Most would accept that house prices in the major Australian centres are too high. Whether you use a measure of price to income, loan value to income, or price to GDP; they are all above long term trends and higher than in most other countries.
Indeed, in Sydney and Melbourne, they are arguably more than 30% higher than they should be. Today we update our thoughts on this critical topic, and identify the winners and losers.
And by the way, if you value the content we produce please do consider joining our Patreon programme, where you can support our ability to continue to make great content.
Ultra-low interest rates currently make large loans affordable for many households, yet overall household debt is as high as it has ever been and mortgage stress, even at these low interest rates is also running hot. Banking regulators are concerned about systemic risks from overgenerous underwriting criteria and they have been lifting capital ratios to try to improve financial stability, with a focus on the fast growing investment sector and underscoring the need for lenders to consider loan servicability. The Royal Commission also uncovered poor lending practice, and the potential for some households to be sitting on unsuitable loans. In many countries around the world, house prices are also high, so from New Zealand to UK, regulators are taking steps to try limit systemic risks. These rises are partly being driven by global movements of capital, ultra-low interest rates and quantitative easing, plus the finance sectors ability to “magic” loans from thin air if there are borrowers willing to borrow. And now interest rates in the USA and Europe are on their way up, creating more pressure on households just as prices are beginning to wain.
Locally of course home prices are now sliding in many centres, and we expect more in the months ahead. However, let’s think about who benefits from high and rising prices. First anyone who currently holds property (and that is two-thirds of all households in Australia) will like the on-paper capital gains. This flows through to becoming an important element in building future wealth. In addition, refinancing is up currently, and we see some households crystalising some of their on-paper gains for holidays, a new car or other purposes, helping to stimulating retail activity. An RBA research paper, suggests that low-income households have a higher propensity to purchase a new vehicle following a rise in housing wealth than high-income households. We also see significant intergenerational wealth transfer as Mums and Dads draw out equity to help their kids buy into the overinflated market. Indeed, we think the Bank of Mum and Dad is now a top 10 lender in Australia, as we discussed recently.
Those holding investment property also enjoy tax-concessions on interest and other costs; and on capital appreciation. Rising wealth generally supports the feel-good factor, and consumer confidence – though currently this is a bit wonky as prices fall, rental streams tighten and interest rates rise. Higher values stimulate more transactions, which creates more momentum. The reverse is also true.
Now, the one-third of households who are not property active, consist of those renting and those living with family, friends or in other arrangements. Their confidence levels are lower and they are not gaining from rising house prices. A relatively small proportion of these are actively seeking to buy, and they are finding the gradient becoming ever more challenging, as saving for a deposit is becoming harder, lending criteria are tightening and income growth is slowing. We have noted previously that a rising number of first time buyers have switched directly to the investment sector to get into the market. Generally younger households are yet to get on the housing escalator, whilst older generations have clearly benefited from sustained house price growth, even if more are now taking mortgages into retirement. This has the potential to become a significant inter-generational issue.
But overall, the wealth effect of rising property is an umbrella which spreads widely. The sheer weight of numbers indicates that there are more winners than losers. No surprise then that many politicians will seek to bathe in the reflected glory of rising values, whilst paying lip-service to housing affordability issues. They will also start to panic if prices fall too far too fast.
There are other winners too. For states where property stamp-duty exists, the larger the transaction value and volume, the higher the income. For example, NSW, in 2016-17 added $9.7 billion to coffers thanks to stamp duties revenue which is 31.6% of the total of $30.7 billion. But now transfer duty revenue over the three years to 2020-21 has been revised down by $5.5 billion according to the state budget papers. Optimistically, they are forecasting a significant rise in property values down the track. The higher the price the larger the income. The tax-take funds locally provided services so ultimately residents benefit. But clearly they have an interest in keeping prices high.
The banks also benefit because rising house prices gives them the capacity to lend larger loans at lower risk (and which in turn allows house prices to run higher again). They have benefited from relatively benign capital requirements and funding, thus growing their balance sheet and shareholder returns. Whilst recent returns have been pretty impressive, future returns may be lower thanks to changes in capital ratios and especially if housing lending continues to moderates. On the other hand, their appetite to lend to productive business and commercial sectors is tempered by higher risks and more demanding capital requirements. The relative priority of debt to housing as opposed to productive lending to business is an important issue and whilst higher house prices can flow through to economic growth in the GDP numbers, it is mostly illusory. The truth is, lending needs to be redirected to productive purposes, not just to inflate home prices.
Finally, building companies can benefit from land banks they hold, and development projects, despite high local authority charges. We also note that some banks are now winding back their willingness to lend to the construction industry (because of potentially rising risks), and some banks have blacklists of postcodes where they will not lend, especially for newly constructed high-rise block. The real estate sector of course benefits, thanks to high transaction volumes and larger commissions. Mortgage brokers also enjoy volume and transaction related income. Even retailers with a focus on home furnishings and fittings are buoyant. But all of these sectors are under pressure as momentum ebbs.
So standing back, almost everyone appears to benefit from higher prices. That is, apart from the one third, and rising, of households renting (who tend to have lower incomes, and reside in lower socio-economic groups). But is it really a free-kick for the rest? Well, for as long as the music continues to play, it almost is. The question now is, what happens as prices continue to fall (remember that during the GFC, northern hemisphere prices fell in some places up to 40%, and several banks collapsed, though since then prices in the US, Ireland and the UK have started to recover). Given our exposure to housing, there will be profound impacts on households, banks and the broader economy if values fall significantly. Yet that looks like where we are headed.
Underlying all this, we have moved away from seeing housing as something which provides shelter and somewhere to live; to seeing it as just another investment asset class. This is probably an irreversible process, and part of the “financialisation” of society, given the perceived benefits to the economy and households, but we question whether the consequences are fully understood.
