The Question Property Speculators Should Be Asking
Australian Property Market Update
1st May, 2018
Where is the property market headed? What does that mean for a buy-and-hold for capital growth strategy?
Before you can properly answer those questions, there’s a more fundamental question you should be considering.
But first, here’s a microeconomic update on auction clearance rates and recent price movements…
Housing Supply and Demand
Demand in the auction market continues to wane as the auction clearance rate percentage across the combined capital cities fell to the low 60’s. The final result later this week, will likely be even lower.
The result is due to a rise in supply relative to demand. This week sellers brought a total of 2,539 homes to auction, a significant spike in supply from last week’s total of 1,799.
Sydney posted a clearance rate percentage in the 50’s for the first time in three months. Melbourne’s auction market remains the strongest, with a preliminary clearance rate of 65.5 percent.
Here are the latest capital city results, as reported by CoreLogic:
Source: CoreLogic
Recent Changes in Home Prices
The pace at which property prices are falling seems to be speeding up. Over the month of April, dwelling values fell more than one-third of a percent in Sydney and nearly a half a percent in Melbourne. Home prices in Brisbane, Adelaide and Perth remained essentially unchanged over the same period.
Corelogic’s monthly data below shows that units continue to attract more buyers than houses. While the Sydney house market has fallen 5 percent over the past year, unit values are up 1 percent. Melbourne houses have seen growth of 3 percent over the past twelve months, but unit values have grown twice that, at 6 percent.
Source: CoreLogic
Will Home Prices Keep Falling?
That Depends on the Availability of Cheap Credit
A few weeks ago, I shared several analyst opinions on the future of home prices ranging from “It’s All Good” to “Oh @%&#, We’re Screwed!”
As the saying goes, there are as many opinions as there are $%&holes, but virtually no one is disputing the premise that home prices are primarily at the mercy of interest rates. While population growth and tax incentives have helped to fuel demand for housing, one fact is undebatable: people can afford today’s prices because interest rates are low and banks have plenty of money to lend out.
As a side note, I made a case for this view three years ago when many investors thought it was ridiculous. You can see for yourself in the comments on “The Ultimate Reason Real Estate is So Expensive.”.
If cheap and readily available credit really is to blame for the imbalances between home prices and our incomes, then higher borrowing costs or tightening lending criteria would equate to falling prices.
On the other hand, if borrowing costs were to fall again, or if lending criteria loosened, more people would be able to afford homes, which would pull even more demand from the future and cause home prices to start rising again.
So where is the lending market headed? That’s the question property speculators should be asking.
In Regulators We Trust
Most people believe that the future of borrowing costs rests solely in the hands of our regulators. After all, the RBA decides on the cash rate and the banks either follow or look like greedy bastards.
We place our trust in the RBA and APRA to never purposefully do anything that would destroy our housing market and economy. So, we reason, if higher interest rates would hurt homebuyers, the RBA just won’t raise rates.
Well, the reality doesn’t play out that way. There’s a limit to the RBA’s power that most people don’t know about. Our regulators can influence short term rates, but they can’t control long term rates. That has more to do with the bond markets. (For more on that topic, you can read what I wrote here).
The US Dollar and the Federal Reserve
The bond market is a reflection of the amount of trust investors have in governments and corporations. As long as people are confident that governments and corporations will eventually repay their debts, their bonds are considered premium or low risk, and investors are willing to accept a low yield.
For the last decade or so, bond yields have been super-low because the Federal Reserve (and virtually every other central bank) has been suppressing interest rates by buying bonds. That drives up bond prices and conversely lowers yield. If the Fed were to stop buying, then bond supply would increase, bond prices would fall, and bond yields would rise. That would mean higher interest rates.
Bankers: “Show Me the Money!”
Rising bond yields overseas would mean that Australian banks have to start paying more for the money they borrow. Because Aussies aren’t keeping a lot of money sitting around in bank accounts, our banks must look elsewhere for money to lend out.
They get most of their money from the overseas lending market. They borrow (essentially selling a bond) at a low interest rate, and then charge a little bit more to borrowers here. If bank borrowing costs were to rise, then the interest rate on your variable mortgage would also go up.
Why? Because just like you, the bankers have mouths to feed – not the least of which are their shareholders.
A Royal Pain in the Commission
Banks make profits primarily by lending out money. As long as debt is rising in our nation, the banks are winning and their share prices are generally increasing.
There’s an incentive then to keep lending criteria as loose as possible (short of taking on too much risk). That’s where our regulators are supposed to step in – to prevent the banks from getting too greedy and short-sighted and creating a problem that can be handballed to the next executive team (while the last one rides off into the sunset all cashed up).
The Royal Commission into misconduct in the banking industry has recently uncovered some evidence that banks have been pushing the boundary a little too far. It seems that many lenders have been underestimating household expenditures and qualifying borrowers that may not have the margin in their budgets to withstand higher interest rates.
Anecdotally speaking, I’ve personally heard from several brokers who have said that after this Royal Commission, banks are now requiring extensive evidence to validate household expenses, even requiring copies of bank statements. If our regulators take more drastic measures to crack down on loose lending, it could become even more difficult for investors and homebuyers to get loans for expensive houses.
A Statistical Inevitability
The RBA met today and decided to leave the overnight cash rate on hold at a record low 1.50 percent. It’s been nearly two years since the RBA cut interest rates, and seven and a half years since we’ve seen an interest rate hike.
Some analysts are forecasting a rate hike in about three months, and others expect it to be toward the end of 2019. Those more pessimistic on the Aussie economy are saying the RBA will be forced to slash interest rates yet again.
One thing that we know for sure is that someday, possibly before those buying homes today have paid off their mortgages, interest rates will rise dramatically. It’s a statistical certainty called mean reversion – prices and returns eventually move back toward their mean or average.
The long-term average variable mortgage rate is around 8.5 percent. That’s a little more than 300 basis points above where we are today.
As Steve McKnight reported a few months ago, it would only take a rate rise of 200 basis points to return many borrowers back to the pain of 1989’s 17 percent interest rates. If you were an adult then, you’ll recall that those were challenging days.
So, where do you see the lending market headed?
Will borrowing costs rise or fall in the short-term?
Will loans become easier or harder to get?
How long until the variable mortgage interest rate reverts to the average of 8.5%?
Take a moment to leave your thoughts in the comment section below, and perhaps share how your view is impacting your investing strategy.
Comments
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Hi Jason,
Nice article. I am completely with you for most of what you say. I also strongly believe interest rates will rise relatively soon. Also anticipating that the Europeans will change their strategy to buy back bonds soonish.
One point I disagree in is that interest rates will necessarily rebound to averafe levels of the past. I think a statistical argument is a bit weak in this respect… Surely it is true that prices are fluctuating around an average but still there are trends. So this statistics argument only holds if nothing changes on the fundamental side. With respect to interest rates there is a clear trend towards lower rates. I think overall lower interest rates are fundamentally justified as interest rates can be viewed as “the price for money”. And over the decades this price has come down as having and getting money has become a lot easier in the past century. So this average of 8.5% doesn’t mean much in my opininion. This is a bit like weather and climate. Nobody (aside from the us president) denies that temperature trends up over tge decades. Still tgere are statistical fluctuation (called weather). And last winter was pretty cold in the US…
That said I still think current interest rates are much too low to reflect “the current value of money” correctly. But I doubt that they will go back to over 8% any time unless there is a huge world crisis coming. I don’t think tgat is going to happen any time soon. Although I wouldn’t completely exclude this scenario either as I think the strategy they chose to defeat the last financial crisis (namely flooding the market with money) is really dangerous and might indeed bring back a global crisis…
Anyway, for now I’d rather expect interest rates to go back to 4-5% rba rate, not 8+
Andre
Hi Andre. Thanks for your thoughtful reply.
In light of weak inflation figures and slow wage growth, I actually don’t think the RBA will voluntarily raise rates for the next few years. I also question the Fed’s resolve to normalise rates.
I think the only reason the price of money is low (and accessing money has become easier) is because the world’s largest central banks have been increasing the global money supply. If they choose to stop (which I don’t think they can without crashing economies) or if they lose control of bond prices (which will happen if/when people lose faith in their governments’ ability to repay), then interest rates will be forced higher, likely overshooting the median for a while. Of course, who knows how long that could take to happen.
So for the near-term, I think the RBA will keep rates low and APRA will turn on and off the faucet of money into real estate to keep prices relatively flat. But if we get a new government, or if something crazy happens overseas, then all bets are off.
Cheers
Jason
A few years ago I stated ‘this is as good as it gets’……..and my long stated comment ‘we can’t all be rich but we all can be poor’
Well it seems the government and the banks as the Royal Commission are about to demonstrate that these two comments have arrived….and are about to be feature in our mindset for some time to come.
The cost of borrowing has a two edged sword based on domestic and global credit markets.
1. Bugger we are in a fix……wages are stagnant and will continue for months if not years to come. The misguided ‘trickle down’ of the corporate handout….is an apt description if ever there was one…..’trickle down’ suggests a less than favorable outcome for the workers of this country.
Just reflect on this scenario…two companies in the same market each with the problem of how to pass on their tax cuts to their employees….who goes first…..how much?……honestly can you see any company being the first to action a lower ROI or impacting on the share price and the all powerful shareholder?
Pigs will fly……
2. Inflation is in decline, any positive movement is due to rising costs of living that do not include wages growth. Spending will therefore decline, particularly in the consumer sector, big ticket items such as car sales, initially non essential spending like, café trips, cinema…..then clothing, electronics…..the picture is grim with large scale layoffs in many industries.
3. The banks are already saying that borrowing will be curtailed to homeowners and small business…..Is that a veiled threat?…. it feels like one……..all because the banks have FAILED to adhere to correct lending principles, corruptly and possible illegal activities endangering the asset values of so many Australians.
4. Asset values will continue to decline,firstly housing, then followed by superannuation returns post the housing market implosion.
5. The Government has a real issue, they are presiding over the greatest threat to Australian assets since the depression of the 1930’s. Their demonstrated policy in removal of overtime payments to some of the lowest paid workers in the country show that the prospect of real wages growth is not visible in the light at the end of the tunnel.
The illusion created by the growth in jobs really is a sleight of hand…..I’d like to see some hard figures on the real added value to the economy and healthy increase in inflation created by WELL PAID JOBS at/or above the wages mean of the country. Anything less is a ‘get out of jail card’ for the government as its tax revenue increases and its liabilities decrease due to additional low income workers signing off Centrelink unemployment benefits.
6. All options are on the table at the budget, will we see the corporate tax cut being redirected into jobs growth by government spending on big projects, roads, infrastructure…..we may do……..if we do it will show the Government is at the crossroads, and by association the Australian economy….is it a question of ‘too little, too late’
7. Global cost of credit are likely to rise as we see growth return to world markets. Pity the RBA they are technically hamstrung with little or no policy levers to pull…..any movement of interest rates are out of their control…….bloody frightening prospect of the major players unable to extract themselves from the mess created, the Government, the banks, the RBA in flux and with no collective and synchronized policy to positively impact on the economy…..the ‘Day of the Greedies’ is with us……..
Can’t disagree with anything you’ve mentioned. It will likely play out to become a difficult time for many, and a great opportunity for others.
Hi, really interesting read that article was, I personally feel that the interest rates won’t be risen any time soon, our job creation numbers were solid last year but wage rise are still at a low and inflation is steadily rising which obviously won’t help with the large amounts of household debt our nation holds.
I think the economy has seen slight growth though recently, I remember seeing some statistics on TV on ABC, this could be the one thing that may get the RBA thinking a bit, I would say it’s safe to say though that we will get the two years straight (August 2018) of no move to interest rates in any direction.
I would say in light of the findings by the royal commission that loans could only get harder from here, probably based on the rise in penalties that government is handing down now to banks who want to attempt to run the gauntlet and not follow proper procedureswhen approving people for loans.
The governments have even now introduced massive fines and jail time as a consquence, based on that I would say the banks will meet and change their direction and focus. I recently became informed of a statistic from core logic that Australia’s percentage of total loans that are investor loans is around 15% and APRA is content with it being 30% or lower, it appears that they now have room to move and could consider loosening regulations as far as that goes or maybe we will see banks slightly drop investor loan rates which may provide a slight boost to demand or sales and clearance rates etc.
What are your thoughts?
Hi Sam.
I’m with you that the RBA’s hands are tied when it comes to raising interest rates. The YoY CPI numbers are still below the 2-3% inflation target. But as I mention in the article, there are other forces that impact mortgage interest rates, so anything is possible there.
That’s a good insight regarding APRA’s changing position on investor loans. What I’m hearing is that APRA will remove the annual 10% growth cap for investor loans, but tighten up on serviceability calculations by heavily weighing debt to income ratios. That means that banks will be able to write more investor loans, but only to the higher income / lower debt portion of the market.
I can’t see competition being great enough for banks to lower rates to attract investors, as that would mean a loss in revenue from their existing loan book. Because the qualifying bar will remain high, I don’t think these changes will do much to boost demand. I think APRA’s number one goal at this point is to keep home prices from rising while somehow keeping the banks in the black.
All of that to say… now is the time to lock in a loan approval as it won’t be getting any easier for the average-joe investor to qualify.
Jason
Good response, very well put, good point about the year on year CPI, yes true absolutely hard to see it getting any easier from here for average joe like you said, also first home buyers.