Pulling In Two Directions – The Property Imperative Weekly 21 Oct 2017

The latest economic and finance data appears to be pulling in two directions, so we discuss the trends.

Welcome to the Property Imperative Weekly to 21st October 2017. Watch the video, or read the transcript!

In this week’s review of the latest finance and property news, we start with data from the Australian Institute of Health and Welfare in their newly released report Australian Welfare 2017. This is a distillation of data from various public sources, rather than offering new research.

In the housing chapter, they reinforce the well-known fact that home ownership is falling in Australia, while rates have been rising in a number of other comparable countries. Contributing to this trend overseas, at least in part, they say, are changes in the characteristics of households (including population ageing, household structure, and income and education) and policy influences, such as mortgage market innovations (including the relaxation of deposit constraints, increasing home ownership rates among lower income households, and tax reliefs on mortgage debt financing). In Australia, the steepest decline in home ownership rates across the 25 years to 2013–14 has been for people aged 25–34. This is typically the age at which first transitions into home ownership are made. But, fewer and fewer people in this age group are entering home ownership, with a 21 percentage point decline to just 39% in 2013–14 (compared with 60% in 1988–89). Home ownership rates for people aged 35–44 also fell, but not so much (12 percentage points).

Also, the proportion of home owners without a mortgage has continued to fall, while the proportion of renters has increased. Now more home owners have a mortgage, compared with those who own their property outright. Another fact is the startling gap between the rise in home prices, relative to disposable incomes, creating a barrier to home ownership for many. This gap has been fuelled by rapid house price growth (up 250% since the 1990’s), after the financial system was deregulated, with the total value of Australian housing estimated to be more than $6.5 trillion. Of course, the impact of higher house prices has been partially offset by lower mortgage interest rates, increased credit availability and changes in financial agency practices. These favourable lending conditions and low interest rates have encouraged buyers into the market, despite the growth in house prices themselves. This could all got wrong should mortgage rates rise.

The final piece of data shows that households are getting a mortgage later in life, and holding it longer, often well into retirement. In 2013, 71% of people born between 1957 and 1966 (mainly baby boomers), were financing a mortgage when aged 45–54. This trend is of particular concern as these households’ approach retirement without their home and asset base being paid off. For people looking to retire in the next 10 years, 45% of 55–64-year-olds in 2013 were still servicing a mortgage, compared with just 26% in 1982.

As the recent Citi report emphasises, and using our Core Market Data, the large level of debt outstanding by borrowers aged in their 50s and 60s means many investors will need to sell property to discharge their debts, especially those holding interest only loans. Given that the average age of wealthy seniors is 63 and the average IO debt is $236,400, Citi expressed concern that this cohort will not have enough time to repay the principal “without a significant hit to household cash flows”.

We still think the mortgage underwriting standards are too lose in Australia, as regulators try to balance slowing the market, but not killing the goose which is laying the golden economic egg.  So we found the Canadian regulators intervention in their mortgage market this week significant. There the index of house prices to disposable income has increased 25%, from 2000,  raising the prospect that real estate overvaluation is driving up overall household debt and overextending borrowers. So they tightened serviceability requirements and imposed loan to value limits on lenders.

Good news on housing affordability this week from the HIA, at least for some. Their Housing Affordability index for Australia improved by 0.5 per cent in the September 2017 quarter but still remains 4.4 per cent below the level recorded a year ago. It also showed that while some owner occupied borrowers had seen their mortgage rates drop, many property investors, has seen their rates rise. Sydney remains the least affordable market they say.

Our friends at Mozo wrote a blog post for us on the impact of the APRA changes to mortgage rates, which underscored the movements by type of loan.

More good news from the ABS. The monthly trend unemployment rate decreased by 0.2 per cent over the past year to 5.5 per cent in September, the lowest rate seen since March 2013. The participation rate remained steady at 65.2 per cent, within that male participation rate was 70.8 per cent, while the female participation rate reached a record high of 59.9 per cent. Over the past year, the states with the strongest annual growth in employment were Queensland (4.1 per cent), Tasmania (3.9 per cent), Victoria (3.1 per cent) and Western Australia (2.9 per cent). However, the underemployment trend rate still does not look that flash, especially in TAS, SA and WA, and we have a very high unemployment rate among younger workers as well as a rise in more casual, part-time work. All of this translates to lower wages.

The latest data from S&P showed a small decline in mortgage defaults in August. S&P said arrears decreased in all states and territories except the Australian Capital Territory (ACT) over the month, with noticeable improvements in Australia’s mining states and territories. The Northern Territory recorded the largest improvement, with arrears declining to 1.63% from 1.98% a month earlier. In Western Australia, arrears fell to 2.22% in August from a historic high of 2.38% in July. They still warned of potential risks in the system, especially from higher LVR IO loans written before 2015. And of course, this is looking a selection of securitised loans which may not be typical, and in any case, in most places home price rises mean struggling borrowers should have the capacity to sell and repay the bank. That would change if prices started to fall seriously.

Talking of risks, there were interesting comments from ASIC this week, suggesting that whilst brokers may be having appropriate conversations with their interest only mortgage customers, there was evidence of poor record keeping. This follows the regulator’s announcement they would commence a loan file review, to ensure that consumers are not paying for more expensive products that are unsuitable. Without good documentation brokers and lenders leave themselves open to the charge of making unsuitable loans, which can have significant consequences.

Another indicator of potential risks in the system is the rise in the number of households seeking short term loans from pay day lenders and other providers. Our surveys show that more than 1.4 million of the 9.5 million households in Australia are looking for finance (and it is rising fast as cash flows are stressed). Not all will successfully obtain a loan. We think more than $1 billion in loans are out there, and our research shows that such short term loans really do not solve household financial issues. However, when people are desperate, they will tend to grasp at any straw in the wind, regardless of cost or consequences. We also find these households are within certain household segments, who tend to be less affluent, and less well educated.

The RBA minutes, release this week, did not tell us much more, but contained this morsel. “Members noted that housing loans as a share of banks’ domestic credit had increased markedly over the preceding two decades. APRA intended to publish a discussion paper later in 2017 addressing the concentration of banks’ exposures to housing.  Members also noted that APRA had intensified its focus on Australian banks strengthening their risk culture”.  We can barely contain our excitement at the prospect! A discussion paper later in the year!

CoreLogic’s latest auction clearance results showed there is still demand for property, with a preliminary clearance rate of 70.6 per cent, and increase from last week when the final clearance rate slipped to 64.4 per cent, the lowest clearance rate since January 2016.

Finally, we released our latest flagship report – The Property Imperative, Volume 9. This is available free on request from our web site and is a distillation of our research into the finance and property market, using data from our household surveys and other public data. Whilst we provide these weekly updates via our blog, twice a year we publish a full report. Volume 9 offers, in one place, a unique summary of the finance and property markets, from a household perspective, over more than 70 pages.

What really struck us as we wrote the report was the amount of change in the property and finance sector, with significant regulatory tightening, changes in mortgage pricing and a rotation in mortgage lending. But the underlying facts of high prices, mortgage stress and rising risks in the system appear unchanged. The number of reports highlighting the risks have risen substantially.

Standing back, sure the data is pulling to two directions, with employment higher, auction clearance rates firm and affordability for some manageable. But the bigger picture contains a number of risks, stemming from the divergence of incomes and home prices, the lose lending standards over the past few years, and the risks from the more recent tightening of the rules, at a time when interest rates are more likely to rise than fall. Without a significant rise in incomes in real terms – and we cannot see where this will come from – the risks to growth and financial stability are still not fully understood.

And that’s the Property Imperative to 21st October 2017. Follow this link to request the Volume 9 Property Imperative Report.

345,000 Aussie mortgage holders have no real equity in their homes

From Roy Morgan Research.

Overall some 8% (345,000) of mortgage holders in Australia in the year to August 2017 have been identified as having little or no real equity in their home, an increase from 7.1% twelve months ago. This is based on the fact that the value of their home is only equal to or less than the amount they still owe, placing them at considerable risk if they have to sell or prices decline.

These are the latest findings from Roy Morgan’s Single Source Survey which is based on over 50,000 interviews per annum, including more than 10,000 with owner occupied mortgage holders.

Apart from the ability to keep up with mortgage repayments, another critical factor in assessing financial risk for mortgage holders is to compare the value of their property with the amount outstanding on their loan. The purpose of this is to establish the level of equity (if any) they have, as this is a major component of most households’ financial position and potential risk.

Mortgage holders in WA most at risk

On average, the value of properties in Australia subject to a mortgage is well in excess of the amount outstanding but there are problem areas. The state at highest risk is WA where 14% (71,000) of mortgage customers’ have no real equity in their home.

Value of home is less or equal to amount owing

Source: Roy Morgan Single Source (Australia). 12 months ended August 2016, n= 10,746; 12 months ended August 2017, n= 10,251. Base: Australians 14+ with owner occupied home loan.

Over the last 12 months there has been an increase of 3.3% points in the proportion of mortgage holders in WA with little or no equity in their home. Tasmania has the lowest proportion of mortgage holders with little or no equity in their home, with only 4.9% (4,000). NSW is the second-best performer with 5.6% (81,000) of mortgage holders facing equity risk, followed by VIC with 6.1% (62,000), SA with 7.6% (26,000) and QLD with 10.3% (89,000). The strong performance in VIC and NSW is due mainly to the rapid rise in Sydney and Melbourne prices which has generally outpaced the amount owing on mortgages.

Lower-value homes face more equity risk

The mortgage holders with little or no equity in their homes have much lower average house values ($501,000) compared to all mortgage holders ($761,000).

Mortgage holders with home value less or equal to amount owing vs all mortgage holders

Source: Roy Morgan Single Source (Australia). 12 months ended August 2017, n= 10,251. Base: Australians 14+ with owner occupied home loan.

Across all states, the value of the homes overall with a mortgage is much higher than the value of homes owned by mortgage holders who have no real equity in their home. In NSW for example, the average value of homes with a mortgage is $975,000, compared to the much lower average of $623,000 for mortgage holders where the value of their home is less or equal to the amount they owe. In VIC the figures are $804,000 for the average home value with a mortgage, well above the $549,000 for mortgage holders with no equity in their home.

Too Little Too Late? – The Property Imperative Weekly 14th October 2017

Another massive week of finance and property news, much of it centred on households and their finances, as the regulators home in on the risks in the mortgage market. But is it too little too late?

Welcome to the Property Imperative weekly to the 14th October 2017. Watch the video, or read the transcript.

We start our review of this week’s finance and property news with the RBA’s Financial Stability report.  This quarterly report, which ran to 62 pages said that International economic conditions, and local business confidence are on the improve while banks now hold more capital, have tightened lending standards, and shadow banking is under control. But, they say, Australian household balance sheets and the housing market remain a core area of interest, and from a financial stability perspective, this is the key risk. They showed that one third of mortgage holders have less than one months’ buffer, and their key concern is the negative impact on future growth as households hunker down;  so nothing new really, apart from some new “Top Down” stress testing.

And nothing to answer the IMF’s downgraded Australian growth forecast. Given the first half result in 2017 was 1.2% a second half forecast at circa 1% is hardly stellar; and the sudden rebound to 3% next year, some might say, appears courageous. The IMF also revised up the unemployment rate, suggesting it will remain at 5.6%, rather than falling to 5.3% as estimated last time. This plus slow wage growth highlights the issues underlying the economy. They also warned about risks from high debt saying growth in household debt relative to GDP is associated with a greater probability of a banking crisis. And Australia is right up there!

On the same day, the ABS released their latest Housing and Occupancy Costs data. The average household with an owner occupied mortgage is paying around $450 a week, slightly lower than the peak a couple of years ago.  This equates to around 16% of gross household income. But of course, the true story is interest rates have fallen to all-time lows, allowing people to borrow more, as prices rise. As a result, should interest rates start to bite, this will cause real pain. Plus, we have recent flat wage growth, in real terms, in the past couple of years. Finally, households have a bigger mortgage held for longer, which is great for the banks, but not helpful from a household perspective, as it erodes savings into retirement and means that more older Australians are still borrowing as they transition from the work force.

Earlier in the week, the ABS also released their latest housing finance data which showed that ADI lending rose 0.6% in trend terms in August, or 2.1% seasonally adjusted. Within that, lending for owner occupied housing rose 0.9%, or 2.1% seasonally adjusted and investor loans rose 0.2% in trend terms, or a massive 4.3% in seasonally adjusted terms. So lending growth is apparent, and signals more household debt ahead. First time buyers continue to extend their reach, despite the fact we are seeing “Peak Price” for property at the moment. In original terms, the number of first home buyer commitments as a percentage of total owner occupied housing finance commitments rose to 17.2% in August 2017 from 16.6% in July.

AFG’s latest mortgage index, shows that property investor appetite is falling, while first time buyers, and property upgraders are more active. First time buyers are reacting to the recent incentives put in place in VIC and NSW, they said.

Citi published a 54-page report on the highly topical subject of interest only (IO) loans, and we provided data from our Core Market Model to assist their research. Even after recent regulatory tightening, they say that underwriting standards in Australia are still more generous than some other countries, at 5.3 times income, compared with 3.7 times in the UK, 4.4 times in Canada and 4.9 times in New Zealand. They conclude that there are vulnerabilities in the IO sector, both from property investors and owner occupied IO loan holders. Overall this is, we estimate, more than $680 billion of the $1.6 trillion mortgage book. They say that tighter lending criteria and rising house prices has meant investors increasingly face net negative cash flows and investors face a growing household cash flow gap and reducing capital gains expectations. The large levels of debt outstanding by borrowers aged in their 50’s and 60’s means many investors will need to sell property to discharge their debts. Owner Occupied IO borrowers are more susceptible to interest rate rises given higher average borrowing levels and higher average loan to value ratios. They concluded “Given the widespread use of IO finance and the reduced prospects of discharging debt via means other than liquidation of portfolio holdings, banks must face an increased risk of mis-selling claims in future years. Mining towns serve as a microcosm of this threat”.

ASIC updated their work on IO loans finding that Australia’s major banks have cut back their interest-only lending by $4.5 billion over the past year. However, other lenders have partially offset this decline by increasing their share of interest-only lending. They say that borrowers who used brokers were more likely to obtain an interest-only loan compared to those who went directly to a lender and borrowers approaching retirement age continue to be provided with a significant number of interest-only owner-occupier loans. Now ASIC will examine individual loan files to ensure that lenders are providing interest-only home loans in appropriate circumstances, to ensure that consumers are not paying for more expensive products that are unsuitable, under the responsible lending provisions.

In this light, it was interesting to listen to some of the Big Bank’s CEO’s in front of the House of Representatives Standing Committee on Economics. Westpac CEO said half of his $400 billion mortgage portfolio was interest only. The other banks were closer to 40%. While both Westpac and ANZ said “we don’t lend to people who can’t pay it back. It doesn’t make sense for us to do so”, the underwriting standards are, we think, way too lose, as the recent regulatory tightening highlights, but it’s probably too late, especially for IO loans which now would fail even the current still generous standards. In an excellent The Conversation article, Richard Holden, Professor of Economics, UNSW rightly highlighted the “Spooky” parallels between our current situation, and the US mortgage market prior to the GFC.  “Australia’s large proportion of five-year interest-only loans – turbocharged by an out-of-control negative-gearing regime – looks spookily similar. It’s one thing for borrowers to do silly things. When it becomes dangerous is when lenders not only facilitate that stupidity, but encourage it. That seems to be what has happened in Australia”.

Smaller lenders are still feeling the pressure, as illustrated by the Bank of Queensland results, which came out this week. While the headline profit was up, underlying growth was lower, and mortgage lending was the key. Net interest margin fell to 1.87%, but was better in 2H. Interest only loans were 40% in 2H16, and 39% in 1H17, but trending down, they say! 8% of loans are higher than 90% LVR on a portfolio basis, and 19% in the 81-90% band.

During their hearing, the big banks also confirmed they had repriced their mortgage back book, especially for interest only and investment loans, but weirdly denied this was to increase profitability.  The quote of the week for me was one CEO saying that people should switch from IO loans to P&I loans “because they were cheaper” – which may be true from a headline interest rate perspective, but the monthly repayments when switching are significantly higher, so in reality, it is not cheaper in cash flow terms!

There was conflicting data relating to Foreign Property Investors, especially from China, with Credit Suisse saying they estimate, based on stamp duty records, that foreign buyers are acquiring the equivalent of 25% of new housing supply in NSW, 17% in Victoria and 8% in Queensland.  If they are correct, this may put a floor on home prices, and they suggest that crackdowns on capital outflows by Chinese authorities appear not have slowed China’s appetite for Australian property.

On the other hand, while the NAB Residential Property Index rose 6 points in Q3, they highlighted lower foreign buying activity in new property markets, VIC saw the share fall to 14.4% (from 20.8% in Q2) and NSW down to 7.8% from 12% in Q2. In contrast, QLD saw a rise to 11.4%, up from 8.6% last quarter. NAB also revised its national house price forecasts, predicting an increase of 3.4% in 2018 (previously 4.3%) and easing to 2.5% in 2019. Unit prices are forecast to rise 0.5% in 2018 (-0.3% previously), with a modest fall expected in 2019.

Our data suggests that Chinese buyers are indeed still active, with a focus on certain postcodes where high-rise units are being built, and often offered direct to overseas buyers. We also see evidence of some high rollers buying larger houses. But overall this is not enough to support home prices into next year.

We published the September update of the Digital Finance Analytics Household Finance Security Index, which underscored the growing gap between employment, which remains relatively strong, and the Financial Security of households. The Index fell from 98.6 in August to 97.5 in September. The state by state view highlights a fall in NSW, while VIC holds higher, and there was a rise in WA from February 2017 lows. This highlights the fact the households across the national are under different levels of pressure. Tracking by age bands we find younger households are significantly less confident, compared with those aged 50-60 years.  But across the board, the general trend is lower.

Similar findings were contained in the latest AlphaWise survey conducted by Morgan Stanley. Income growth has not recovered, ‘cost of living’ inflation is re-accelerating and ‘macro-prudential’-related tightening of credit conditions is extending from housing into consumer finance. They say Australian households are in a vulnerable financial position, especially those who have taken out a mortgage. And in an era of weak incomes growth, soaring energy prices and high levels of indebtedness, with the prospect of higher interest rates on the way, many intend to cut discretionary spending in anticipation of even tighter household budgets. That’s bad news, not only Australia’s retail sector, but also the broader economy. They forecast discretionary consumption volumes will slow to just 0.2% in 2018, dragging overall consumption growth down to 1.1% and well below consensus of 2.5%.

So, in summary the evidence is building that we are entering a concerning episode where growth is likely to be lower, households will remain under pressure, and risks in the system are considerably higher than the RBA is willing to concede. The mystery though is why the regulators are still allowing mortgage lending to grow way faster than inflation, and wages. This surely must be slowed, and soon. Once again, too little too late.

So that’s the Property Imperative Weekly to 14th October. If you found this useful, do leave a comment below, subscribe to receive future updates and check back next week.

Rising US Rates Will Clip Home Prices Here

Interesting research is contained in a BIS Working Paper “Interest rates and house prices in the United States and around the world“.

They show that home prices are indeed connected to interest rates, and changes in rates do have a flow on effect to prices, and that there are spillover effects, especially relating to interest rates in the USA.

This means that as the FED lifts rates, as is now well signalled, we should expect prices to fall here and in other countries. There may be some delay, the modelling is complex, and the relationships are not straight forward. But it is is worth remembering that in the US real house prices fell by as much as 31% over the course of 2007–09!

This paper estimates the response of house prices in 47 advanced and emerging market economies (EMEs) to changes in short- and long-term interest rates. Our study has four novel aspects. First, we analyse in some detail the impact of short-term interest rates on house prices. Second, we look at the responsiveness of house prices around the world to US interest rates. Third, we use a unique data set on house prices compiled by the BIS in cooperation with national statistical and monetary authorities. And fourth, our empirical framework tries to capture the important role of inertia in house prices.

One striking feature of house price growth is its persistence. With the exception of Germany, Portugal and Switzerland, advanced economies have seen real house prices growing by an average of at least 6% per year for 40 years or longer. In the United States, for instance, this resulted in a 13-fold increase in real house prices over a period of 47 years; in Norway, in a 77-fold increase over 66 years. And in South Africa, real house prices increased nearly 150 times over half a century.

Another way to appreciate the persistence of house prices is to contrast the length of their upswings and downswings. We define an upswing (downswing) as a period of house price increases (decreases) sustained in an individual country for three years or more. Based on this definition, periods of upswing accounted for nearly 80% of the advanced economy sample. The upswings lasted on average 13 years; with the longest one, in Australia, still continuing after half a century. By contrast, downswings accounted for only 8% of the advanced economy sample; they lasted on average five years, and the longest one, in Japan, lasted 13 years. In EMEs, upswings accounted for two thirds of the sample. They lasted on average eight years, and the downswings four years.

The surge in house prices has been particularly pronounced since the turn of the millennium. Between 2000 and 2015, real house prices increased by 100% or more in half the economies in our sample.  Most countries experienced a housing boom before 2007 (light bar segments). But many have also seen very rapid house price growth since 2007 (dark bar segments). These included Australia, Austria, Canada, the Netherlands, Norway, Sweden and Switzerland among advanced economies; and Brazil, Hong Kong SAR, Israel, Malaysia and Peru among EMEs.

Our focus on short-term interest rates is motivated by their link to monetary policy. As a house is a long-lived asset, the interest rate appropriate for relating the service flow from a house to its price is arguably a long-term rate. However, house prices also depend importantly on ease of access to credit, which is in turn significantly affected by the monetary policy stance. Bernanke and Blinder (1992), for instance, showed that changes in the US federal funds rate were associated with changes in lending by US banks, an effect that has become known as the bank lending channel of monetary policy. Short-term interest rates, which are more closely related to the stance of monetary policy, might therefore be just as important a “fundamental” for house prices as longer-term rates. Indeed, we find a surprisingly important role for short-term interest rates as drivers of house prices, especially outside the United States. Our interpretation is that this reflects an important role for the bank lending channel of monetary policy, especially in countries where securitisation of home mortgages is less prevalent.

The motivation for looking at the responsiveness of house prices around the world to not only domestic but also US interest rates is that the latter have become a key measure of the global cost of financing. We do find spillover effects from US interest rates, both short and long ones, on house prices outside the United States.

Our study draws on the BIS residential property price statistics and, in particular, the “preferred” house price series as identified by national statistical offices or central banks. We compiled over 1,000 annual observations on house prices for the non-US countries in our sample from these series and about a half century of quarterly house prices for the United States. We use these data to estimate the dynamic impact of changes in interest rates and other explanatory variables on real house prices around the world.

Most empirical studies assume that short-term interest rates do not influence house price growth other than through the domestic cost of borrowing, ie by their influence on long-term interest rates. The findings in this paper suggest that this view might be mistaken: changes in short-term interest rates seem to have a strong and persistent impact on house price growth.

Moreover, global, ie US short-term interest rates – not just domestic ones – seem to matter, both in advanced economies and EMEs. We interpret the relative importance of short-term interest rates in driving house prices as indicating an important role for the bank lending channel of monetary policy in determining housing financing conditions, especially outside the United States, where securitisation of home mortgages is less prevalent.

The larger effect of interest rates on house prices we find reflects in part the use in our regressions of a long distributed lag of interest rate changes. For the United States, our estimates for the period from 1970 to the end of 1999 suggest that a 100 basis-point fall in the nominal short-term rate, accompanied by an equivalent fall in the real short-term rate, generated a 5 percentage point rise in real house prices, relative to baseline, after three years. We find an even larger effect if we include the data through end-2015. For other advanced economies and EMEs, we estimate that a 100 basis-point fall in domestic short-term interest rates, combined with an equivalent fall in the US real rate, generates an increase in house prices of up to 3½ percentage points, relative to baseline, after three years. Another reason we find larger interest rate effects is by allowing for inertia in house price movements. We find strong evidence against the random walk hypothesis: real house prices around the world tend to move in the same direction for about a year after being hit by a disturbance, then exhibit a modest reversal.

We think that this inertia in house prices reflects the large search and transaction costs associated with trading residential real estate and shifting between owner-occupied and rental housing. These costs are ignored in the user cost model, which predicts a fairly high interest rate sensitivity for house prices.

Our findings also suggest a potentially important role for monetary policy in countering financial instability. While higher short-term interest rates alone cannot significantly dampen the demand for housing, slower house price growth can give supervisors more time to implement measures to strengthen the financial system. At the same time, the finding that house prices adjust to interest rate changes gradually over time suggests that modest cuts in policy rates are not likely to rapidly fuel house
price bubbles.





Note: BIS Working Papers are written by members of the Monetary and Economic Department of the Bank for International Settlements, and from time to time by other economists, and are published by the Bank. The papers are on subjects of topical interest and are technical in character. The views expressed in them are those of their authors and not necessarily the views of the BIS.

Households Spending Less On Housing…But

Data from the ABS today – Housing Occupancy and Costs – highlights the average household with an owner occupied mortgage is paying around $450 a week, slightly lower than the peak a couple of years ago.  This equates to around 16% of gross household income, on average.

This does not include repayments on investment properties of course (and many households have multiple properties as investing in property rises).

But of course, the true story is interest rates have fallen to all time lows, allowing people to borrow more, as prices rise. As a result, should interest rates start to bite, this will cause real pain. Then of course we have recent flat wage growth, in real terms, in the past couple of years.

Also, households have a bigger mortgage for longer, which is great for the banks, but not helpful from a household perspective, as it erodes savings into retirement and more older Australians are still borrowing. And of course the current high home prices show a paper profit, but that could be eroded if prices slide.

Thus, the ABS data should not be interpreted as everything is fine, it is not! In fact, underwriting standards should be much tighter now, as we highlighted this morning, Australian Banks are willing to go up to around 6 times income, higher than many other countries, with similar home price bubbles.

The proportion of income mortgagees are using for housing has declined over the last decade, according to new figures released today by the Australian Bureau of Statistics (ABS).

“In 2005-06, owners with a mortgage paid 19 per cent of their total household income on housing costs. By 2015-16 this had fallen to 16 per cent. This is likely driven by lower interest rates coupled with growth in household incomes over the last decade, ” Dean Adams, Director of Household Characteristics and Social Reporting, said.

In 2005-06, owners with a mortgage paid $434 per week in housing costs, similar to the $452 paid in 2015-16 in real terms. But over the same period, average total household incomes for mortgagees rose from $2,272 to $2,759 per week.

“Mortgage and property values have also increased in the last decade. Ten years ago, the real median mortgage value was $171,000 which rose to $230,000 in 2015-16. Meanwhile, the real median dwelling value increased from $449,000 to $520,000,” Mr Adams explained.

Going back another decade, the results also reveal that households are entering into a mortgage at older ages. The proportion of younger households (with a reference person aged under 35 years) represented 69 per cent of first home buyers in 1995-96 which dropped to 63 per cent by 2015-16.

“Having a mortgage is now the most common form of ownership for households whose reference person was aged between 35 and 54 years. Among this group, ownership with a mortgage increased by 15 percentage points over the last two decades, from 41 per cent to 56 per cent. Meanwhile, the rate of outright ownership in 2015-16 (12 per cent) was one-third the 1995-96 rate (36 per cent),” Mr Adams said.

The rate of older households (with a reference person aged 55 years and over) who were still paying off a mortgage has tripled between 1995-96 and 2015-16 (from 7 per cent to 21 per cent). Older households are spending more of their income on housing costs than two decades ago, increasing from 8 per cent to 14 per cent for those aged between 55 and 64, and from 5 per cent to 9 per cent for those aged 65 and over.

UK Government Plans to Increase Social Housing Grants

From Moody’s

Last Wednesday, UK Prime Minister Theresa May announced that housing associations and local authorities will receive an additional £2 billion in grants for social (i.e., public) housing, including social rented homes. She also announced that rent increases will be set at CPI plus 1% starting in fiscal 2021 (which starts 1 April 2020) for five years. These announcements are credit positive for English housing associations because they signal greater support for the social rented sector.

Increased grant funding will reduce external financing needs and provide incentives to focus on social renting activities, which provide more stable cash flow than markets sales. The rent-setting regime provides clarity about housing associations’ operating environment and signals a shift from the previous government policy, which had negative financial effects on the sector.

The amount of grant funding available under the Affordable Homes programme for housing associations and local authorities will increase by £2 billion to £9.1 billion over the length of the program. Housing associations historically have relied on government grants to finance the production of new social homes, but such grants have significantly dwindled since the financial crisis.

The new grant programme aims to fund the construction of an additional 25,000 homes, and we expect the average subsidy per home to more than double to £80,000 from £32,600 in the last allocation round of the programme in 2016 and from £23,500 in the 2014 round. Although the distribution of the grants will depend on yet-to-be-defined criteria that determines which areas are most in need, we expect the 39 English housing associations that we rate to receive £650-£900 million of new grant funding, which would contribute to financing 8,000-11,250 homes.

The additional grants will reduce housing associations’ external financing needs, and should reduce future borrowing, which we currently expect will reach nearly £4 billion during fiscal 2018-20. However, some housing associations may choose to use the freed-up financial capacity to further increase their production of homes for open market sale rather than to stabilise indebtedness.

The grant programme signals a rebalancing of the government’s position in favour of rented social housing. The social letting business provides more stable cash flows for housing authorities than low-cost home ownership programmes, which had been at the centre of the previous housing policy. The lack of grants for building social rented homes and political pressure had encouraged housing associations to subsidise social homes by building units for open market sale that expose housing associations to the cyclicality of the housing market. The share of such sales to turnover has steadily increased over the past five years, reaching 15% in fiscal 2016 for our rated issuers and more than 40% for a small number of housing associations. Hence, this shift in the availability of funding and the direction of policy is credit positive.

The black swan turns pale

From Capital and Conflict.

For a few months we’ve been following the story of Australia’s housing bubble with new interest. It’s the potential crisis on no European’s screen. Which is concerning given the level of funding which Europe supplies to some of the world’s largest banks Down Under.

The issue in Australia is surprisingly similar to the sub-prime story in the US. And everyone agrees it’s all about land prices at the core.

Which is odd given the amount of land Australia has. But even that is up for debate if you read the papers.

Let’s turn to a more interesting angle in this Capital & Conflict.

How big is the Australian housing bubble? Capital Economics calculated that, based on a median house price to income ratio, Australian houses are about 38% overvalued. Which happens to be far worse than the US’s 30% in 2006.

ABC News reassured its readers that this time is different and Australia is special:

However, he noted that this measure does not take into account the long-term lower level of interest rates and therefore the bigger amount people can comfortably borrow and the lower rental returns investors demand.

This is morbidly hilarious. Rising interest rates happen, which increases the risk, not decreases it. Something that will only temporarily be affordable is not affordable and won’t benefit the buyer in the end.

Not only that, but rising rates are precisely what popped the sub-prime bubble, so it should be obvious that low rates are dangerous.

The latest development is a remarkable survey from Finder.com.au on just this issue. Australian Broker reports:

A staggering 57% of mortgage holders could not handle a $100 increase in their [monthly] loan repayments, according to new research by Finder.com.au.

This additional $100 is equivalent to an interest rate rise of just 0.45% based on the national average mortgage of $360,600. This means the average standard variable rate of 4.83% would only have to rise to 5.28% to put more than half of mortgage holders in stress.

Not only are Australians walking a tightrope on their repayments, but 39% of mortgages are interest only. A hit to house prices could spell disaster.

Surprisingly, it’s the wealthy that are in trouble. Martin North of Digital Finance Analytics tracks mortgage stress by suburb. And it’s the famously wealthy ones that are showing signs of distress.

Never forget how small a problem the US’s sub-prime bubble looked in 2007. Australia’s house price bubble is brewing trouble for you.

Top 10 Mortgage Stress Count Down – September 2017

Mortgage stress rose again in September according to Digital Finance Analytics analysis, crossing the 900,000 household rubicon for the first time. The latest RBA data shows household debt to income rose again in June, to 193.7, further confirmation of Australia’s debt problem.

Across the nation, more than 905,000 households are estimated to be now in mortgage stress (last month 860,000) and more than 18,000 of these in severe stress. This equates to 28.9% of households. A rising number of more affluent households are being impacted as the contagion of mortgage stress continues to spread beyond the traditional mortgage belts. We estimate that more than 49,000 households risk default in the next 12 months, up 3,000 from last month.

Watch the video to learn more, and count down the latest top 10 post codes. We had some new regions “promoted” into the list this time.

The main drivers of stress are rising mortgage rates and living costs whilst real incomes continue to fall and underemployment remains high.  Some households are now making larger mortgage repayments following out of cycle interest rate rises, and are simultaneously facing higher power prices, council rates and childcare costs. This remains a deadly combination and is touching households across the country, not just in the mortgage belts.

Our analysis uses the DFA core market model which combines information from our 52,000 household surveys, public data from the RBA, ABS and APRA; and private data from lenders and aggregators. The data is current to end September 2017. We analyse household cash flow based on real incomes, outgoings and mortgage repayments, rather than using an arbitrary 30% of income.

Households are defined as “stressed” when net income (or cashflow) does not cover ongoing costs. Households in mild stress have little leeway in their cash flows, whereas those in severe stress are unable to meet repayments from current income. In both cases, households manage this deficit by cutting back on spending, putting more on credit cards and seeking to refinance, restructure or sell their home.  Those in severe stress are more likely to be seeking hardship assistance and are often forced to sell. The debt-to-income (DTI) ratios in severely stressed households are on average eleven times their current annual incomes and this is high on any measure. The combined statistics suggest there are continuing concerns about underwriting standards.

We revised our expectation of potential interest rate rises, given the stronger data on the global economy. Probability of default extends our mortgage stress analysis by overlaying economic indicators such as employment, future wage growth and cpi changes.

Martin North, Principal of Digital Finance Analytics said that “continued pressure from low wage and rising costs means those with bigger mortgages are especially under the gun. These stressed households are less likely to spend at the shops, which will act as a further drag anchor on future growth. The number of households impacted are economically significant, especially as household debt continues to climb to new record levels”. The latest household debt to income ratio is now at a record 193.7.[1]

Gill North, joint Principal of Digital Finance Analytics and a Professorial Research Fellow in the law school at Deakin University, citing her recent research, suggests the Australian house party has been glorious – but the hangover may be severe and more should be done to mitigate future risks and harm to highly indebted households and the nation.[2]

She notes that at the beginning of 2016 the RBA and APRA stood largely aloof from concerns around levels of household debt and the major risk was complacency. While the RBA and APRA have been more vocal since and have taken steps to tighten lending standards, she calls for additional measures and highlights the continuing vulnerability of many households without financial buffers for adverse contingencies.[3]

Regional analysis shows that NSW has 238,703 households in stress (238,755 last month), VIC 243,752 (236,544 last month), QLD 168,051 (146,497 last month) and WA 124,754 (118,860 last month). The probability of default rose, with around 9,300 in WA, around 9,100 QLD, 12,800 in VIC and 13,100 in NSW.

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Note that the detailed results from our surveys and analysis are made available to our paying clients.

[1] RBA E2 Household Finances – Selected Ratios June 2017

[2] Gill North ‘The Australian House Party Has Been Glorious – But the Hangover May Be Severe: Reforms to Mitigate Some of the Risks’ in R Levy, M O’Brien, S Rice, P Ridge and M Thornton (eds), New Directions For Law In Australia (ANU Press, Canberra, 2017). An earlier version of this book chapter is available at https://ssrn.com/author=905894.

[3] See also, Gill North, ‘Regulation Governing the Provision of Credit Assistance & Financial Advice in Australia: A Consumer’s Perspective’ (2015) 43 Federal Law Review 369. An earlier draft of this article is available at https://ssrn.com/author=905894.


Sydney House Values Fall in September as Capital Gains Continue to Lose Steam

From CoreLogic.

The September results confirmed that dwelling values edged 0.2% higher across Australia over the month, led by a 0.3% rise in capital city values and a 0.1% gain across the combined regional markets. The latest figures take national dwelling values 0.5% higher over the September quarter, which is the slowest rate of quarter-on-quarter growth since June 2016, and national values are up 8.0% over the past twelve months.

According to analysis by CoreLogic head of research Tim Lawless, the combined capital city trend growth rate is clearly losing steam with dwelling values rising by 0.7% over the September quarter and well down from the recent peak rate of quarter-on-quarter growth which was recorded at 3.5% over the December 2016 quarter. Mr Lawless said, “This slowing in the combined capitals growth trend is heavily influenced by conditions across the Sydney market where capital gains have stalled.”

Mortgage Tightening – The Property Imperative Weekly 30 Sept 2017

Mortgage Lending is slowing and banks are tightening their underwriting standards still further, so what does this tell us about the trajectory of home prices, and the risks currently in the system?

Welcome to the Property Imperative weekly to 30th September 2017. Watch the video, or read the transcript.

We start our review of the week’s finance and property news with the latest lending data from the regulators.

According to the RBA, overall housing credit rose 0.5% in August, and 6.6% for the year. Personal credit fell again, down 0.2%, and 1.1% on a 12-month basis. Business credit also rose 0.5%, or 4.5% on annual basis. Owner occupied lending was up $17.5 billion (0.68%) and investment lending was up $0.8 billion (0.14%). Credit for housing (owner occupied and investor) still grew as a proportion of all lending. The RBA said the switching between owner-occupier and investment lending is now $58 billion from July 2015, of which $1.7 billion occurred last month. These changes are incorporated in their growth rates.

On the other hand, data on the banks from APRA tells a different story. Overall the value of their mortgage portfolio fell 0.11% to $1.57 trillion. Within that owner occupied lending rose 0.1% to $1.02 trillion while investment lending fell 0.54% to $550 billion. As a result, the proportion of loans for investment purposes fell to 34.9%.

This explains all the discounts and special offers we have been tracking in the past few weeks, as banks become more desperate to grow their books in a falling market. Portfolio movements across the banks were quite marked, with Westpac and NAB growing their investment lending, while CBA and ANZ cutting theirs, but this may include loans switched between category. Remember that if banks are able to switch loans to owner occupied categories, they create more capacity to lend for investment purposes.  Putting the two data-sets together, we also conclude that the non-bank sector is also taking up some of the slack.

Our mortgage stress data got a good run this week, with the AFR featuring our analysis of Affluent Stress. More than 30,000 households in the nation’s wealthiest suburbs are facing financial stress, with hundreds risking default over the next 12 months because of soaring debts and static incomes. This includes blue ribbon post codes like Brighton and Glen Iris in Victoria, Mosman and Vaucluse in NSW and Nedlands and Claremont in WA.

The RBA is worrying about household debt, from a financial stability perspective, according to Assistant Governor Michele Bullock.  She said households have really high debt – mainly mortgages, as a result of low interest rates and rising house prices, and especially interest only loans. “High levels of debt does leave households vulnerable to shocks.” She said. The debt to income ratio is rising (150%), but for some it is much higher. We will release our September Stress update this coming week.

Debt continues to remain an issue. For example, new data from the Australian Financial Security Authority shows that in 2016–17, the most common non-business related causes of debtors entering personal insolvencies was the excessive use of credit (8,870 debtors), followed by unemployment or loss of income (8,035 debtors) and then domestic discord or relationship breakdown (3,222 debtors). However, employment related issues figured first in WA and SA.

It is also worth saying the Bank of England has now signalled that the UK cash rate will rise, and this follows recent statements from the FED in the same vein. It is increasingly clear these moves to lift rates will raise international funding costs to banks and put more pressure on the RBA to follow suit.

Meantime, lenders continue to tighten their underwriting standards.

ANZ announced that it will be implementing new restrictions on some loans for residential apartments, units and flats in Brisbane and Perth. Now there will be a maximum 80 per cent loan-to-value ratio for owner-occupier and investment loans for all apartments in certain inner-city post codes. We think these changes reflect concerns about elevated risks, due to oversupply and price falls. ANZ’s policy changes apply to all apartments in affected postcodes, including off-the-plan and non-standard small residential properties valued at less than $3 million. Granny flats though are excluded.

More generally, ANZ also issued a Customer Interview Guide with specific which topics brokers should discuss with home and investment loan borrowers. “We expect brokers to use a customer interview guide (CIG) to record customer conversations as a minimum moving forward,” noted ANZ “while it is not required to submit the CIG with the application, it should be made available when requested as a part of the qualitative file reviews.”

CBA launched an interest-only simulator to help brokers show customers the differences between IO and P&I repayments and a new compulsory Customer Acknowledgement form to be submitted with all home loan applications that have interest-only payments to ensure that IO payments meet customer needs. CBA said that brokers must complete the simulator for all customers who are considering IO payments irrespective of whether the customer chooses to proceed with them. These requirements will be mandatory for all brokers and will become effective on Monday, 9 October.

Suncorp announced it is introducing new pricing methodology for interest only home lending. Variable interest rates on existing owner-occupier interest only rates will increase by 0.10% p.a and variable interest rates on all investor interest only rates will increase 0.38% p.a., effective 1 November, 2017.

But what about property demand and supply?

The ABS said Australia’s population grew by 1.6% during the year ended 31 March 2017. Natural increase and Net Overseas contributed 36.6% and 59.6% respectively. In fact, all states and territories recorded positive population growth in the year ended 31 March 2017, but Victoria recorded the highest growth rate at 2.4%. and The Northern Territory recorded the lowest growth rate at 0.1%. Significantly, Victoria, the state with the highest growth rate is currently seeing the strongest auction clearance rates, strong demand, and home price growth. This is not a surprise, given the high migration and this may put a floor on potential property price falls.

On the other hand, we also see an imbalance between those seeking to Trade up and those looking to Trade down, according to our research. Those trading up are driven by expectations of greater capital growth (42%), for more space (27%), life-style change (14%) and job change (11%). Those seeking to trade down are driven by the desire to release capital for retirement (37%), to move to a place which is more convenient (either location, or for easier maintenance) (31%), or a desire to switch to, or invest in an investment property (18%).  In the past we saw a relative balance between those seeking to trade up and those seeking to trade down, but this is now changing.

Intention to transact, highlights that relatively more down traders are expecting to transact in the next year, compared with up traders. Given that there around 1.2 million Down Traders and around 800,000 Up Traders, we think there will be more seeking to sell, than buyers able to buy. As a result, this will provide a further drag on future price growth, especially in the middle and upper segments of the markets, where first time buyers are less likely to transact. This simple demand/supply curve provides another reason why prices may soon pass their peaks. Up Traders have more reason to delay, while Down Traders are seeking to extract capital, and as a result they have more of a burning platform.

Finally, auction clearance rates were still quite firm, despite the fact that property price growth continues to ease and time on market indicators suggest a shift in the supply and demand drivers, especially in Sydney.

So, overall, banks are on one hand still wanting to grow their home loan portfolios (as it remains the main profit driver), but lending momentum is slowing, and underwriting standards are being tightened further, at a time when home price growth is slowing.

This leaves many households with loans now outside current lending criteria, households who are already feeling the pain of low income growth as costs rise. More households are falling into mortgage stress, and this will put further downward pressure on prices and demand.

So we think the risks in the mortgage market are extending further, and the problem is that recent moves to ease momentum have come too late to assist those with large loans relative to income. As a result, when rates rise, as they will, the pain will only increase further.

And that’s the Property Imperative weekly to 30th September 2017.