Tag: The Property Imperative

Household Incomes are growing at the slowest rate for two decades, putting more strain on family budgets who are wrestling with rising costs and bigger mortgages and battling the debt monster.

What the implications for home prices, and the broader economy? Welcome the Property Imperative weekly to 19^th August 2017, as we look at the latest finance and property news.

Last week we saw auction clearance rates accelerate. According to CoreLogic they rose to 2,011, compared with 1,857 over the previous week.  This was the largest number of auctions held since the last week of June 2017 and one third higher compared with the same week a year ago. Melbourne has held the record for the largest number of sales, but Sydney achieved a higher clearance rate at 72%. So not much sign of the property market flagging.

More data came from the RBA when Assistant Governor Christopher Kent discussed insights from a dataset which covers about 280 ‘pools’ of securitised assets and has information on 1.6 million individual mortgages with a total value of around $400 billion. Currently, this accounts for about one-quarter of the total value of home loans outstanding in Australia.

A couple of caveats. While the dataset covers a significant share of the market for housing loans, it may not be entirely representative across all its dimensions. In particular, the choice of assets in the collateral pool may be influenced by the way that credit ratings agencies assign ratings and by investor preferences. Also, in practice it may take quite a while until new loans enter a securitised pool.

But the first thing to note is that rates on owner-occupier loans and investor loans used to be similar, but investor loans became relatively more expensive from the latter part of 2015. In fact, up until most recently, actual rates paid on interest-only loans have been lower than those on principal-and-interest loans. But now, interest only loans are significantly more expensive for both owner-occupied and investor borrowers. This is reflecting recent bank repricing as they seek to repair margins and throttle back interest only lending in response to regulatory pressure. Monthly repayments are on the rise, and on large loans this is a significant impost.

Looking at loan to value ratios, we see that there is a large share of both owner-occupier and investor loans with current LVRs between 75 and 80 per cent. That is consistent with banks limiting the share of loans with LVRs (at origination) above 80 per cent. Also, borrowers have an incentive to avoid the cost of mortgage insurance, which is typically required for loans with LVRs (at origination) above 80 per cent. This is consistent with the DFA market model, and suggests that a common held view that the average LVR is circa 50% is not correct any more. Bigger loans, lower equity, larger repayments.

Finally, they looked at offset accounts, which showed strong growth up to 2015 probably related to the rise in the share of interest-only loans, with the two being offered as a package. Interestingly, we saw a significant slowing in growth in offset balances around the same time as growth in interest-only housing loans started to decline. Offset balances provide some security for borrowers in times of finance stress.  But the RBA highlights that for investor loans, even after accounting for offset balances, there is still a noticeable share of loans with current LVRs of between 75 and 80 per cent. And for both investor and owner-occupier loans, adjusting for offset balances leads to only a small change in the share of loans with current LVRs greater than 80 per cent. This suggests that borrowers with high current LVRs have limited repayment buffers.

Oh, and note there was no analysis at all on the most critical metric – loan to income ratios, which as we have been highlighting is a more reliable risk assessment tool, but one which in Australia we appear loathe to discuss.

This becomes important when we consider that home prices continue to rise in most states. Separate analysis from CoreLogic showed that the cost of housing has continued to rise across most parts of the country over the past 12 months, pushing the proportion of homes selling for at least one million dollars to new record highs.  Bracket creep should come as no surprise in markets like Sydney and Melbourne where dwelling values have increased by 77% and 61% respectively over the past five years.  While the rise in housing values has been most pronounced in Sydney and Melbourne, most other capital cities and regional areas have also seen a proportional lift in home sales over the million-dollar mark.

The banks continue to lend strongly in the mortgage sector, with system growth still sitting around 6% over the past year. ANZ, who reported their third quarter results this week revealed that they had grown their owner occupied lending at 1.3 times system growth, whilst investor loans grew at 0.8%. Lenders are still banking on mortgage credit growth.

The RBA minutes were more muted this month, perhaps because of the reaction to the 2% rate lift to neutral last month, which was hurriedly walked back subsequently! They mentioned concerns about high household debt again, and that inflation is running below 2%. They also mentioned that the Australian Bureau of Statistics intends to update the weights in the CPI in the December quarter 2017 CPI release, to reflect changes in consumers’ spending behaviour over recent years. This is expected to lead to lower reported CPI inflation because the weights of items whose prices had fallen were likely to be higher, whereas the weights of items whose prices had risen were likely to be lower.

Underlying inflation was expected to be close to 2 per cent in the second half of 2017 and to edge higher over the subsequent two years. Retail electricity prices were expected to increase sharply in the September quarter. They said “ongoing low wage growth and the high level of debt on household balance sheets raised the possibility that consumption growth could be lower than forecast”.

The income data from the ABS confirmed low wage growth, with seasonally adjusted, private sector wages up just 1.8 per cent and public sector wages up 2.4 per cent through the year to June quarter 2017. So wages for those not fortunate enough to work in the public sector continues to be devalued in real terms.  Also, whilst more jobs were created in July, the employment rate is still quite high, and underemployment remains a significant factor – one reason why wages growth is unlikely to shift higher.

So, what are the consequences of home lending rising 6%, inflation 2% and incomes below this? The short answer is more debt, and mostly mortgage debt.

To get a feel for the impact of this, look at our recent focus group results.  Around two thirds of the households in the session held a basic assumption that high debt levels were normal. They had often accumulated debts through their education, when they bought a house, and running credit cards. Even more interestingly, their concern from a cash flow perspective was about servicing the debts, not repaying them. One quote which struck home was “once I am dead, my debts are cancelled, I just keep borrowing until then”.

Debt, it seems has become part of the furniture, and will remain a spectre at the feast throughout their lifetime.  The banks will be happy!

So it is worth looking at some long term trends, as we did on Friday using RBA data.

The traditional argument trotted out is that household wealth is greater than ever, this despite low income growth and rising debt. But of course wealth is significantly linked to home prices, which in turn is linked to debt, so this is a circular argument. You get a different perspective by looking at some additional trends.  And if property prices fell it would all turn sour.

But let’s start with the asset side of the ledger. Since 1999, superannuation has grown by 181.2%, and at the fastest rate. But it is arguably the least accessible asset class.

Residential property values rose 160.2% over the same period, and grew significantly faster than equities which achieved 135.8% growth, so no wonder people want to invest in property – the capital returns have been significantly more robust. Deposit savings grew 159.1% (but the savings ratio has been declining recently). Overall household net worth rose 151.2%. So the story about households being more affluent can be supported on this view of the data. But it is myopic.

Overall household debt rose 161.9%, a growth rate which is higher than residential property values, at 160.2% and above overall household net worth at 151.2%.

But the growth in income, which is a puny 60.5%, under half the asset growth. OK, interest rates are lower now, but this increase in leverage is phenomenal – and explains the “debt is normal” findings from our focus groups. I accept debt is not equally spread across the population, but there are significant pockets of high borrowing, as can be seen from our mortgage stress analysis – and it’s not just among battling urban fringe mortgage holders.

Finally, it is worth noting the growth in the number of residential properties rose by just 29.8% over the same period. So the average value of individual properties has increased significantly. On paper.

To me this highlights we have learned nothing from the GFC. Our appetite for debt, supported by the low interest rate monetary policy, significant tax breaks, and salted by population growth has created a debt monster, which has the capacity to consume many if interest rates were to rise towards more normal levels. Unlike Governments, household debt has to be repaid, eventually.

This data series shows clearly the relationship between more debt and home prices, they feed of each other, and this explains why the banks have enjoyed such strong balance sheet growth. But the impact on households is profound, and long term. Our current attitude to debt will be destructive eventually.

If you are interested in this debate, try to watch ABC Four Corners on Monday night, as they will be looking at the housing bubble and mortgage stress, and using some of our data in the programme.

And that’s the Property Imperative to 19^th August 2017. If you found this useful, do subscribe to get updates, and check back for next week’s installment. Thanks for watching.

Demand for housing credit remains firm, which explains the ongoing high auction clearance rates. So has the property market further to run and what is the RBA likely to do?

Welcome to the Property Imperative weekly to 12^th August 2017, our weekly digest of the latest finance and property news.

Company results released this week included the full-year outcomes from the CBA,  half year from AMP, and 3^rd Quarter results from NAB. There was a common theme through them all. Mortgage loan growth has continued, and thanks to loan and deposit repricing, net interest margins have improved in recent months. This was also helped by more benign conditions in the international capital markets. In addition, overall provisions for bad loans were reduced, despite higher delinquency rates in the troubled Western Australia market.  We think the banks, overall, will continue to churn out larger profits as they use repricing to cover the extra regulatory costs and bank taxes.  In fact savers are taking a lot of the pain, especially on term deposits, as rates fall even lower, this gets less focus compared with all the commentary is on mortgage interest rates.

Mortgage Brokers were in the news again, this week, with NAB suggesting that changes do need to be made to “improve the trust and confidence that consumers can have in brokers”.  UBS put out a research note suggesting that broker commissions will be trimmed soon, whilst CBA reported a fall in the volume of new mortgages sourced via brokers, compared with their branch channels. We are beginning to see significantly differentiated distribution strategies, with some suggesting a migration to digital will reduce the importance of the branch, whilst other lenders, like CBA are investing in new, smaller, outlets with the expectation of driving more business generation through them.   On the other hand, CBA, as a result of John Symond exercising his put option, is also buying the remaining 20% interest rest of Aussie Home Loans. Interesting timing!

RBA Governor Philip Lowe’s Opening Statement to the House of Representatives Standing Committee on Economics today contained a few gems.

Globally monetary policy stimulus may be reducing, whilst low wage growth is linked to a complex range of global factors, from technology, competition and lack of security. Locally, business investment is still sluggish, and the RBA says, household are adjusting to lower wage growth plus rising power prices and the burden of household debt.  They still back 3% growth in the years ahead. The next move in the cash rate will be up, but not for some time yet.

Ten years ago this week, French bank BNP Paribas wrote a warning of the risks in the US securitised mortgage system. Later, UK lender Northern Rock saw customers queuing to get their money from the bank, a reminder of what happens when confidence fails.  Later still, Lehmann Brothers crashed. In the ensuing mayhem, as banks fell from grace and were either left to die, or were bailed out – mostly with public funds – and as mortgage arrears rocketed away in many northern hemisphere centres.

Whilst much has changed, and banks now hold more capital, we still think there are risks in the financial system. In fact, if the RBA does raise rates here, there is a risk we could have our own version of the GFC. It was the sharp move up in mortgage rates which finally triggered the crash a decade ago. We have very high household debt, high home prices, flat income, rising living costs and ultra-low, but rising mortgage rates. We also have a construction boom, with a large supply of new (speculative) property, and banks that have around 60% of their assets in residential property. Arguably lending standards are still too lose despite recent tightening (which note, had to be imposed on the lenders by the regulators!). So the RBA will need to lift rates carefully to avoid a crash.

Lending data from the ABS showed owner occupied housing lending rose 0.5% in trend terms in the past month – or around 6% annually, well ahead of inflation.  Lending for new construction rose. But lending for investment housing fell 0.85% month on month, despite ongoing strong demand from investors in Sydney and Melbourne. First time buyers were more active in June, they made up 15.0% of transactions, compared with 14.0% in May. Property demand is actually stronger than a couple of months ago as confirmed by the still strong auction clearance rates. Other personal finance fell 1.8%.

The trend series for the value of commercial finance commitments rose 1.8%. Non housing fixed lending rose 3% and revolving credit rose 1.8%. So, perhaps, finally, we see lending by business beginning to gain momentum! This is needed for sustainable growth. The ANZ Job ads were also stronger in July, and the NAB business confidence indicators were also higher. All pointing to strong business investment, perhaps.

On the other hand, the July DFA household finance confidence index was lower with the average score at 99.3, down from 99.8 last month and below the neutral setting. However, the average score masks significant differences across the dimensions of the survey results. For example, younger households are considerably more negative, compared with older groups. This is strongly linked with property owning status, with those renting well below the neutral setting (and more younger households rent these days), whilst owner occupied home owners are significantly more positive. We also see a fall in the confidence of property investors, relative to owner occupied owners. Across the states, we see a small decline in confidence in NSW from a strong starting point, whilst VIC households were more confident in July.

The driver scorecard shows little change in job security expectations, but lower interest rates on deposits continue to hit savings. Households are more concerned about the level of debt held, as interest rate rises bite home. The impact of flat or falling incomes registers strongly, with more households saying, in real terms they are worse off. Costs of living are rising fast, with the changes in energy prices, child care costs and council rates all hitting hard. That said, the continued rises in home prices, especially in the eastern states meant that net worth for households in these states rose again, which was not the case in WA, NT or SA.

Sentiment in the property sector is clearly a major influence on how households are feeling about their finances, but the real dampening force is falling real incomes and rising costs. As a result, we still expect to see the index fall further as we move into spring, as more price hikes come through. In addition, the raft of investor mortgage rate repricing will hit, whilst rental returns remain muted.

So, overall, we see a mixed and complex picture, with demand for property remaining firm, lending still rising, incomes still under pressure and lenders able to buttress their profits thanks to lifting margins. This puts pressure on the RBA, who continues to warn of the risks to households but then cannot lift rates very far. This tension will all play out, not just in the next few months, but over the next two or three years.

And that’s the Property Imperative to 12^th August 2017. If you found this useful, do subscribe to get future updates, and check back for the latest installment.

The latest data suggests mortgage delinquencies are rising, as the number of mortgaged households increase. Yet the RBA is bullish about future growth prospects, despite anemic retail spending, a stronger dollar and home lending reaching another new record. So what’s going on?

Welcome to the latest Property Imperative weekly to 5th August 2017.

We released our mortgage stress and default modelling for Australian mortgage borrowers, to the end July 2017.  Across the nation, we estimate more than 820,000 households are now in mortgage stress (compared with last month 810,000) with 20,000 of these in severe stress. This equates to more than a quarter of borrowing households.  We also estimate that nearly 53,000 households risk default in the next 12 months.

We have been tracking the number of households in stress each month since 2000, and since a small easing in February 2016, the number under pressure has been rising each month.  The RBA cash rate cuts provided some relief, especially directly after the GFC, but now mortgage rates appear to be more disconnected from the cash rate as banks seek to rebuild their margins.

There were more mortgage rate changes this week, with Virgin Money increasing the standard variable rates for owner occupied and investment interest only loans for new and existing customers and also increasing the fixed interest only rates for both owner occupied and investment loans. The increases ranged from 15 basis points, or 0.15%, up to 50 basis points for a 3 year lower LVR owner occupied fixed loan.

Teachers Mutual Bank increased the interest only variable rate by 20 basis points to 5.66% p.a. Interest only rates for the Solution Plus Home Loan rose by between 30 and 50 basis points depending on the LVR. Rates span between 4.49% p.a. and 4.67% p.a. They decrease rates for the principal & interest Home Loan by 15 basis points to 4.39% p.a for those borrowing between $240,000 and $499,999 where the LVR is greater than 80% and less than or equal to 90%.

CBA doubled the waiting period for customers seeking to switch to an interest-only repayment loan from 90 days to 180 days. This is a further move to try to reduce the proportion of IO loans held, following regulatory pressure to meet the 30% limit.  CBA has already lifted interest rates, tightened lending criteria and throttled back applications via mortgage brokers.

Once again we see a differential shift, with interest only loan rates being lifted, whilst rates on some owner occupied principal and interest loans below specific LVR’s and value are reduced. This underlines the current behaviour where specific types of “low risk” borrowers are being recognised. Expect more of the same from other market participants.

A new report by the Australian Housing and Urban Research Institute (AHURI) revealed than an estimated 1.3 million households  – around 14% of Australian households –  are in housing need, whether unable to access market housing or in a position of rental stress. This figure is predicted to rise to 1.7 million by 2025. This includes 373,000 households in New South Wales, where the number is expected to increase by 80% to more than 670,000 by 2025.

The newly released Household, Income and Labour Dynamics in Australia (HILDA) data showed that home ownership among 18 to 39-year-olds has fallen from 36 per cent in 2002 to a new low of 25 per cent. On top of that, between 2002 to 2014, the average mortgage debt of young homeowners increased by 99 per cent in real terms, from $169,000 to $337,000.  In fact, the decline in home ownership has been greater than the decline in owner-occupied households. This is largely because adult children are living with their parents for longer.

More broadly, HILDA also highlighted growing inequality, something which we have been discussing for some time. It is parents passing wealth down to their children that are once again starting to define who gets into property and who doesn’t – we’re going back to a 1950s-style class division. Our research suggests the average hand-down from the Bank of Mum and Dad is more than $85,000.  This rising inequality was also confirmed by the latest ME Bank Survey. They say the overwhelming majority of Australian households (68 per cent) saw their incomes stagnate or fall. Only 32 per cent got pay rises – the lowest in three years.

There are other barriers to property purchase. Data from the HIA suggested that the average stamp duty bill paid by an Australian owner-occupier increased by 16.4% to $20,725 over the past 12 months. And that’s nationally with the average cost in Sydney and Melbourne — Australia’s most expensive housing markets where just under 40% of Australia’s population live — substantially higher at $29,105 and $26,870 respectively. The median dwelling prices in both those cities has more than doubled since the start of 2009, according to CoreLogic. The HIA says recent changes to stamp duty in NSW mean that foreign investors now pay almost $100,000 in transaction taxes to acquire a standard apartment in Sydney – almost four times as much as local buyers.

Fitch Ratings says Australia’s mortgage arrears increased by 12bp QoQ to 1.21% at end-1Q17, due to seasonal Christmas/holiday spending and possible difficulties faced by consumers because of low real-wage growth.

Suncorp, underwhelmed the market with their FY17 annual results. Their housing portfolio now sits at $44.8 billion (up from $44.27 billion in 2016), with 66 per cent coming from the “Brokers”. The results were helped by overall lower provisions and the repricing of mortgages, but despite this, bank NIM fell. Past due home loans rose from 0.79% last year to 0.85% in FY17, and they have significant portfolio concentrations in QLD and WA.

Genworth, the listed Lenders Mortgage Insurer (LMI) released their 1H17 results, and as a bellwether for the mortgage industry, we see continued pressure on mortgage defaults, up 5 basis point, to in WA 0.86% and QLD 0.72%, and a fall in higher LVR lending leading to lower volumes of new premiums being written, but at higher prices.  The average original LVR of new flow business written in 1H17 was 82%.

The latest credit aggregates from the RBA to June 2017 shows continued home lending growth, up 0.5% in the month, or 6.6% annually. Business lending rose 0.9%, or 4.4% annually, and personal credit fell 0.1% or down 4.4% over the past year. However, they changed the seasonally adjusted assumptions, so it is hard to read the true picture, especially when we still have significant reclassification going on. The net value of switching of loan purpose from investor to owner-occupier is estimated to have been $55 billion over the period of July 2015 to June 2017, of which $1.3 billion occurred in June 2017.

In original terms housing loans grew to $1.69 trillion, another record. Investor home lending grew 0.5% or $3.13 billion, but this was adjusted down in the seasonal adjusted series to 0.2% or $1.13 billion. Owner occupied lending rose 0.9% or $9.83 billion in original terms, or 0.7% or $7.34 billion in adjusted terms.

APRA’s latest monthly banking statistics for July 2017 reconfirms that growth in the mortgage books of the banks is still growing too fast. The value of their mortgage books rose 0.63% in the month to $1.57 trillion. Within that, owner occupied loans rose 0.73% to $1,017 billion whilst investor loans rose 0.44% to $522 billion. Investor loans were 35.18% of the portfolio. The monthly growth rates continue to accelerate, with both owner occupied and investor loans growing (despite the weak regulatory intervention).  On an annual basis, owner occupied loans are 6.9% higher than a year ago, and investor loans 4.8% higher. Both well above inflation and income growth, so household debt looks to rise further. The remarkable relative inaction by the regulators remains a mystery to me given these numbers. Whilst they jawbone about the risks of high household debt, they are not acting to control this growth, do not seem worried.

Indeed, the latest RBA Statement on Monetary Policy released today appears to be very upbeat. Despite forecasting growth down a bit in the near term, they are still holding the view of growth of 3% plus later, supported by and improving international economic outlook, a rise in business investment, strong exports and low unemployment. If this is correct, then it seems to me conditions would be right to lift the cash rate towards the neutral position (which as we saw recently they hold to be 2% higher than current levels). That said, many economic commentators think the RBA is overly bullish, given high household debt, flat income growth, and risks in the property market.

Within the statement they acknowledge that slow real wage growth is likely to weigh on consumption, especially if households expect the slow growth to continue for some time and  ongoing expectations for low real wage growth remain a key downside risk for household spending. The recent sharp increase in the relative price of utilities poses a further downside risk to the non-energy part of household consumption to the extent that households find it hard to reduce their energy consumption; this is likely to have a larger effect on the consumption decisions of lower-income households.

They also make the point that some households may also feel constrained from spending more from of their current incomes because of elevated levels of household debt. This effect would become more prominent if housing prices and other housing market conditions were to weaken significantly. Household debt is likely to remain elevated for some time: housing credit growth overall has been steady over the past six months, but has continued to outpace income growth.

That said, the composition of that debt is changing, as lenders respond to regulators’ recent measures to contain risks in the mortgage market. Investor credit growth has moderated and loan approvals data suggest this will continue in coming months. Also, new interest-only lending has declined recently in response to the higher interest rates now applying to these loans and other actions by the banks to tighten lending standards.

They held the cash rate again on Tuesday, and said rent increases remain low in most cities, but Investors in residential property are facing higher interest rates. There has also been some tightening of credit conditions following recent supervisory measures to address the risks associated with high and rising levels of household indebtedness. Growth in housing debt has been outpacing the slow growth in household incomes.

The latest Australian Bureau of Statistics (ABS) Retail Trade figures showed that the trend estimate for Australian retail turnover rose 0.4 per cent in June 2017 the same rate as in May. Compared to June 2016, the trend estimate rose 3.6 per cent. The trend by state shows Tasmania and ACT ahead of the average, with Western Australian and NT, continuing to trail.

So standing back, we have a mixed picture, but one where household debt is still rising, income remains under stress, and costs rising. As a result, we think the drag on growth is stronger than the RBA suggest. Pressure on budgets will constrain spending.  But, here’s the thing, if they are right, we should expect cash rate rises sooner, adding more pressure on household budgets. Looks like its heads you lose, tails they win – borrowing households will remain under the gun for some time to come, and the property market is at the centre of the storm.

And that’s the property imperative weekly to August 5^th 2017

Rental Stress is growing, and more property investors are underwater when it comes to covering their mortgage costs on an ongoing basis, so what are the implications for property investment as mortgage rates continue to rise? Welcome to the Property Imperative Weekly to 29^th July 2017.

We start with our research on property investment, which was published this week. We look at this from two perspectives, first from the point of view of those renting, and second, from the perspective of those who are property investors.

Whilst there is considerable discussion about mortgage stress, rental distress hardly gets a mention yet there are more households in rental stress than in mortgage stress according to our analysis. We know their financial confidence on average is lower. First, we need to define rental stress. Whilst some will use a “30% of income to pay the rent” as a benchmark, we do not think it is an adequate measure – 30% is too arbitrary!

So we look at net cash flow. If households, once they pay their rent, tax and other outgoings have close to nothing left, or a small deficit, at the end of the month, they fall into our mild stressed category. Those with a severe cash deficit at the end of the month, are in severe stress.

We start by looking at the causes of rental stress. Using data from our surveys, we find that costs of living, under employment and flat incomes are the main causes.

More than half of renters in NSW are in rental stress (on our definition), and the highest proportion of any state here are in severe rental stress. The proportion of households in stress fades away as we look across the other states and territories. But the three most populous states have the highest rental stress levels.

Looking across our segments, we see that older households are more under stress, and a significant proportion are in severe stress.  Whilst wealthy seniors may hold some savings, stressed seniors do not. Many are reliant on Government support.

Greater Sydney and the Central Coast have the highest representation of stressed renters as a proportion of all households renting.

Looking across our geographic zones (a series of concentric rings around our main urban hubs) we see significant levels of stress in the urban centres, as well as on the urban fringe. The former is being created by high rents – especially in the newly constructed high-rise blocks being thrown up across the eastern states, often occupied by young affluent households; whilst in the urban fringe, it is more about depressed incomes. We see stress rolling out into the regions, but is less apparent in the more rural and remote areas.

All this highlights the issues renters have due to the combination of flat incomes, and rising costs, despite only small rises in rents.

Now, if we look at the other side of the coin, our research shows more investors have a net cash-flow problem, thanks to that flat rental income, whilst mortgage rates continue to rise.

The CPI data released this week by the ABS showed that overall inflation remains low.

But within the series there is a striking contrast. The Housing Group category of data rose 0.3 per cent for the quarter, and 2.4 per cent for the year to June 2017 but rent rose only 0.2 per cent for the quarter, and 0.6 per cent for the year.

It is worth reflecting on this in the light of the out of cycle rate hikes which property investors are experiencing, as the banks improve their margins using the alibi of regulatory tightening. In fact recent hikes being applied not just to new mortgages but to the entire book deliver a significant “bonus” to the banks.

First, let’s be clear rental rates have more to do with income that property prices, and the fact that rental rates have hardly grown reflects the stagnation in wages. Vacancy rates are also rising.

Second, the fact is a greater proportion of property investors are now underwater on a net rental cash flow basis. But the situation varies by state.  VIC and NSW have on average negative net returns. The net rental calculation is before any tax offsets.

Investors seem ok with negative cash-flow returns because in many cases they just offset the losses against tax, and comfort themselves with the thought that the capital value of the property is still rising (in most eastern states at least).

However, the divergent movement of mortgage rates and net rental returns are a leading indicator of trouble ahead, especially if capital growth reverses.

Given flat incomes, we think rentals will not grow much at all for some time, and remember more new properties are coming on stream, so vacancy rates are likely to continue to rise!

So in summary, we think more rental property will be vacant so holding rentals low (despite being expensive for many potential tenants) whilst investment costs will go on rising. As a result, we expect to see weaker demand for investment property, and should capital values start to fall, more owners will try and sell. In fact we think many property investors are in for a rude awaking, sufficient to tip the overall market lower, despite recent quite strong auction clearances.

More broadly the HIA reported that housing affordability declined further in the past quarter,  largely due to a rise in the median dwelling price of 9.1% per cent to a record high of $540,200. They say, NSW was the most significant negative influence on this result with affordability in Sydney now declining past a critical level (Sydney, – 0.7% and the rest of NSW, – 2.2 per cent). Acquiring and servicing a mortgage on a house in Sydney now requires more than two standard Sydney incomes. Sydney is the only market to have achieved this outcome in the 15-year history of their report. Affordability in Melbourne improved marginally in the quarter but remains 6.0 per cent less affordable than this time last year. Of the capitals where affordability worsened, the biggest deterioration was in Perth (-1.3 per cent).

Despite the fact the US Federal Reserve held their cash rate this week, signalling a slower rise in interest rates in America, Westpac lifted a range of their fixed term investor loans, with for example their 2-year fixed rising 31 basis points.  Bank West said  they would impose a 25 basis point increase for interest-only investor home loans; and a 35 basis points increase for interest-only owner-occupier home loans. They did offer small reductions to some owner occupied principal and interest borrowers. We are seeing a small flurry of rate cuts for some new borrowers ANZ for example is offering a 31 basis point drop for new two-year fixed residential investment loan for customers paying principal and interest (P&I), falling from 4.34 per cent per annum (p.a.) to 4.03 per cent p.a.

The round of mortgage rate repricing which we have been tracking for the past few weeks, with investor loan portfolios being strongly repriced, and owner occupied loans less impacted, has created a significant well of opportunity for banks to selectively offer attractor rates to principal and interest borrowers. In addition, funding costs are now lower, and the yield curve is less strongly indicating future increases, thanks to changes in the US financial markets and news that the ECB will continue its bond buying programme. But many existing borrowers are saddled with higher rates.  We expect to see a flurry of selective, targetted offers, aimed at acquiring new business and supporting loan portfolio growth.

Wages growth in Australia will remain muted for some time to come yet and RBA Governor Philip Lowe said that if some of the long standing links between income growth and monetary policy are not working as they did, more monetary stimulus may encourage investors to borrow to buy assets, which poses a medium-term risk to financial stability. In comments after the speech, he also made the point that surging asset prices has led to a growth in inequality across Australia.

We think the policy chickens are coming home to roost.  We have seen a significant decline in home ownership in recent years, from 69.5 per cent in 2002, to 67 per cent at the 2011 census, and to 65.5 per cent last year. This is a direct result of RBA policy, and the household debt bubble, which has pumped property prices way too high.

As a result, many younger Australians are being forced to rent, or take out very large mortgages. This debt burden will suck up much of their disposable income for the next 20-30 years, and will leave them exposed to future rate hikes. In a low interest rate environment, the capital owed does not depreciate as fast, so the burden is longer and heavier.  This has a knock-on effect on their ability to save for retirement, so their entire life may well be debt laden.

On the other hand, households holding property have enjoyed significant paper gains. Whether they keep them will be determined by future property prices, but there are more reasons to think prices will fall than rise.

A generation of poor myopic property driven policy will have significant negative long-term impact on the economy and lays at the heart of the inequality across the country, which was subject to much discussion this week. Prices may not drop much in the short term, but we believe they will correct eventually. The longer that takes, the bigger the fall ultimately will be.

And that’s the Property Imperative Week to 29^th July 2017. Do subscribe to get our latest updates, and check back again next week. Thanks for watching.

How much will mortgage rates rise, and when? Welcome to the latest edition of the Property Imperative Weekly, our digest of important finance and property news.

Today we are looking back over the week to 22 July 2017. Banks, Mortgage Rates and Household Finances were all in the spotlight.

We start with APRA’s announcement that they will require banks to lift their capital ratios over the next few years, to ensure they are, to quote the Financial System Inquiry “Unquestionably Strong”. APRA focussed on the CET1 ratio, and they chose to take a long-term, through-the-cycle approach, rather than tying capital ratios to the top quartile of international banks.

Major banks will be required to hold an additional 150 basis points by 2020, whilst those on the standard capital approach, typically, smaller banks, will need a 50 basis point lift. In fact, most regional banks are already operating well above the target minimums, and the majors have been lifting their capital already, with some like ANZ likely to be at the required levels, whilst others, like CBA will need to bulk up, either using dividend re-investment plans, or by issuing more capital.  It does tilt the playing field slightly towards the smaller guys, but those who are investing big to migrate to the advanced IRB capital method will be a bit miffed.

APRA did not address the question raised by the Basel Committee and the new international framework still in the works, which is likely to raise internal-ratings based risk weights for investor mortgages and mortgages with high loan-to-value ratios. This change would further add to Australian banks’ capital needs.

Two points to make on all this. First, APRA has come out with a relatively small lift and below the expectations of many analysts, which is one reason why the bank stocks rose this week. It had all been well signalled. Second, APRA says the net impact will be around 10 basis points on income, and they flag this may be recovered from borrowers or from reduced dividends. If all of this was applied to mortgage portfolios, we think an uplift of 20 basis points or more would be needed. In practice there are so many moving parts in the banks treasury operations, we will never be able to isolate the impact of a single factor. But it does put more pressure, not less, on future mortgage rates

Also this week, the RBA released the minutes of their July meeting. It contained on interesting discussion on what the neutral interest rate in Australia at the moment. The “neutral” official cash rate they estimate is 3.5 per cent – a full 200 basis points above where the cash rate is now. This has two implications, first the current settings are stimulatory, and second, it was taken by many as hinting that rates will rise in the months ahead. The media spoke about a 2% rise in mortgage rates, coming soon.

We have been highlighting for some time now the current cash rate will rise at some point and the RBA language certainly reduces the likelihood of a further cut.  How soon a rise will hit though is uncertain, with Malcolm Turnbull on one hand warning households that they should prepare for higher rates, whilst on the other, later in the week, Deputy Governor Guy Debelle seemed to be hosing down expectations of a rise anytime soon.  He also indicated that the neutral cash rate is probably lower now than in the past, despite a trend towards rising rates elsewhere.

All of this may be confusing, but our perspective is the next move to the cash rate will be up, not down, and it could come anytime in the next few months, especially if inflation rises, and the growth in employment, as reported this week continues. What this means is that households do need to start planning for higher future rates, and we know from our mortgage stress work that around a quarter of mortgage holders have no wriggle room. Personal insolvencies have risen in the past year.

Whilst the current round of bank led mortgage repricing may have abated – there were no significant hikes for the first time for weeks – we do not think this is the end of rate lifts.

We think there are three groups of households who should be taking great care just now.

There are some amazing offers around for first time buyers, and lenders are falling over each other to try and attract them. This is because banks need new loans to fund their growth. But these buyers should beware. They are buying in at the top of the market, when rates are low. Banks have tightened their underwriting standards, but still they are too lax. Just because the bank says you can afford a loan does not mean it is the right thing to do. Any purchaser should run the numbers on a mortgage rate 3% (yes 3%) higher than the current rates on offer. If you can still afford the repayments, then go ahead. If not, and remember incomes are not growing very fast – best delay.

Second, there are people with mortgages in financial difficulty now. Well over 24% of households do not have sufficient cash-flow to pay the mortgage and other household expenses. The temptation is to use the credit card to fill the gap – but this is expensive, and only a short term fix. Households in strife need to build a budget (less than half have one) so they know what they are spending, and start to cut back. Talk to your lender also, as they have an obligation to assist in cases of hardship. And be very careful about refinancing your way out of trouble, it so often does not work.

Third there are property investors who are seeing rental incomes and mortgage repayments moving in opposite directions. As a result, despite tax breaks, investment property looks a less good deal. Of course recent capital gains are there – and some savvy investors are selling down to lock in capital value – but be careful now. New property investors are in for a shock as mortgage rates rise further. And multiple investors, are most at risk. Should property values decline, then this will mark the real turning point; but we think the investment property party may be over.

Cutting to the chase, mortgage rates will continue to rise, but the speed of such increases is hard to predict.

Next, the noise about mortgage broker commissions continued with consumer groups reinforcing their view that brokers are conflicted and current commission structures mean consumers are not getting the best outcomes, whilst industry associations continue to rubbish the criticism, and argue that brokers help to propagate competition in the mortgage market, and mortgage rates would be higher without brokers.

We think the right route is to reinforce disclosure. If brokers were to fully disclose their commissions, consumers could make a more informed choice. Some may choose to go with brokers who charge an advice fee, others may run with those offering the current “free” advice in return for payments from lenders. Mortgage brokers do actually offer a valuable service and should be remunerated for their efforts, but conflicts of interest which beset the current arrangements according to ASIC must be addressed. We are not sure the current industry led committee approach will get to the right outcome.

Finally, we published our latest household surveys which shows that whilst there are segmental movements in play, overall demand for property remains intact, despite rising mortgage interest rates and concerns about stalling income growth.

Results from our latest 52,000 survey show that first time buyers are being encouraged by the more generous first home owner grants on offer in several states. On the other hand, the relative benefit of home purchase relative to renting has reduced.

 

The biggest changes in the barriers first time buyers are experiencing relate to the availability of finance, whilst concerns about future interest rate rises, and rising costs of living reduced a little compared with our May results. Overall first time buyer demand is up.

Turning to property investors, the barriers to purchase are changing with a rise in those concerned about rising mortgage interest rates and availability of finance. The reasons to transact have shifted, with a significant rise in those saying they were driven by tax benefits (both negative gearing and capital gains) whilst there was a fall in those looking to appreciating property prices and low finance rates. Overall, investor demand is down a bit.

Another important group are those refinancing. After a strong swing in 2016 to get a better loan rate, there has been a rise in those seeking to reduce their monthly repayments.

So plotting the change of transaction intention over the next 12 months, we see a significant fall in both portfolio and solo property investors, but a rise in first time buyer purchasers expecting to transact.

Finally, we see that in relative terms, there is a fall in the proportion of property investors expecting to see home prices rising in the next 12 months, whilst first time buyers are a little more positive, and there has been little change in expectation across our other segments.

Putting all this together, we think demand for finance, and for property will remain quite strong, and on this read, it is unlikely home prices will fall much at all in the major eastern state markets. Other states are more at risk of a fall, which once again underscores the diversity in the market across Australia.  As a result, lenders will still be able to write more business, though the mix is changing. But affordability will remain a challenge.