A large portion of the Australian population own property, which is why the state of the property market is always a hot topic. At the time of the 2011 Census, 67% of Australians owned their own home. According to the ATO, in financial year 2010/11, 19.2% of individuals that reported a taxable income owned investment properties.
Lately there has been a lot of discussion about the stability of the market and whether property prices are too high. According to RP Data, home prices rose by 1.4% in June and are up 10.1% over the year. There has also been a lot of talk about what is driving the market. Some claim that foreign buyers are distorting prices and pushing first home buyers out of the market.
Doubts have been raised over the Foreign Investment Review Board’s ability to ensure that foreign investment is restricted to new housing. RP Data recently supported a parliamentary inquiry into foreign investment by supplying data extracted from Treasury figures. In the last 9 months $5.5bn worth of existing housing has been purchased by foreign investors. RP Data estimates that almost 16,000 properties worth $24.9bn were approved for sale to foreign buyers in the year to March. This represents 13.2% of the total value of real estate sold, roughly double last year’s value. NAB estimates that in terms of total demand, foreign buyers now account for just over 1 in 7 new properties and around 1 in 10 established homes.
These figures raise questions about the future trajectory of property prices as investment, particularly foreign investment, tends to be speculative in nature. The concern is that high levels of foreign investment is not only distorting the market but may also lead to instability and a sharp decline in property prices in the near future.
Foreign investment is not the only trend that is important when evaluating the health of the residential property sector. Below are some other important factors to consider.
It’s often stated that property prices are higher than they should due to the lack of housing supply. There are a number of regulatory restrictions that make it difficult for land to be released. RBA Governor Glenn Stevens in a recent Q&A forum in Hobart agreed that the supply side of the housing sector in Australia is quite constrained. He stated that it’s “….a huge issue in housing and in a sense if we’re too rigid on the supply side then fundamentally housing prices have to be higher. That’s not a bubble, that’s fundamental…” he then went onto say “…really in a country this size, and the land we have, I can’t see how we shouldn’t be able to have fairly inexpensive shelter…”.
In spite of these known housing supply issues, CommSec Economist Savanth Sebastian stated in a research release this week that “While the discussion of a housing bubble will continue to be mentioned in media headlines, it is likely that increases in land sales, healthy building approvals and solid new home sales will result in a greater supply of homes over 2014. And, as a result of increased home supply, price gains will become more restrained later in the year”.
Indicators to watch
Approval is one of the first stages of the construction ‘pipeline’ and is thus a key leading indicator of future activity. Dwelling approvals are on the rise and increased by 9.9% in May – the first gain in four months. Approvals are up 14.3% over the year. The current number of dwelling approvals (16,425) is still well above the decade average (13,501) and five-year average (14,092).
Housing demand can be split into owner-occupier demand and investment demand. As mentioned previously investor demand tends to be more speculative in nature. The RBA’s March 2014 stability review found that the low interest rate environment and rising asset prices have encouraged households to take on greater risk. In the March 2014 quarter, 41.24% of new lending was for residential investment. This was slightly lower than the December 2014 quarter, which was 41.53%. The pick-up in residential investment approvals is particularly evident in NSW and VIC, while there has been a decline in the activity of first home buyers across all states. At the Q&A forum in Hobart, Governor Glenn Stevens stated that “….for most owner-occupier borrowers I don’t think we’ve seen imprudent borrowing in this recent period. The area where we need to watch is the investor market in Sydney”.
Indicators to watch
The risk appetite and lending practices of financial institutions has a direct impact on property prices and the longterm stability of the residential housing sector. If lenders aggressively expand their portfolios and adopt more lenient lending terms then you can expect to see a jump in property prices. Demand will rise as a greater portion of the population will have access to funding. The total volume of lending indicates the degree to which the market is expanding. The value of investment loans is closely watched as it may indicate an increase in speculative demand. Below is a table of some calculations I’ve done using APRA lending statistics. Lending to investors has steadily increased since the March 2013 quarter. In the March 2014 quarter, 41.24% of new lending was for residential investment. This was slightly lower than the December 2014 quarter, which was 41.53%.
|Owner-occupied (as a percentage of all loans)||67.10%||66.95%||66.85%||66.66%||66.52%|
|Investment (as a percentage of all loans)||32.90%||33.05%||33.15%||33.34%||33.48%|
Loan to Value Ratio (LVR)
LVR is a measure of the risk appetite of lenders. The higher the ratio the more willing lenders are to extend credit to those who have low deposits. According to APRA in the March 2014 quarter, 15.56% of new residential lending had an LVR > 90%. The below table shows LVR rates for the last 5 quarters, which have been consistently over 15%. There was a slight fall in the March quarter.
|Loans approved LVR<60%||30.75%||33.21%||29.48%||28.76%||27.81%|
|Loans approved LVR 60%-80%||46.13%||44.50%||46.60%||47.35%||47.59%|
|Loans approved LVR 80%-90%||23.12%||22.29%||23.93%||23.89%||24.61%|
|Loans approved LVR>90%||17.26%||15.63%||16.39%||15.67%||15.56%|
(ADIs with greater than $1 billion of residential term loans held 98.3 per cent of all residential term loans as at 31 March 2014.)
Debt to Income Ratio
This measure indicates the ability of borrowers to repay outstanding loans. It’s a measure that should be closely watched by regulators as it indicates the risk appetite of lenders and the degree to which borrowers have extended themselves financially. The RBA’s March 2014 stability review found that the household savings rate remained within the 10% range. According to this study many households have used lower interest rates to pay down mortgages at a quicker rate than required, which has meant that an almost 15% aggregate mortgage buffer (balances in mortgage offset and redraw facilities), equivalent to 24 months of payments at current interest rates will offer some protection against a temporary fall in income or unemployment. The review also found that household gearing and indebtedness remained at historically high levels as illustrated in the graph below.
Digital Finance Analytics (DFA) mortgage stress survey maintains a rolling sample of 26,000 statistically representative households using a custom segment model nationally. Each month DFA executes surveys to 2,000 households.
DFA defines mortgage stress as:
Mild = households maintaining repayments, but by reprioritising expenditure, borrowing more on loans or cards, and refinancing
Severe = households who are behind with their repayments, are trying to sell, are trying to refinance, or who are being foreclosed
DFA’s January 2014 survey indicates that 15% of first time buyers are in some form of mortgage stress, with 41,200 first time buyer households in mild stress and 19,800 in severe stress. Amongst other owner occupied households, 4% are in stress, with 30,000 in mild stress and 12,200 in severe stress.
RP Data publishes rental yields on a regular basis. Rental yields are an important indicator to watch as this in addition to capital appreciation represents the total return on investment. Logic states that as rental yields decline there will be a fall in the demand as investors seek higher yielding opportunities. As demand falls so should property prices. There is an inverse relationship between yield and price. When they move too far out of sync with one another there will inevitably be an adjustment. Gross rental yields are lowest in Sydney and Melbourne, which have both experienced the highest price growth.