Is It Time to Put the Brakes on Home Prices?
Auction Results for week ending March 26, 2017.
This week’s preliminary auction results point to a spike in demand, even as the number of homes for sale across the country increased. The combined capital city clearance rate came in at 77.1 percent, and auction volume was 3,147. Last week’s final tally showed that 74.1 percent of 2,916 auctions were successful.
Over the same weekend last year, we were celebrating the Easter long weekend, so volumes were substantially lower, with only 554 homes taken to auction.
The City Stats
Sydney posted another preliminary result in the 80’s this week, with 81.1 percent of auctions successful. Last week’s seemingly red-hot initial tally of 83.9 percent was adjusted down to 76.8 percent by the time all the results were counted. The total number of auctions held this week was 1,082, a little higher than last week’s recorded volume of 1,001.
Melbourne was by far the busiest market in the country, with vendors there offering 1,601 properties at auction. Preliminary results show that 79.9 percent of them found a winning bidder. Last week, the final clearance rate was adjusted up to 77.0 percent, over one basis point higher than the initial count of 75.9 percent.
The Graph
The Preliminary Numbers
Sydney | Melbourne | Brisbane | Adelaide | Perth | Tasmania | Canberra | |
Clearance Rate | 81.1% | 79.9% | 44.0% | 68.2% | 30.8% | 66.7% | 76.6% |
Auctions | 1,082 | 1,601 | 196 | 124 | 13 | 7 | 104 |
The Analysis
So much for those initial signs of softening in the Melbourne property market. With last week’s clearance rate adjusted up to 77.0 percent and this week nearly clearing 80 percent on higher supply, buyers have shown themselves to be alive and well in the Victorian capital.
The same is well and truly the case in Sydney. Even though last week’s clearance rate was adjusted down to 76.8 percent, any result above 70 percent tends to be conducive to rising prices. If this week’s clearance rate holds above 80 percent, we’ll see tangible evidence that demand there continues to grow ever stronger, even amidst out-of-cycle interest rate hikes from lenders.
CoreLogic just released its latest house price data, confirming what most investors expected. The Sydney property market continues to surge higher, with the median house price there leaping 5.3 percent since the New Year. Melbourne isn’t far behind, with home prices rising by 4.4 percent since the start of 2017.
Highlighting the economic disparity across the country that the RBA must wrestle with, the median house price in Perth has fallen 1.1 percent over the same period.
What It Means For Investors
With the Perth property market limping along, and last week’s jobs numbers pointing to anaemic economic growth nationwide, an increase in the RBA cash rate could have painful and far-reaching effects. As I said last week, our regulators have created an economic environment that has become dependent on cheap credit.
At the same time, our reserve bank governor Philip Lowe is pointing to the risks of rising home prices in Sydney and Melbourne brought on by artificially low interest rates. The higher property prices run, the greater the likelihood of a sharp pullback, which would put the most recent home buyers, especially investors, in quite a precarious position. For more on why, see my comments on the greater fool theory here and here, as well as Steve McKnight’s insights here.
Considering its conundrum, the RBA will be leaning strongly upon APRA to redirect the flow of cheap credit away from the housing market, and hopefully into capital investment by businesses. Their hope is this would lead to more productive investment and a boost in the labour market, rather than ever-inflating home prices. As I reported last week, thanks to APRA, some investors may see their interest rates rise by as much as 3 percentage points, even as the RBA cash rate remains steady.
Let’s not forget about the Government’s role in fuelling home price growth. A recent poll from Fairfax Media suggests that voters are split down the middle, essentially along party lines, on whether negative gearing and the 50 percent CGT concession should be scrapped. But even with the Coalition in power, changes may be afoot.
The Turnbull government is currently putting together its package of housing affordability measures for the May budget, and capping the size of investor tax deductions is now being discussed. As banks are hiking rates in anticipation of tougher capital requirements from APRA, the Government will be one of the biggest losers. For every 25-basis point increase in mortgage interest rates, government revenue drops by about $500 million under the current tax concession arrangement. Expect our politicians to plug that hole as quickly as possible by limiting how much investors can write off in losses.
Given these macroprudential changes already unfolding, if I was a betting man, I’d say home prices in our two largest cities will peak sometime this year, then decline as much as 10 percent by the middle to end of 2018. Even after such a pullback, investors who bought in Sydney in mid-2012 would still be up around 60 percent in Sydney and 40 percent in Melbourne.
But of course, I could be wrong. It all depends on just how hard our regulators apply the brakes. If you’re feeling lucky, keep riding the wave. Just be sure you don’t end up the greatest fool.
What do you think? Are our regulators on the right track?
Is it time to put the brakes on the property market, or should those in power keep their foot on the accelerator?
Do you think a 10 percent pullback in property prices sounds reasonable, or do you see home values climbing even higher?
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The results listed here are based on preliminary reporting by CoreLogic, which is likely to be revised once a full reporting is made. The final results will be detailed in next week’s post.
For the historical data of weekly auction clearance rates, click here.
Comments
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Hi Jason,
I have been concerned as prices keep going up, even as wages stagnate. Obviously, it is the abnormally low Interest Rates that has allowed this, so I welcome a return to more suitable interest rate levels. But, on that, this comment from you is scarey:-
“some investors may see their interest rates rise by as much as 3 percentage points”
..and all I can say is “I hope not!” With rates at such a low level, (let’s say 5% for most) a 3% rise is really WAY more than it appears.
In reality, that would be a 60% rise in Interest paid !!
Think about that !!
Would any renters be willing to cover a 60% increase in their rents? Or will it simply mean that more and more investors will “head for the exits once again” – a return to 1985/6? And if so, from whom do renters then rent? Up go the rents anyway – perhaps wildly. Even if not 60%, everyone in the rental market gets hammered – tenants and investors alike.
Scarey stuff – at least for those of us who remember !!
I hope the RBA, APRA, banks, Govts, et al take a bit of time to “STOP and THINK” before they end up with another huge suite of “unintended consequences”.
Benny
PS Top article BTW.
Thanks Benny. Those investors who are hit the hardest by rate rises make up only about 10 percent of the whole, so I don’t think it will be that far-reaching. It is an interesting question though on the impact of rent prices. Typically higher rates mean higher yields, not necessarily an increase in rent prices. And you know what that would mean. I tend to think we’ll need some inflation in wages before rents rise too much.
As far as “unintended consequences” go, I think it’s too late to avoid. At this point, someone gets screwed – either savers, property investors, or banks (and owners of bank shares). I say screw the banks :)
Jason, could you please explain the “higher rates = higher yields ” comment?
Are you referring to property rental yields as I thought the only way to get higher yeilds was either when rents went up or loan costs went down?
Thanks
Hi George.
Sure, no problem. Benny was making the point that as interest costs from investors rise, landlords will pass those costs on to their tenants in the form of higher rents. My response was that there will be a limit to the rent increases that tenants will tolerate. They will simply move out, and then the landlord would be forced to find someone else willing to pay the higher rent they want. In other words, unless wages rise, it will be tough for landlords to raise rents significantly.
The likely response from landlords to higher interest costs would be to maybe raise rents a little if possible, but to hold on to the property as long as possible in hopes of things turning around. We’ve seen this the last few years in mining towns. If cash flow became too stretched, they would sell the property, likely at a lower value than current market price as there would be other cash-flow stretched landlords also needing to sell. In other words, property values would decline across the area.
Yield = annual rent / purchase price
In the above equation, yield rises in two scenarios: 1. rents increase or 2. property prices decrease
By that definition, yield does not rise when interest rates (loan costs) fall. Lower interest rates usually mean rising prices, which makes yields fall. So, when loan costs go down on a property that you’re holding, your yield is not actually improving. What’s happening is your cash flow (cash-on-cash return) is improving.
This article I wrote will explain this difference between cash-on-cash return and yield (gross rental return): https://www.propertyinvesting.com/5-formulas-for-evaluating-property-deals/
So in summary, higher interest rates equal higher rental yields mainly because investors will demand a higher yield to compensate them for their risk, which means real estate prices come down. If I own a property that rents for $500 per week and it’s worth $520,000, that’s a 5% gross yield. If the bank a year later is paying 5% on a term deposit, investors may demand a 7% yield from residential property because of the perceived risk of capital loss. That would mean that investors would only be willing to pay about $370,000 for that same property.
Or the other way to look at it from the owner-occupier’s perspective, if interest rates rise, people will be able to borrow far less to purchase the property, which would mean in a forced sale, it would bring a lower purchase price. For an investor who might purchase the property, that would mean a higher yield.
Hope that makes sense. The inverse relationship between yield and price can get a little confusing.
Jason
Thanks Jason. Great explanation.
So the yield for new purchases of investment properties will get better as rates rise, due to cheaper house prices.
But obviously existing investment properties will find it hard to increase yield from what you mentioned due to a ceiling, I guess you would call it, being placed on rental prices unless wages rose.
Thanks
George
Did you see that 4/4 in Castle Hill (Sydney) either didn’t meet the reserve OR were withdrawn before auction……..
I’m not sure 81% clearance in Sydney is all that accurate about reality of whats going on.
You mentioned that last week as well, and by the end of the week, the final clearance rate had come down to 76%. It does make you wonder if agents are inflating their results in the initial reporting just to build more exuberance going into the following weekend. By then, the final results come out, but they don’t really make the news.
Shares look like better value than residential property now because of the dividends you get.
True for income investors, but for those chasing growth, shares and residential real estate both seem a little top heavy at the moment. I guess that makes the liquidity of shares attractive to some speculators as well.