near You

We have updated our mortgage stress models, to take account of the latest tranche of economic data, including falling real incomes, potential uplifts in capital requirements and inflation running hot, so creating the need to lift interest rates; and demand for property continuing to go ahead of supply. Our recent post the Anatomy of Mortgage Stress explains our modelling assumptions, and importantly the definitions of stress we are using. We also explained why households are highly vulnerable to mortgage stress, because of larger loans, and flat incomes in our article If The Worm Turns. Today we will look at our projections out to 2017, once we factor in these various drivers. It is only one scenario, but this is our central case.

We use a series of questions to diagnose mortgage stress focusing on owner occupied households. Through these questions we identify two levels of stress – Mild and Severe.

Mild = households maintaining repayments, but by reprioritising expenditure, borrowing more on loans or cards, and refinancing
Severe = households who are behind with their repayments, are trying to sell, are trying to refinance, or who are being foreclosed

First we will look at the Australia-wide projections. We expect to see stress amongst first time buyers lift considerably from its current relative low levels. If rates do rise, unemployment stays high, and incomes continue to languish, then by 2017, we think that 40% of first time buyers will be in mortgage stress. Many who brought in the 2008-2009 boom are likely to be hardest hit. More recently the number of first time buyers has fallen to a long term low, so the number of more recent first time buyer households in stress will be lower.

We can look at the state variations. We see that VIC and QLD first time buyers are more likely to be impacted, whilst SA households less so, with WA and NSW first time buyer households sitting in the middle. This is partly a function of absolute house prices, and partly a function of income and unemployment trends across the states. We did not include the smaller states on the chart, but they are included in the average.

Finally, we look at the other, non-first time buyer households. Many continue to pay more than the minimum monthly mortgage repayments, taking advantage of the current low rates so they have some protection. However, as rates and unemployment bites, some households who have held property for some time will also experience stress. By 2017 up to 15% of established households will be in stress in our central scenario.

Our research suggests there is an 18 month to 2 year grind between the onset of stress and households taking bold steps (or forced to) like selling up. Before that, they often get into the debt cycle of more credit card debt, refinancing, and a general hunkering down to try and keep the mortgage payments going. It is the broader economic impact of this refusal spend which will have a significant dampening impact on economic growth. In addition the outworking of stress leads to selling a property, so we would expect to being to see some forced sales in 2017 and beyond, another reason why we think house prices are likely to correct to more normal loan to income ratios.

In coming posts, we will look further at the state and postcode level data.

Foreign Commercial Property Investment Significant – RBA

In the RBA Bulletin there is an interesting analysis of foreign property investors in the commercial sector. The FIRB publish data on approvals for proposed foreign investment on an annual basis. The value of these approvals has increased substantially in recent years, from $11 billion in 2009/10 to nearly $35 billion in 2012/13

Foreigners have accounted for around one-quarter of the value of commercial property purchases in Australia since 2008, up from one-tenth in the previous 15 years. In the first half of 2014, they purchased nearly $5 billion worth of commercial property, about 40 per cent of the value of properties that were sold. Net purchases (which also account for sales) by foreigners amounted to $4 billion in the first half of 2014, close to its level for all of 2013.

The recent increase in foreign investment has been most pronounced in the market for office property. Foreigners’ purchases have accounted for around one-third of the value of turnover of office buildings since 2008, with purchases consistently exceeding the value of foreign sales.

Since 2008, foreign buyers have accounted for 40 per cent of the value of purchases in New South Wales, compared with 20 per cent of turnover in Victoria, Queensland and Western Australia. Foreigners’ preference for New South Wales reflects their strong appetite for office buildings in the Sydney CBD, which industry participants attribute to the greater liquidity of the market and the large amount of prime-grade office space.

Foreigners from many parts of the world have become more active in Australian commercial property markets, although much of the rise in net investment in the past few years reflects an increase in purchases by investors based in Asia and North America. Net investment from Europe has also increased, albeit by much less.

They conclude that the available data indicates that foreign investment in commercial property has increased in recent years, with foreigners having accounted for around one-quarter of the value of commercial property purchases in Australia since 2008. The higher demand for Australian buildings has been broad based across a range of institutions from Asia and North America, although sovereign wealth funds and pension funds have accounted for a greater share of foreign investment more recently. Foreign buyers have typically purchased existing buildings, enabling domestic firms to sell assets for higher prices, supporting their financial position and freeing up capital to be used on new developments. To date, foreigners have shown a preference for purchasing office buildings in New South Wales, but analysts expect foreigners to spread into other markets as they become more familiar with Australia. In any case, foreigners’ acquisitions have benefited developers operating in several states and sectors, and so the indirect effects on construction activity have not been constrained to the New South Wales office market.

Further High House Price Evidence – BIS

The BIS has published the latest data from their analysis of house prices across countries. “The BIS currently publishes more than 300 price series for 55 countries, among which it has selected one representative series for each country. For 18 countries, it also publishes series that span the period back to the early 1970s. House prices can serve as key indicators of financial stability risks, as property booms are often the source of vulnerabilities that lead to systemic crises.”

They show that in trend terms, after correcting for inflation and seasonality, Australian prices are relatively higher than other advanced countries. This is consisted with data from the IMF, Economist, and DFA’s own analysis. “Year-on-year residential property prices, deflated by CPI, rose by 9.5% in the United States and 6% in the United Kingdom. Real house prices also grew, by 7% in Canada, 7.7% in Australia and 2.2% in Switzerland, three countries that were less affected by the crisis, as well as in some countries that were severely affected by the crisis, such as Ireland (+7.2%) and Iceland (+6.4%)”.

They also show the relative benchmark between house price growth and price to rent. Here, overall average house price growth, after inflation, in Australia is close to zero over the last three years (because of averages across the states, the ABS shows how prices vary state by state), and Australia has high price to rent rations, but not the highest. This is because rents are more linked to interest rates and income growth than house prices directly.

Turning to their other measure, comparing house prices to income ratios (the measure we prefer as the best judge of house prices), we find that Australia is shown as the second highest, after Belgium, despite the close of zero growth in absolute prices, after inflation, in the past 3 years.

The codes for the various countries are listed below:

Their comments are important:

Work at the BIS has pointed to the early warning indicator properties of real estate prices. Leverage fuelled housing booms that turn into busts have so often been at the very heart of episodes of systemic distress. Historical experience has demonstrated that the interactions between rapidly growing house prices and excessive credit expansion are a tell-tale sign of the build-up of vulnerabilities in the household sector and the source of future losses for banks.

Strong Investment Lending In Latest Finance Data

In the final element of the monthly series, the ABS today released their lending data for July. The total value of owner occupied housing commitments excluding alterations and additions rose 0.3% in trend terms and the seasonally adjusted series was flat. The trend series for the value of total personal finance commitments rose 0.4%. Revolving credit commitments rose 0.8% and fixed lending commitments rose 0.1%. The seasonally adjusted series for the value of total personal finance commitments fell 1.3%.

Revolving credit commitments fell 4.7%, while fixed lending commitments rose 1.5%. The trend series for the value of total commercial finance commitments rose 2.7%. Revolving credit commitments rose 5.1% and fixed lending commitments rose 1.6%. The seasonally adjusted series for the value of total commercial finance commitments rose 3.7% in July 2014, following a rise of 11.8% in June 2014. Fixed lending commitments rose 20.7%, following a rise of 0.8% in the previous month. Revolving credit commitments fell 25.9%, after a rise of 37.7% in the previous month. Looking at the data in more detail, we see the concentration of lending by the banks (and mainly the big four).

Within the commercial category, lending for housing investment by individuals was a significant element. Here is the absolute dollar amount by states, with a trend line, showing the relative strength in lending for investment purposes in NSW in particular, then VIC. The investment lending boom is not uniformly spread across the country. Another way to look at the data is on a per capita basis across each state. This chart shows the average amount per capita between January 2011 and July 2014. The movement is NSW in particular since May 2013 highlights both the volume and size of the average loans for investment purposes in NSW, compared with the other states. It is also worth noting the differences between NSW and some of the other states, especially TAS and SA, and we see WA, NT and VIC roughly marching together, behind the rabid pace set by NSW.