Units Win In New Construction

The ABS today published its latest figures on residential construction. The trend estimate of the value of new residential building work done rose 0.4% in the September quarter. The value of work done on new houses fell 1.7%, while new other residential building rose 3.7%. The seasonally adjusted estimate of the value of new residential building work done rose 1.3% to $10,602.2m. Work done on new houses fell 0.4% to $6,336.3m, while new other residential building rose 3.8% to $4,265.9m.

Looking at the number of houses and units being built, we see a clear trend. Unit construction is up significantly, whereas the number of houses are below their long term trend. Public sector construction of all types is at a low level, following the peak in post GFC stimulus investment in 2010.

Const1This continues to represent a significant shift in the nature of housing in Australia, with a greater proportion of both owner occupied and investment property being built as multiple units, rather than stand alone houses. We already highlighted the fact that more first time buyers are buying units, and that the average plot size is shrinking fast. The shift in life-style that increased high-rise and medium/high density housing will have on households should be considered, as we are seeing the consequence of chronically high house prices working though to the detriment of many.

Foreign Property Investment (a.k.a The Chinese Factor)

One factor which is driving the residential property market, especially in the major centres of Sydney, Melbourne and Perth is a rise in overseas purchasers. They may be Australian residents, overseas purchasers buying property for investment through an approved development, or locals acting for overseas purchasers, who are attracted by the sustained house price growth and relative economic stability. China is often identified as a major source for potential purchasers.

Foreign Residential Property Investment is subject to the regulations as stipulated by the Foreign Investment Review Board (FIRB). The overarching principal is that foreign investment in residential real estate should increase Australia’s housing stock and all applications are considered in light of this. To quote them:

Residential real estate means all land and housing that is not commercial property or rural land. In that regard, ‘hobby farms’ and ‘rural residential’ blocks are residential real estate.
Temporary residents need to apply if they wish to buy an established dwelling. Only one established dwelling may be purchased by a temporary resident and it must be used as their residence in Australia. Such proposals are normally approved subject to conditions (such as, that the temporary resident sells the property when it ceases to be their residence). Temporary residents cannot buy established dwellings as investment properties, but can buy established dwellings for redevelopment. Temporary residents need to apply to buy new dwellings in Australia. Such proposals are normally approved without conditions. Temporary residents need to apply to buy vacant land for residential development. These are normally approved subject to conditions (such as, that construction begins within 24 months).

Foreign persons that operate a substantial Australian business need to apply to buy established dwellings to house their Australian based staff. Such proposals are normally approved subject to conditions (such as, that the foreign person sell the property if it is expected to remain vacant for Six months or more).
Non-resident foreign persons need to apply to buy established dwellings for redevelopment (that is, to demolish the existing dwelling and build new dwellings). Proposals for redevelopment are normally approved as long as the redevelopment increases Australia’s housing stock (at least two dwellings built for the one demolished) or where it can be shown that the existing dwelling is derelict or uninhabitable. Approvals are usually subject to conditions. Non-resident foreign persons need to apply to buy new dwellings in Australia. Such proposals are normally approved without conditions. Non-resident foreign persons need to apply to buy vacant land for residential development. These are normally approved subject to conditions (such as, that construction begins within 24 months)

Residential Real Estate was freed up in 2009, although in 2010 changes were made to remove an earlier exemption that currently applies to temporary residents buying residential real estate in Australia. This ensures that temporary residents need to notify the Treasurer before buying residential real estate in Australia. Short-term visitors such as tourists, business people and those here for a medical procedure are not temporary residents.

But overseas students studying in Australia may purchase. In addition, foreigners may apply to redevelop a second hand dwelling.  Development must increase the number of dwellings and no rental income can be obtained from the existing dwelling prior to demolition. Such redevelopments are required to demolish the existing dwelling and commence construction of the new dwellings within 24 months in line with vacant land.

Under existing laws, developers are able to sell 100% of their developments to non-residents.

According to the FIRB Annual Report 2011-12 overall Residential Property Investment by overseas parties grew from $14.92bn in 2008 to $19.70bn in 2012, with $10.92bn from 70 Developer off the plan projects, (235, $5.48 in 2008). This shows a significant rise in custom development targeted at overseas markets. Portals like Investorist  offer the opportunity for overseas investors to view property projects for sale in Australia.

Foreign1
Some argue that this is going to become a significant force driving the market higher, and it will continue to displace local first time buyers, given the sheer numbers of for example Chinese buyers who face Chinese Government restrictions at home and significant savings. Bear in mind the size of the Chinese population, as one indication each year 7 million students graduate from Chinese universities with degrees!

One factor to watch is the exchange rate,  Here is the 2 year view from dollars.com. As the AU dollar falls against the Chinese Yuan, the purchasing power of investors from China will improve.

AUD_CNY_2yearThere is no good data source for the number of overseas purchasers buying property, other than the 2012 FIRB data. Interestingly, China registers as the highest number of FIRB approvals (though FIRB does not adequately separate out different types of investment), so this may be deceptive.

Foreign2

The average transaction from China is in the order of $800k, which looks more like the price of a house/unit to me. The Australian approvals are most likely to be the construction on approved residential tower blocks, like we see being built at Hurstville, or Wolli Creek in Sydney.

Foreign3

So far as I can see, good data is not captured at the point of purchase. Even if it were, it would be complex. To illustrate this, we looked back over our surveys and identified the following scenarios:

  • Australian residents from overseas buying units off plan in a number of city suburbs, across Sydney, Melbourne, Brisbane and Perth for own occupation and investment. Many of these will be pre-approved by the developer with FIRB.
  • Australian citizens buying property in their own names, using money from family or friends overseas, for investment. No FIRB approval needed.
  • Overseas investors purchasing via an Australian company structure. Many need FIRB approval.
  • High-Rollers from overseas purchasing up-market property for residential use. Many need FIRB approval.
  • Overseas companies buying Australian land and existing property for development. FIRB approval required.

We also see the reverse by the way:

  • Australians buying property overseas, in markets including Spain, Italy, UK, for investment

We are essentially becoming part of a more globalised property market and it is unlikely this will change. Given what we know about the state of the market, and that locals are being priced out by other purchasers, including investors and overseas purchasers, we need to be wary of these current trends – so I think the Chinese Factor is a critical issue. With limited supply, continued overseas investment in our market will drive prices higher, that is, until conditions change. If China caught an economic cold, it is possible we would see a reversal in property fortunes in Australia, so we are probably more leveraged to China through property than we know or realise.

I would advocate capturing more comprehensive data so we can at least get a handle on overseas property investments. I do not think we are able to stop globalisation, but we need to understand the implications a whole lot better.

SME’s On The Edge

We have updated the DFA SME Survey, to take account of the latest statistical data from the ABS, and our rolling surveys. Overall commercial credit was up slightly, but borrowings by SME continues at a low level. This is a continuation of the trend started in 2009, despite the low current interest rates. SME’s are unwilling or unable to borrow more, which is concerning, given that they are the dynamo of the economy, providing employment for more than half the work force. Many continue in survival mode, with little expectation of growth recovery in 2014.

SMEDec1

As we highlighted previously, working capital, thanks to longer debtor days was the main driver for credit, plus vehicle acquisition, whilst business expansion is hardly on the agenda.

SMEDec4

In our survey we asked SME’s about the barriers which are stopping them from borrowing, and their levels of satisfaction with the banks and their ability to assist. Around 20% were not able to get the funding assistance they required, although price and compliance factors were also in play. In recent years, poor service as a factor has reduced in importance, thanks perhaps to service improvement initiatives, or it being outweighed by other issues.

SMEDec3

Finally we also asked them to rate the service and products provided by their banks – the higher the scores, the better. ANZ wins out on service, whereas ING wins on product quality. (The product category examines how well specific products are delivered, not the range of products available).  This is a summary chart of a number of different service and product factors.

SMEDec5

The bottom line is that SME’s are yet to see a significant rebound in confidence or growth, so we would expect to see lending to continue at close to current levels. It is unlikely any further interest rate cut would be sufficient to kick lending along.  As we have said previously, perhaps there is scope to change capital allocations to encourage banks to lend more this important sector.

Investors V FTB; No Contest

Today the Australian Bureau of Statistics released the final element of the monthly housing finance data, investor loans by state. There is a startling contrast between borrowing by individuals for investment purposes verses first time buyers. As we highlighted already, Investors are ruling the roost, and first time buyers are being squeezed out of the market. The most extreme is NSW, where more than 50% of loans in October were for investment property, and first time buyers languished.

JawsNSW

But, we see similar emerging trends in Victoria:

JawsVIC

In WA first time buyers are more evident, but investors are highly active :

JawsWA

In Queensland, investors are running hard:

JawsQLD

and South Australia, first time buyers are still active, but investors are on the move:

JawsSA

Such strong momentum is likely to continue given low interest rates, stock markets off their peak, and strong expectations in terms of property price growth. Banks are enjoying the easy balance sheet growth investment lending offers but this might not be good news long term.

We know investors are piling into property and this is inflating prices. This, long term is not sustainable, and is probably a symptom of market failure.

More Households Excluded From The Property Market

Overnight the AFR released a long interview with Glenn Stevens, including coverage of the property market. He is not that worried about house price growth if it is decoupled from credit growth. However, the DFA Household survey  as published in the “Property Imperative” showed clearly that rising house prices have a damping economic impact as first, more are excluded from the market, and second those who are in the market need to deploy ever more of their disposable income to stay there.

Glenn Stevens quotes are interesting:

“So to that extent I haven’t found it (housing market developments) that troubling or constraining, and I think the other thing to say is the price rises that worry you most are the ones driven by rising leverage”

“I think if we saw a return to the kind of double digit credit growth to households that we saw for so many years in the past, I would have to wonder whether that would be wise given the level of debt from where we start. That would be a different proposition to what we’ve seen lately so thus far, I think it’s okay but obviously, it’s a thing we have to watch.”

“To come to your point about risk, I think the key thing to keep your eye on is the leverage. If we have an asset bubble in some asset class and it isn’t with borrowed money, I’m a lot less worried. You know, if there’s a boom and bust in rare coins or art or something, or even minor segments of property where it’s not – where you haven’t got the banking system geared into it, well, you know, I’m not sure that’s kind of a macroeconomic policy concern. But where you’ve got an asset class with a lot of leverage building up behind it and risks to the lenders, as well as the borrowers, that’s really the issue. So that’s why I say I think it’s important to note that to date we haven’t seen a big rise in leverage in the housing market so far.”

The DFA Household survey includes an examination of households into those which were property inactive, and those who were property active. Property inactive households were defined as those who currently rent, live with parents, or are homeless, with no plans to enter the market. Property active households are those who own, or actively desire to own property, either as an owner occupier, or as an investor, and either own the property outright, have a mortgage or are actively looking.  The analysis shows that about 26 percent of households are Property Inactive, which equates to about 2.3 million households.

Inactive1

Examining prior years data, and applying the same analysis, we discovered that even correcting for population growth and migration, the property inactive proportion of the household population has been steadily increasing.

Inactive2

Finally, we looked across states, noticing some regional variations.

Inactive3

The rise in house prices is the major barrier to people who want to buy but cannot.

Inactive4

We also found that many households in the market were just about managing, despite low interest rates, because of rising costs of living, including power, rates and child care. First time buyers are particularly hard hit.

So, if we are to tackle the current market failures in the property sector, we need to focus on building, more, much more property; removing incentives for leveraged investments; and perhaps the RBA should be taking more notice of absolute house prices, irrespective of credit trends.

To be clear, I am not convinced that the current price levels and trends are doing us much good, (apart from for those on the ladder already, the states harvesting greater stamp duty tax takes, the construction sector, the real estate sector, etc etc). Long term strategies need to be put in place to get the market back into equilibrium, but its not clear to me where responsibility should lay. The complexity of the stakeholders involved makes intervention by any single agency myopic.

The SMSF Property Conundrum

The DFA Household Survey included coverage of households who held, or were considering property within a SMSF. Overall our survey showed that around 3% of households were holding residential property in SMSF, and a further 3% were actively considering it. Of these, 29% were motivated by the tax efficient nature of the investment, others were attracted by the prospect of appreciating prices (28%), the attractive finance offers available (17%), the potential for leverage (12%) and the prospect of better returns than from bank deposits (5%).

SMSF1We have done further work on those SMSF with property investments. We asked where the trustees had received advice on their property investment strategy. As expected, some used mortgage brokers or financial planners. Others relied on their own knowledge, information from developers, or from the internet. The scores are adjusted for multiple answers.

SMSF2We also asked about the proportion of the SMSF is invested in residential property (this excludes any by an SME). We found quite a range, some trustees spreading their investment risk, others have higher property exposure.

SMSF3
According to APRA as reported in their Annual Superannuation Bulletin (issued Jan 2013), total superannuation assets increased by 3.7 per cent during the year to 30 June 2012 to $1.40 trillion. Of this total, $439.0 billion are held by SMSFs, which are regulated by the ATO. The number of SMSFs grew by 8.0 per cent to 478,263 funds during the 2012 financial year. The Reserve Bank revealed recently about $18 billion is invested in residential property.

There are significant tax incentives for SMSF property investment, including the potential to offset costs, gain tax free capital growth, and the potential to structure loans such as to obtain more than 100% of the potential purchase price (most banks will only lend to 70%, but SMSFs can get loans from the trustees to lift the balance higher).

To quote Australian Property Investor: ” A negatively geared property can have the following benefits:

  • Wipe out income tax on investments.
  • Wipe out contributions tax (and income tax).
  • Get back all, not just part, of franking credits.
  • Save up income losses for future years when concessional contributions might be higher.

In fact, your SMSF can get itself into the position where it pays no tax inside the fund now.” Thus, for many its a totally logical, and sensible investment strategy, given the current tax regime.

Granted there are some limitations imposed thanks to limited recourse borrowing arrangements . Geared SMSF property risks include:

SMSF Trustees have a number of significant obligations. There have been warnings from the ATO. ASIC and others about the risks involved, including rolling up the costs and commissions into the transactions. Lenders and Brokers have obligations about ensuring any loans are “not unsuitable”. Nevertheless spruikers are on the march! Just execute a web search….

But of course the real risk is if property prices take a dive. Nevertheless, but there is significant momentum here, adding to the current investor hubris.

I believe the negative gearing rules are to blame for this phenomenon, and should be changed. I would redirect property investment tax breaks only towards the building of new property, with a view to significantly increasing the supply.

But the most worrying aspect for me from our survey is that some of the “Want To Buys“, those who were not able to enter the owner occupied market, are attracted by the SMSF property route, because of the higher tax concessions, and the potential to break into an otherwise locked up market.

 

Mystery of the Missing Non-Bank Data

The Australian Bureau of Statistics provides lending for housing statistics each month, and they provide some good data points. However, when you start to dig into the data, it gets quite interesting. We know from our surveys that non-bank lending is on the rise, and that some of the higher loan to value deals are being provided here. But, who precisely are the non-banks,  how are their lending portfolios reported, and do we see any rise coming through in the data?

The ABS split lending into banks and non-banks. They say “together with banks and building societies, at least 95% of the Australian total of finance commitments is covered, and at least 90% of each state total is covered. While many smaller contributors to the Non-Banks series are excluded under these coverage criteria, at least 70% of finance commitments by wholesale contributors are covered

So, the top line view of lending (and here I will concentrate on owner-occupied data) is as follows. Non-Banks are about 10% of the market, plus or minus.

Non-Bank-1Its when you start to drill into the non-bank data, things get really interesting. ABS tells us “Housing loan outstandings are classified to the following lender types: Banks; Permanent Building societies; Credit unions/cooperative credit societies; Securitisation vehicles; and Other lenders n.e.c.. The first three of these types are components of the grouping Authorised Deposit-taking Institutions (ADIs). Loan outstandings for the ADI lender types are published monthly, and are classified by purpose (owner occupied housing or investment housing). All other institutions, including securitisation vehicles, are only available on a quarterly basis. The release of loan outstandings data for those lenders reporting on a quarterly basis will be lagged by one month – for example March outstandings for securitisation vehicles and other lenders n.e.c. will be released from the April publication onwards.

So, here is the non-bank data to September 2013. These are the raw numbers, before any seasonal adjustments or trending.  The number and value are pretty static, but some data will be quarterly, lagging by a month.

Non-Bank-3

Within the non-bank sector, ABS tells us that “The Wholesale Lenders series almost exclusively comprises securitisation vehicles (typically special purpose trusts), established to issue mortgage backed securities. It excludes commitments where a bank or permanent building society, acting as a wholesale provider of funds, is the lender on the loan contract. Those commitments are published as bank or permanent building society commitments.”

Here is the wholesale data to September 2013. It shows growth in recent months, both in terms of value and volume.  We noted recently the changing mix of securitised deals.

Non-Bank-5But that leaves quite a gap in the non-bank data, which I think is becoming quite important.

Non-Bank-6The orange area are loans which are made by non-banks, but funded by direct, or indirect investment, not securitisation. It is not accounted for by banks offering wholesale funding to a non-bank lender where the bank is the lender on the contract. Some non-bank lenders have become quite active, funded privately by investors, and others have received large cash injections from banks and other institutions. But do we see whats really going on in this section of the market? Is it a large enough sector to want more detail?

Lets assume a major bank makes a direct investment in one of the small non-bank lenders. Consider how this would be reported and the capital allocations which would be made. Its not clear to me that the major would have to report the loans in the normal way, rather it would appear in the balance sheet as an arms length investment. This is separate to any consolidation for accounting purposes.

The non-bank lender who received the funds, which may be from a bank, or private investors, may be small enough not to appear on the ABS radar, or simply rolled up into the non-bank reporting. The non-bank would be the lender on the loan contract. These non-bank lenders have more freedom to make higher LVR loans, and may charge prospective borrowers a premium. APRA data does not include non-banks. There is a rise in mortgage brokers directing clients to these non-banks.

Whilst more competition is better, this looks like an area where we would benefit from more detailed data inclusion from the ABS. We really have no idea how big this issue may be. But it seems to be a mystery worth trying to solve!

 

Property Market Investors Rule!

There is an interesting story to be told about how investors are tapping into the property market. First from our household survey we know that investors are widely spread across household groups. Down Traders for example, are quite likely to add an investment property into the mix when they release capital.  However, there are about 993,000 households who only hold investment property, 2% of which are held within Superannuation. Households in this segment will own one or two properties, but do not consider they are building an investment portfolio. Around 95% of households expect prices to rise in the next 12 months, 67% of households expect to transact within the next year, 44% will need to borrow more, and 38% will consider the use of a mortgage broker.

Compare these with portfolio investors, households who maintain a basket of investment properties. There are 180,000 households in this group. The median number of properties held by these households is eight. Most households expect that house prices will rise in the next 12 months (98%), and 71% will transact in the next 12 months. Many will borrow more to facilitate the transaction (78%), and 43% will use a mortgage broker.

Digging into why they are transacting now, it is clear from our survey that appreciating property values, tax benefits, low finance rates and the prospect of better returns than deposits are driving their decisions:

InvestorsNow

Many investors were looking at the same type of property as first time buyers, and in many cases, investors will win because of easier access to finance. (There are two other small factors in play, first, there is a rise in overseas investors tapping into the local market, and property held within a superannuation fund is also rising – these merit separate more detailed analysis, which I won’t cover now.)

However, looking at the recent APRA data we see that the stock of both owner-occupied and investment loans has been growing for the last few quarters. Stock of course includes new loans added in a quarter and existing loans less loans repaid.

LoanGrowth

Interestingly, the mix between investment and owner-occupied loan stocks has remained static over the past decade (this was a surprise as I would have expected to see a shift towards investors, but not so). In March 2012 32.7% were investment loans, in September 2013, it was 33.1%:

LoanStock

Individual lender types have seen some change in mix, with regional banks and building societies giving up investment loans to the major banks.

There has been quite a rise in the value of interest only loans being written (which APRA does not split out to investment loans) but DFA modelling suggests about 70% are investment loans.

InterestOnly

We also find that the average loan balance for interest only loans is higher:

AverageBals

So what does all this tell us? Investors are on the march, encouraged by the prospect of rising house pieces, tax breaks, and the prospect of better returns than from deposits. Banks are happy to lend, and will offer interest only deals, allowing investors to leverage, to maximise their  tax benefit.  This is creating significant momentum in the market, squeezing out many first time buyers, and lifting prices. It is likely to continue, carried along by the current lower than average interest rates and the generous tax breaks. Incidentally, a quick calculation suggests that the only real return comes from expected capital appreciation, as the net costs of renting the property, even after tax, are on average, neutral.

Households and Their Credit Cards

Each month the Reserve Bank publishes Credit Card data as part of its statistical tables. DFA incorporates this data into the market models we maintain, and we use a cards specific segmentation to analyse it. But this time, we also overlaid our property household segmentation to draw additional insights with this lens. So today I will summarise our findings using this perspective. Overall, the data shows growth in the number of accounts issued (the blue area), growth in limits being offered, but a decline in both overall balances and revolving balances. So, other than the banks continuing to offer product, not much to see. Indeed, on average households appear to be paying off debt. However, segmented analysis brings out interesting and concerning detail.

CardsAll

First we look at the first time buyers, those who entered the market, or have plans in train to do so. We find that they are accumulating more credit card accounts and credit limits, and that most of the balances on the cards are revolving. Compared with the average, they are more in debt. Our survey also shows they tend to source their cards across multiple providers, and also use store credit. They are managing their multiple debts close to the card limits. This may be fine, so long as unemployment does not hit.

CardsFTB

Now, compare this with the down traders, those older households looking to move to a smaller property and release equity for savings or investment. A different story, with the number of card accounts and credit limits falling, lower revolving balances, and lower balances overall.

CardsDownTraders

The want to buys (those not in the property market because they are priced out), show characteristics closer to first time buyers, but not so extreme. However, I note that card accounts and limits are growing in this cohort, and they are utilising revolving credit, though well within their limits. Our survey revealed that existing debt (like cards) was one of the  barriers to them entering the property market.

CardsWTBuy

I won’t display data for all the other segments, but suffice to say, there are significant variations in behaviour, card use, revolving credit balances and even number of accounts. So the final chart addresses the average number of card accounts per household, by type. (There may be multiple cards on one account of course).

CardsNo

There is an interesting inter-generational issue here, with younger property aspirants or purchasers holding more cards (perhaps with lower limits?) than older households, who are using their cards quite differently. We know that overall household debt remains high, and the credit card portfolio is an important factor in this. The fact that overall card debt is falling appears to mask the greater concentration amongst more vulnerable households. Remembering that yesterday we showed households are more in debt for longer now, this additional data helps paint the more complete, segmented, picture.

 

Households Hold Mortgages For Longer

Last week when we published our mortgage industry report we had a number of requests for additional trend data. Specifically, is it true that more households are holding mortgages for longer and how does this align to age cohorts? So we ran some additional detailed analysis on our household survey data, looking at 2006, 2009 and 2013, and comparing the relative distribution by household age cohorts of mortgage holders, households without mortgages and renters. This is not straight forward because we needed to correct for population growth and distribution. But the results are in.

First, lets look at the 2013 results. As expected, younger households are more likely to have a mortgage, older households are more likely to be mortgage free, and renters are most evident in middle age. There is a natural run off as households age.

Ownership2013

We then looked in detail at owners with a mortgage, over time.  The first observation is that mortgages are being taken out at a later age in 2013, compared with 2006, a greater proportion of households are holding a mortgage for longer, and this is true even into retirement.

HouseholdsMortgages

We then looked at households who are mortgage free. Our analysis shows that households are now less likely to be mortgage free, and if they are they will be so later in life.

HouseholdsNoMort

Finally we looked at renters. We see a greater proportion of households renting in 2013, and this is true across the age cohorts. Our survey results indicate that many of those aspiring to buy a property cannot get on the ladder because prices are too high relative to income, even with higher LVR loans more available now.

Renters

So, putting the analysis together, we see validation of the fact that, as previously observed, households are more in debt today, they are having to wait longer to get a mortgage, and will be saddled with it for longer, despite record low rates. Its fair to assume this is because prices have grown more strongly then income for many. The current housing model appears broken.

Glenn Stevens, RBA Governor in his statement on why the bank left rates at their lows said “The pace of borrowing has remained relatively subdued overall to date, though recently there have been signs of increased demand for finance by households. There is also continuing evidence of a shift in savers’ behaviour in response to declining returns on low-risk assets.”

There may indeed be some demand (though house prices are moving faster than credit growth) but our analysis indicates that there are worrying structural trends in amongst households, and that looking for growth from the housing sector is fraught with risk at current price levels.