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:
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.
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.