Is This Australia’s Sub-Prime Debt Shocker?
I doubt you need me to point out that Australian capital city home prices have dramatically increased since the mid to late 1990’s, especially in Sydney and Melbourne. The growth in property values has been primarily attributed to limited housing supply, and at the same time steady population growth, a more liquid loan market and cheaper finance.
So just when does a boom become a bubble? The answer: when the rational becomes irrational. This happened in Australian real estate some time ago – the moment when the average person, on the average income, couldn’t afford the average home.
Yet the property price party raged on. And on. And on. Not everywhere, mind you… while Sydney and Melbourne have been dancing on the ceilings, there’s been a real estate hangover in WA for the past few years, and Darwin is still in the midst of a significant property price contraction. And then we have the likes of Moranbah and Gladstone, where home prices completely collapsed.
Speaking of collapse, my opinion previously was that, in the absence of a black swan event (like a war, plague, hyperinflation, large-scale natural disaster, etc.), an Aussie capital city price crash was quite unlikely to occur. Instead, I preferred the thesis of a soft landing in the form of a small price jolt (say up to a 10% decline), followed by a substantial multi-year period of static prices.
However, if what I’m about to share with you is true, then my mind has changed and I believe a more substantial price correction (say up to 30% decrease in value), and maybe even a crash (>50%), is not just possible, it’s actually quite probable.
The game-changing information comes from UBS – an investment bank that completed a survey revealing that only 67% responded that their mortgage application (on their home loan application made in 2017) was “completely factual and accurate”. In other words, a third of those surveyed confessed to lying.
Furthermore, the study estimated that there is “roughly US$500 billion (A$657.95 billion) worth of factually inaccurate mortgages on the banks’ books in Australia.” That’s $657,000,000,000, or (at the current median house price) the equivalent of 562,733 Sydney houses!
Again, if this UBS study, and its associated forecast, are accurate, then the dodgy debt mentioned – which have been dubbed Liar Loans – is surely Australia’s equivalent of the US sub-prime debt crisis, and is just waiting for a spark to ignite it. That spark could well be the Royal Commission in the Australian banking and investment sector.
Should that Royal Commission find that the loan application process lacked integrity and recommends that lenders re-qualify their loans against more stringent standards, or make other prudential recommendations that cause lenders to reassess the quality of their assets, then it may be that lenders start demanding additional capital contributions on ‘Liar Loans’ that were initially approved on deceitful details and dodgy declarations. Where such money cannot be provided, loans may be called in, which will, in turn, cause a sudden spike in housing stock for sale, which in turn would put downward pressure on property prices.
Even taking the most conservative expectation from the upcoming Royal Commission, you have to believe there will be more checks and balances (read red tape) to qualify for a loan. That’s not necessarily a bad thing, but it will mean it will be harder and will take more time, to qualify for a loan.
Add to this:
- News that Sydney and Melbourne property prices are softening, fast
- News that mortgage stress is already biting (like the 1 in 10 households in Western Sydney who are reportedly finding it difficult to make their repayments)
- The likelihood that interest rates are to go up in 2018
- The so-called glut of apartments coming online soon in Sydney, Brisbane and Melbourne
- The cooking of the golden foreign buyer goose at the hands of State and Federal governments raising fees and duties for overseas buyers
- A new tax on vacant property
- Recent adverse changes to depreciation; and
- Labor’s policy of changing negative gearing rules, once in power
and you don’t need to be Nostradamus to predict headwinds coming for Aussie property.
What do you think though? Will it be doom, gloom or boom in 2018?
Finally, as this is my last article for 2017, I’d like to acknowledge the hard work and fine contribution made by my fellow worker bees here at PropertyInvesting.com. On behalf of us all, we wish you a very Merry Christmas and a Happy New Year.
Until we meet again, goodbye and God Bless.
– Steve McKnight
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Thanks Steve. Such funny timing – I watched “The Big Short” last night, and you helped me with some questions I’ve had going round my head this morning after watching the movie.
Have a happy Christmas. Looking forward to more of your blog posts next year.
Aha! Stalker Steve is watching Jane.
Happy Christmas.
Steve
Hi Steve and your great team at PropertyInvesting.com
It has been a great 2017! Thanks for organising such a great Mega Conference in mid September and the boot camp in November, not to mention the regular updates and Steve-isms throughout the year.
I do wish you all have a wonderful Christmas and a great 2018. You all deserve a well earned holiday break.
I Look forward to catching up in 2018..
Blessings
I’m looking forward to seeing you in 2018 Raymond, and hopefully having you join me on a trip to the US to see the Fund’s properties in person.
Regards,
– Steve
G’day Steve, Mortgage stress is the big issue that has been really under estimated in a potential property crash. Digital Finance Analytic’s October figures showed 29% of households were under mortgage stress, meaning their income doesn’t cover their expenses and mortgage payments. All this at a time when interest rates are at historical lows! The economic impact of the job losses in the manufacturing industries are still yet to ripple through, and I believe things are going to get a lot worse. Pay down debt, and any job is a good job. Thanks for your engaging contributions during the year. Merry Christmas to you and those close to you.
Thanks for the post Fergo.
Yes, mortgage stress is an issue now, but when interest rates rise it could become a pre-cursor to substantial economic pain.
The RBA has been at pains to tell borrowers that interest rates will eventually rise, and even before the RBA has done this, the banks have done their dirty work for them – at least for investors and interest only borrowers.
Regards,
– Steve
Hi team,
I saw this in the news today:
Let’s hope interest rates don’t rise any time soon.
– Steve
Hi Steve,
THAT is scarey !!! Banks have adopted a significant “Qualifying Rate” recently – something like checking that all new borrowers can handle a 7.5% Interest Rate, while actual Rates sit about 4.5%. So THEY should not be in any trouble. Then there are “all the rest” who haven’t renewed their mortgages recently, BUT Interest Rates have dropped such that it should be EASIER to handle their mortgages than before (unless they Fixed them at a high rate).
What other scenarios are there? Other things might be in play here.
Anyone’s Power Bills been increasing lately? Hmmm? What about Petrol Costs? Gas? Rates? Water? Land taxes? Food? Have your wages been keeping pace?
Maybe the problem isn’t a mortgage at all – but “other costs” that are helping to make any existing mortgage hard to find….. and any mortgage increase will be adding insult to injury??
Waddaya reckon?
Benny
Hi Steve,
Relax, you can go back to sleeping well at night :-)
Credit conditions in Australia are already tight, and have been for a number of years. This means that in my opinion the housing market is going through, and will continue to go through a slow deflation in Sydney and Melbourne. It won’t be a crash. In fact some states are now definite value on an affordability basis (eg Perth and Brisbane).
The UBS report is not “game changing”, it is headline grabbing click bait. The amount of supporting information lenders now demand (and have for a number of years) is extensive. Their lending standards are stringent. The so called report around “liar loans” and “factually inaccurate info” predominantly relate to items around applicants living expenses. For example clients not disclosing they have Foxtel, or that they spend $100pm on pet grooming. This information is not material to credit worthiness and in most cases are discretionary expenses. When applicants don’t disclose a personal loan or credit card (which sometimes happens, and these are important) the bank still finds about them due to a credit check or scanning transaction statements.
And remember that banks assume a “servicing rate” on loans at a minimum interest rate of 7.25%pa while most borrowers home loans are under 4% (and you can still fix your loan for 5 years at close to 4%).
Combine this with low bank loan to value ratios, higher capital requirements, a plunge in interest only lending, high levels of offset balances, average borrowers ahead 56 weeks in their repayments, improving affordability and continued population growth, I simply can’t see the conditions for a sustained price crash.
I’ve been a mortgage broker for 14 years and have submitted about 2000 loans in that time so I am happy to provide any further insight from the “coalface” if you like.
Cheers, Ian Simpson, Smartline
Great insight Ian. I am totally with you on this topic this time. We had a positive geared property portfolio of 3.5m 12 months ago and the rental income covered not only the interest payments for the 3 investment properties, but also the interest payment for our PPR. Both my wife and myself earn good salaries and it was a big surprise to see how hard to acquire another slightly negative gear property in Sydney’s northwest. We used a mortgage broker and asked a few banks ourselves and only NAB could do the 80% lending. Other banks could only lend say 70 to 75% of the purchase price.
Richard you are exactly the case in point. Good equity, good incomes, experienced investors and good credit history, yet you find it hard to buy another investment property due to banks stringent credit conditions. This is simply why a GFC style crash due to loose lending isn’t going to happen (which is of course a good thing, as frustrating as it is). Cheers Ian Simpson, Smartline.
Well said!
These are comforting words Ian, and I hope you’re right.
Let’s role play though… what if UBS are right and 1 in 3 loans are based on factually inaccurate data. What might the consequences be in your opinion?
It’s time for a cup of warm milk and then off to sleep :-)
– Steve
Great question Steve.
In my opinion the so called factually incorrect data in loan applications is immaterial to the economic outcome of the housing market. As I mentioned, the data that matters (income, liabilities) is verified by lenders. What generally doesn’t matter is past living expenses which is also what banks ask (and is the predominant fodder for the UBS report). For example most first home buyers might understate their past living expenses (which is what the banks ask) because guess what, they are now buying a house and getting a mortgage so going forward their living expenses won’t involve regular lavish dinners, smashed avo every other morning and trips to Hawaii.
It is easy for me or a bank to differentiate between who will be a sound borrower and who will not be one. Ability to save, low/no personal debt, no/low credit cards, modest/no car, clean credit check. These are the factors that make good borrowers. And trust me it is very hard to get applicants approved if they fail on a few of these criteria.
As an aside, low doc loans are really the area where materially important factually incorrect info can make it to a lender. However this represents less than 5% of lending in Australia and lenders usually require equity of greater than 40% before approval so this area is also of little concern.
My concern is long term US bond yields reverting back up to more normal levels and causing a general tightening of global liquidity. This will happen sometime sooner or later and will mean higher rates here. I still advocate borrowers consider fixed rates for a good portion of debt and build an ample cash surplus while times are good.
I hope that helps. Cheers Ian Simpson, Smartline [email protected]
Interesting! Will you still buy property in Sydney or Melbourne Steve?
Hi PCN,
There are always great deals in any market, but I think they days of buying and holding for quick and easy growth may be over, for now.
– Steve
Yes I agree.
I am planning to buy an Investment Property in Melbourne in early 2018. May be I should wait base on this article.
Depends on what you are planning to buy, and the strategy you are planning on executing.
Regards,
– Steve
Wasn’t this just a survey of just 900 people?
Hi Don,
I’m gathering the headlines are being populated off the UBS press release because I am struggling to find a link to the actual report.
The best I can come up with is “more than 900 people”.
I’ll keep looking…
– Steve
Great article as always :)
I think it is certainly not unlikely to see a depressed market in Sydney for the next few years. A recent study (unfortunately I cannot remember the proper reference anymore) said that -from affordability measures- Sydney house prices are ~30-35% too high. So unlikely that this level can be kept up by owner occupiers. Rental yields are in the 2% range, so it is not attractive from an investing standpoint either, given that people realize that price increases will be limited in the next 5 years…
So for me the signs are all on red at the current stage…
Well, there are people who say that the demand is still higher than supply, which I can’t really verify. I just see a lot of construction going on in my neighbourhood and I think this is the way for investors to still make money in the property market. However, this will add to the supply in the mid term…
Thanks Steve…. until next year. Thanks writing great articles.
Thanks for the post Steve. I’d be interested to know how a media release like this actually plays into the psyche of potential buyers and sort of talks us into a ‘crash’?
Do you think that such reports make most people nervous and less inclined to buy? I’m not sure how you’d measure this, but would be interesting to know.
Merry Christmas and a Happy New Year!
Cheers.
Hi Gary,
I don’t think the report is crash-making, although it sows doubt (which can be a healthy thing).
I see this as a fog horn warning ships finding it hard to navigate in tricky times to a potential danger.
Regards,
– Steve
Hi Steve,
What a great subject! You are so good at coming up with these random subjects, then turning them open for us to “have a crack at”. This means we all learn more as we read of the summation from a property guru, then turn our own thoughts toward the subject.
You ask “Will it be doom, gloom, or boom” that comes next?
Well, I don’t see doom – though surely, you make some very salient points that COULD have been promoting doom. Perhaps gloom, as I see the more likely scenario being a continued softening (Syd/Mel) or simply flat the way things are right now. Boom, nah probably not for a few years yet as things settle down (or settle up?).
A few thoughts of my own:-
1. Syd/Mel softening – Hmm, yeah – they had a big boom, so time for a wee bit of downtime for a few years.
2. Mortgage stress – sure thing. The lack of wages growth won’t be helping that. But then Home-Owners will fight tooth and nail to keep what they have. Is this figure of 10% much higher than “normal” anyway?
3. Rates to rise in 2018 – so long as the RBA takes all things into consideration, any rise should be minimal. With electricity prices screaming up, our workers, and our biggest emploer (small business) are not having a great time. I can’t see the RBA doing anything so stupid as to increase rates too quickly – they shouldn’t be !!
4. Apartment glut – will push their values down, for sure – I doubt this would reflect in house prices so much though. Am I wrong there?
5. Cooking the foreign “Golden Goose” – yeah sure, not the smartest move IMHO – that will likely hurt most in the apartment value space (forcing values down even more). Will it effect houses though?
6. A new tax on vacant property – Wow did I miss this? Who? Where? A State thing? That could for sure have an effect if far-reaching !!
7. Depreciation changes – this could chase some investors away, or stop new ones getting in to investing. Certainly deflationary. But if combined with low vacancy rates, it could signal a lift in rents too. I’m split on that one.
8. Labor and Negative Gearing – Oh yeah – that would be a BIG one if implemented. 1986 revisited !! Doesn’t sound good, so definitely a price crash possibility there !!
In summary then, with the exceptions of 6 (perhaps) and 8, I am not seeing major doom (as in huge crashes).
But certainly I see gloom (as in prices softening, or staying flattish). And that may well be just Syd/Mel as other centres seem to still be “affordable” to me. Boom – perhaps – on a centre-by-centre basis (e.g. Bne, etc)
I’m enjoying reading all of the other comments too – keep ’em coming peeps,
Benny
Thanks for taking the time to lay out your thinking Benny.
It makes an interesting and valuable addition to the conversation.
– Steve
Very well said Benny. You are spot on. These are all factors that will dampen the market but a crash is very unlikely. In fact any healthy bull market requires a big dose of worry from many participants.
Hi Steve – a most illuminating post! I remember the sub-prime debacle driven by greed and dishonesty – it was the home owners and general consumer in America (taxpayers) who suffered the consequences and the banks who were largely protected, granted immunity and bailed out (I remember reading how many execs were given a bonus when the banks received the bailout)!
Anecdotally, it’s interesting to read that Chinese banks are holding trillions of dollars worth of unsecured loans on their books while whole apartment blocks remain unoccupied. What have they used Aussie iron ore for, if not to “build” their economy in the pursuit of relentless growth?
As China is our major trading partner and… ‘if China sneezes, the world catches a cold’ – I can see our own version of sub-prime happening after the royal commission documents how many liar loans each Australian bank holds. Legally they will have to call those in and then investors and homebuyers may just believe the ‘rational has become irrational’ and panic selling and price collapse could ensue.
Well – it’s ‘interesting times ahead’… Personally, I think those holding high debt should cash up before it’s not too late. Of course – if this happens at scale it will only speed up the spiral to the bottom… Just rambling thoughts…
Hi Steve
Being at the start of my investment journey, you will not hear me complain if prices go down, if they do come down eventually they will go back up and hopefully the investor community will be rewarded yet again.
To you and your team
Merry Xmas and a Happy New Year
Franz
If prices crashes, it’s just an opportunity to pick up an investment property at a discount (if u have non-equity based cash lying around)! But I think the scenario you’re painting is worst case, and I hope unlikely bar a major world economic disaster….(on second thoughts Trump got in, Brexit was voted for, North Korea is testing nukes….)
Hi Steve and Disciples,
Firstly thank You Steve and your team for a great Boot Camp and all the effort all year round!
A Merry Christmas and a Happy New Year to all!
I agree with Steve and those that believe that there are Storm Clouds building. I do not know how far away they are…but they are coming.
Below are a few links of people who’s opinions i respect.
They have their agendas just like most people in the public eye.
Phil Anderson ( Not the Cyclist!) is one and Egon Von Greyerz and Matt Barrie are the others.
Phil believes in Cycles…no not the one’s with pedals! His theories are based on Henry George.
https://www.youtube.com/watch?v=odj96JmJSPo
Egon is a Gold Buff and deals in Gold….yes i know vested interest and such….nonetheless…he has some interesting things to say in a dozen or so articles. He is an ex banker and his Insights seem to make sense.
https://goldswitzerland.com/the-biggest-wealth-transfer-in-history/
Matt is a Journalist…the article posted on Medium is very detailed….it takes about 40 min to read!
https://medium.com/@matt_11659/matt-barrie-australias-economy-is-a-house-of-cards-6877adb3fb2f?source=user_profile———1—————-
I think these guys make a lot of sense as to why the party will be over within the next 6?…7?…8?years.
From what i get from their much greater wisdom than mine is that we will see a relative small correction 2018/19. Then the money printing and will cause prices to shot up madly before a massive collapse.
Nobody can say with 100% certainty as to what and when things will eventuate. My suspicion is that the massive deficits and low interest periods can not go on forever. All that easy credit based on money printing without a Gold Standard has flown into grossly overpriced assets. Inflation is much much higher than the official spin figures. So is unemployment or underemployment! The events Steve brought up here are a symptom of the “Spanish Flu” that is coming. Look at Bit Coin and all the other Crypto Money that is popping up. I am much rather aware that the clouds are there and perhaps arrange some insurance in the shape of Gold. It has proven its resilience over thousands of years! I want to be ready…just in case!
Greetings
Juerg
Juerg I love that you mention Phil Anderson because I have been following him for many years and really respect his opinions. Watch out for the boom in to 2026! And yes an 18/19 slowdown is on the agenda (we are already in the early stages of that mild slowdown now due to all the reasons Steve and others have stated in this thread). But that slowdown will just set up the conditions for a really big bull run in to 2026. That’s when we should get really concerned. Sydney median price will be $1.5m+ and debt levels then will really be out of control. My concern about US bond yields may not fully come to fruition about then too.
So the advice is that now you can invest sensibly and sleep easy for a number of years. Then once the big run into the mid 2020’s hits it’s straps start battening down the hatches :-)
Cheers Ian Simpson, [email protected]
Hi Steve,
Very interesting, I personally believe that corrections are essential in a cycle to enable good steady growth. Almost all central banks wants to have a “beautiful deleveraging” (Dalio, 2012) at some point.
Have a Merry and safe Christmas, and a prosperous new year.
Best Regards,
Erwin
I think this chart says it all, the present situation is unsustainable.
http://www.abc.net.au/news/2017-06-03/house-price-to-income-ratio/8586524
Any consistant rise in interest rates will return the house price to income ratio back toward the mean (3-4?) and possibly an overshoot below that.
If I was a betting man, I would say we are far more likely to get a rise in interest rates, rather than a rise in wages.
As an aside Canada is also a resource based economy with a booming property market, this article puts Australia as the higher risk to a property downturn
http://www.abc.net.au/news/2017-12-11/australian-real-estate-vulnerable-to-variable-interest-rates/9237202
Merry Xmas Steve and Jason, and many thanks for all your hard work during the year keeping us informed on the property market!
Hi Andy,
Interesting comment:-
“Any consistant rise in interest rates will return the house price to income ratio back toward the mean (3-4?) and possibly an overshoot below that.”
I find it hard to agree with there being any overshoot, nor even getting close to 3 – 4 times annual wage. But then, what IS the actual definition of “affordability”?
When they mention “Four times yearly wage”, is that 4 times AWOTE (Ordinary Time Earnings), or does it allow for Regular Overtime too? Or is it a “household wage” (where two parents work and both incomes are considered in the figure)? If just AWOTE, I don’t see any major Australian city getting back to a 3 or 4 year figure ever again. It may be possible in Regional areas though.
For Interest Rates to create that effect, we would HAVE to see Rates around 10% or more. And that can’t happen quickly without completely undermining all new Home Owners and those still with mortgages. That would lead to distressed sales, lower prices, and a stuffed up economy if done too quickly. We CAN’T just double all Mortgage Payments (by taking Interest Rates from 5% to 10%) without having a major de-stabilising effect on everything.
Benny
Hi Benny,
From the ABS average wage is bit over $80,000
http://www.abs.gov.au/Ausstats/[email protected]/0/7F76D15354BB25D5CA2575BC001D5866?Opendocument
Australian interest rates are largely hostage to global interest rates, global interest rates have been artificially held down for many years now, when they inevitably begin to rise, which they will at some point, Australia will also be dragged along.
As you say higher interest rates in Australia would cause a major de-stabilising effect, but the RBA would have no option but to keep up with international rates to attract and keep overseas money in Australia. A falling Australian/Canadian/New Zealand property market would be on the tail end of this.
To get a very long-term perspective here is a chart of global interest rates which shows present rates well below the historical norm.
https://www.marketwatch.com/story/seven-centuries-of-interest-rates-and-why-alan-greenspan-got-it-right-in-one-chart-2017-11-08
And from this article:
“Generally, there is solid historical evidence, therefore, for [former Fed Chair] Alan Greenspan’s recent assertion that real rates will rise ‘reasonably fast’ once having turned,”
Hi Andy,
That is an interesting chart eh? I’d always heard the “long-term average” for Interest in Australia was about 7%. The chart is saying about 4.8% – but then, it seems to ignore the overall “trend” that shows the Rates over time have headed downward (check out the graph).
Re your comment – “Australian interest rates are largely hostage to global interest rates, global interest rates have been artificially held down for many years now, when they inevitably begin to rise, which they will at some point, Australia will also be dragged along.” Andy, I hold on to a couple of hopes that have me think it won’t be THAT bad……
1. The USA went down to a 0% “Cash Rate” while we are currently at our lowest at 1.5%
2. During the GFC, the RBA wasn’t following the world – right after Rudd became PM, our Interest Rates went UP while the world were madly cutting theirs…. So I don’t believe we are in “lockstep” with the rest of the globe (not completely anyway), and
3. Even as Rates were dropping, our big banks were “holding on” to some of the extra – their portion added on top of the Cash Rate de jour started out as +1.3% or thereabouts and today they sit around +3%
Someone in there then, there appears to be some “slack” that should allow the RBA to stop and smell the roses, rather than playing catchup as Rates start climbing again.
That’s my hope – keeps me sane for now as I struggle with overblown power costs, rates, water, petrol, etc. I wonder when the cost of utilities will become “the new mortgage”. It’s heading in the right direction. But then, lift the Rates and that will allow the mortgage to hold onto its first place !! :p
I just hope MANY got to pay down their mortgages as the Rates dropped, so that any “hit” as they rise again will be manageable for them.
Benny
Hi Benny,
I tend to look at where the larger trend has been to hopefully get an idea of where it is heading and not look at smaller fluctuations within the trend.
Here’s a chart of global interest rates for the last 10 years, which shows a clear correlation between Australian and global interest rates.
https://global.pimco.com/-/media/global-assets/resources/education/pimco_education_negativeinterestrates_dec2016_fig1.ashx?h=260&w=601&la=en-gbl&vs=1&d=20171204011714&hash=5362AA817616AE2A09A318BC15835E25E7CB9B3E
As from the article I linked earlier I tend to agree with “that the current period, starting in the 1980s, represents the second-longest stretch of declines, but it looks to have finally come to an end.”
Australia’s high household debt and mortgage stress makes the property market especially vulnerable to coming rate rises.
Thanks for the discussion Benny and have a great Xmas! Andy
A good fisherman catches fish in rain hail or shine.
But a great fisherman, studies the weather and forecast, assess the situation prior to action and accounts for any variations.
Amaizng article topic, hope there are more debatable and open articles for 2018
Perhaps an alternative framework for decision making is simply valuation. There are quantitative metrics for this (price:income, price:trend, cost:replacement etc).
Gearing and mortgage stress are good coalmine canaries. Isn’t life simpler however when we simply look at any investment and ask “is it priced at a discount, or a premium”? If one filters all opportunities and commits to the discipline of only investing in assets that are of reasonable to high quality, priced at a discount for a reason we can clearly identify (our definable “edge”), then the stress of trying to predict where and when the market is headed disappears.
Alternatively, we could all cast aside real estate as a barbaric relic of a centralized, pre-digital age of restrictive private ownership and jump on the Bitcoin bandwagon. If valuation truly doesn’t matter then maybe that really is where the smart money is.
Place your bets…
For sure! If only people acted sensibly, and there were no speculators.
One person’s lemon is another person’s lemonade.
Bitcoin? Lol. Bring it on.
Regards,
Steve