Don’t bet the house on a property market correction

From The New Daily.

Experts have warned against predicting that property prices have peaked just yet.

A flurry of headlines this week generated by UBS analysts, Australian Financial Review columnists and others all warned that Sydney and possible Melbourne prices had peaked and we should brace for a correction.

Most were based on slower price growth in Sydney dwelling values and slight reductions in auction clearance rates compiled by CoreLogic, a property data firm.

However, CoreLogic director of research Tim Lawless cautioned against reading into the results (especially dwelling values, which are yet to be officially released for April) because April and May are generally weaker periods.

“Potentially there is some seasonality creeping into these numbers and that’s one of the reasons why I would probably suggest caution calling the peak right now before we see a few more months and see if the trend actually develops,” Mr Lawless told The New Daily.

“When we look at, say, a year ago or any sort of seasonality in the marketplace, yeah, we do generally see some easing in our reading around April and May.”

A further complication is that CoreLogic adjusted how it calculated dwelling values in May 2016 to account for seasonality. The result, according to Mr Lawless, is that “technically speaking, there are some challenges and complexities making a year-to-year comparison”, although he said the adjustments were “quite minor” and values could still be compared.

The change sparked a scandal last year, with the Reserve Bank ditching the company as its preferred data source after claiming it had overstated dwelling values in April and May.

Despite this, CoreLogic remains the most widely cited property data source because it reports dwelling values daily. But the most authoritative is the Australian Bureau Statistics, which has measured similar quarter-on-quarter falls in the past, especially between the December and June quarters. And yet, the trend has been ever upwards.

IFM chief economist Dr Alex Joiner agreed we shouldn’t jump to conclusions based on the latest statistics.

“I wouldn’t suggest that anyone looks at any month-to-month data in Australia and makes firm conclusions from it,” Dr Joiner told The New Daily.

“People might want to rush to call the top, but the trends are for gradually decelerating growth, and I think that’s about right.”

But if this is not the peak, the market is “very much approaching it” because the Reserve Bank and the banks are likely to lift interest rates even as wage growth stays low, Dr Joiner said.

“When that actually decelerates price growth, whether it’s this month or later in the year, I don’t know. But we’re certainly eeking out the very last stages of price growth in the property market.”

Sydney property prices down: CoreLogic

From The Real Estate Conversation.

CoreLogic has revealed the property market has been largely flat during the month of April, ahead of the release of its end-of-month numbers on Monday.

CoreLogic’s hedonic home value index for Australia’s top five property markets held virtually steady in the first 27 days of the month, indicating that the current cycle could be moving through its peak.

Sydney prices recorded a “subtle” decline, according to CoreLogic, a dramatic though welcome turnaround from the blistering 18.8 per cent increase recorded in March. The five-city aggregate also recorded an exceptionally strong result in March, rising 12.9 per cent despite a 4.7 per cent decline in Perth prices.

Leeanne Pilkington, deputy president of the Real Estate Institute of New South Wales, says the April decline in Sydney prices was only very slight, and will vary from suburb to suburb.

“None of my agents are telling me they’re worried about prices going down,” she said.

However, Pilkington said her agents are saying there a lower numbers at open houses, which means there could be less competition in the market between buyers.

“We’ve seen that [trend] with the lower clearance rate last week,” she said. Pilkington said clearance rates above 80 per cent were not sustainable, and that a modest decline in clearance rates would actually be desirable.

“We really want some stability in the market,” she said.

Pilkington said April was a holiday month, containing both Easter and ANZAC day, so the numbers for the month may not reflect the true state of the market. Auction clearance rates over the weekend will provide clearer guidance, she said.

Tim Lawless, head of research Asia Pacific with CoreLogic, attributes the flat overall result to recent regulatory changes which have led to higher mortgage rates and weaker investment demand, causing a “dampening” effect on the property market.

Housing’s Echo Bubble Now Exceeds The 2006-07 Bubble Peak

From Of The Two Minds Blog.

If you need some evidence that the echo-bubble in housing is global, take a look at this chart of Sweden’s housing bubble.

A funny thing often occurs after a mania-fueled asset bubble pops: an echo-bubble inflates a few years later, as monetary authorities and all the institutions that depend on rising asset valuations go all-in to reflate the crushed asset class.

Take a quick look at the Case-Shiller Home Price Index charts for San Francisco, Seattle and Portland, OR. Each now exceeds its previous Housing Bubble #1 peak:

Is an asset bubble merely in the eye of the beholder? This is what the multitudes of monetary authorities (central banks, realty industry analysts, etc.) are claiming: there’s no bubble here, just a “normal market” in action.

This self-serving justification–a bubble isn’t a bubble because we need soaring asset prices–ignores the tell-tale characteristics of bubbles. Even a cursory glance at these charts reveals various characteristics of bubbles: a steep, sustained lift-off, a defined peak, a sharp decline that retraces much or all of the bubble’s rise, and a symmetrical duration of the time needed to inflate and deflate the bubble extremes.

It seems housing bubbles take about 5 to 6 years to reach their bubble peaks, and about half that time to retrace much or all of the gains.
Bubbles have a habit of overshooting on the downside when they finally burst. The Federal Reserve acted quickly in 2009-10 to re-inflate the housing bubble by lowering interest rates to near-zero and buying over $1 trillion of mortgage-backed securities.

When bubbles are followed by echo-bubbles, the bursting of the second bubble tends to signal the end of the speculative cycle in that asset class. There is no fundamental reason why housing could not round-trip to levels below the 2011 post-bubble #1 trough.

Consider the fundamentals of China’s remarkable housing bubble. The consensus view is: sure, China’s housing prices could fall modestly, but since Chinese households buy homes with cash or large down payments, this decline won’t trigger a banking crisis like America’s housing bubble did in 2008.

The problem isn’t a banking crisis; it’s a loss of household wealth, the reversal of the wealth effect and the decimation of local government budgets and the construction sector.

China is uniquely dependent on housing and real estate development. This makes it uniquely vulnerable to any slowdown in construction and sales of new housing.

About 15% of China’s GDP is housing-related. This is extraordinarily high. In the 2003-08 housing bubble, housing’s share of U.S. GDP barely cracked 5%.

Of even greater concern, local governments in China depend on land development sales for roughly 2/3 of their revenues. (These are not fee simple sales of land, but the sale of leasehold rights, as all land in China is owned by the state.)

There is no substitute source of revenue waiting in the wings should land sales and housing development grind to a halt. Local governments will lose a majority of their operating revenues, and there is no other source they can tap to replace this lost revenue.

Since China authorized private ownership of housing in the late 1990s, homeowners in China have only experienced rising prices and thus rising household wealth. The end of that “rising tide raises all ships” gravy train will dramatically alter China’s household wealth and local government income.If you need some evidence that the echo-bubble in housing is global, take a look at this chart of Sweden’s housing bubble. Oops, did I say bubble? I meant “normal market in action.”

Who is prepared for the inevitable bursting of the echo bubble in housing? Certainly not those who cling to the fantasy that there is no bubble in housing.

Top Of The Housing Cycle? – UBS

From Investor Daily.

Australian house price growth will slow to 7 per cent in 2017 before it collapses to between zero and 3 per cent in 2018, predicts UBS.

In a new housing outlook report, UBS said it is “calling the top” for Australian residential housing activity despite a surprise rebound in February approvals to 228,000.

While the “historical trigger” for a housing downturn is missing (namely, RBA interest rate hikes), mortgage rates are rising and home buyer sentiment is at a near record low, said UBS.

“Hence, we are ‘calling the top’, but stick to our forecasts for commencements to ‘correct but not collapse’ to 200,000 in 2017 and 180,000 in 2018,” said the report.

House prices are rising four times faster than incomes, noted UBS, which is unsustainable and suggests that growth has peaked.

“We see a moderation to [approximately] 7 per cent in 2017 and 0-3 per cent in 2018, amid record supply and poor affordability, with the new buyer mortgage repayment share of income spiking to a decade high,” said UBS.

The report also pointed to the March 2017 Rider Levett Bucknall residential crane count, which has more than tripled since 2013 to a record 548, but is now flat year-on-year.

Housing affordability has gone from “bad to even worse”, said UBS, with the house price to income ratio soaring to a record 6.5.

“With record low rates, repayments haven’t yet reached historical tipping points where prices fell, but would if mortgage rates rose by only [approximately] 100 basis points,” said the report.

The gross rental yield for two-bedroom unit has fallen to a record-low of less than 4 per cent, said UBS, which is now below mortgage rates of 4.25-4.50 per cent.

UBS also pointed to Australia’s household debt to GDP ratio of 123 per cent, which is one of the highest in the world.

Are regulators too concerned about housing?

From Australian Broker.

Although dwelling valuations in Australia are 5-15% above historical averages, the risk of a catastrophic collapse in the housing market is low, argues Merlon Capital Partners, a Sydney-based boutique fund manager.

In its latest paper, entitled Some Thoughts on Australian House Prices, Merlon acknowledged that the nation is currently at a cyclical high point, with “house prices, housing finance activity and building approvals … all at historically elevated levels.” At the same time, interest rates are at record lows and have begun to hike, particularly for investors.

“We think the housing market is 5-15% overvalued relative to ‘mid-cycle’ levels. Contrary to recent commentary, we do not find this over-valuation to be concentrated in the Sydney market,” said Hamish Carlisle, analyst at Merlon Capital Partners.

Carlisle doesn’t find the modest system-wide overvaluation to be particularly surprising at the current point in the economic cycle, and notes that the nation is a long way off from what are considered to be “mid-cycle” interest rates. “Rising interest rates – as we are currently experiencing – are likely to be a precursor to a turn in the cycle so it is likely we will enter into a phase of more subdued house price inflation.”

Favourable tax treatment of housing, coupled with historically low interest rates and favourable fundamentals (i.e. income and rental growth), mean that it’s highly unlikely that house prices will retrace to “mid-cycle” levels in the foreseeable future.

Carlisle further asserts that regulator concerns about house prices are “overblown”. Growing regulatory restrictions, which force banks to ration lending, particularly to property investors, are probably unnecessary and will achieve little other than improving the short-term profitability of banks via higher interest rates for borrowers.

“As with all our investing, we work on the basis that, over time, interest rates will revert back to long term levels as will aggregate housing valuation metrics. Against this, we think aggregate rents and household incomes will continue to grow which will cushion the overall impact on dwelling prices and that the exposure of the household sector to higher interest rates means that the time frame over which interest rates will rise could be quite protracted. As such, we think the risk of a catastrophic collapse in the housing market is low,” he said.

Reserve Bank governor Philip Lowe zeroes in on bank lending

From The Australian Financial Review.

The Reserve Bank of Australia under governor Philip Lowe has backed the concerns of regulators about bank lending standards, seizing on the rising number of households who are a month away from missing a mortgage payment in his first major review of the financial system.

Dr Lowe has zeroed in on a rise in the percentage of households who have a buffer of less than one month’s mortgage payments, in contrast with the last review conducted under his predecessor which saw risks abating.

The RBA has put the spotlight firmly bank on the banks in its twice yearly report by noting “one-third of borrowers have either no accrued buffer or a buffer of less than one month’s payments”.

This latest study of the financial architecture adds more detail to the worrying picture emerging about the unbalanced housing market. It follows concerns from the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority about a build up of risks and warnings from credit ratings agencies that the property market could face an orderly unwinding of prices.

The RBA also noted that these risks would have consequences for the banks themselves, pointing to the prospect of additional losses on mortgage portfolios for banks with exposures to the mining sector.

Significant pivot

The focus on households and the state of their balance sheets marks a significant pivot from the previous Financial Stability Review released one month before Dr Lowe was made governor and found that risks to households had lessened.

Founder of boutique research house Digital Finance Analytics Martin North said it was about time the Reserve Bank woke up to the risks posed by higher levels of household debt and stagnant incomes.

“This situation hasn’t fundamentally worsened in six months so it stands to reason what has changed is the RBA’s perception of the world,” Mr North said.

Statistics from Digital Finance Analytics show the percentage of Australian households that are cutting back expenditure, dipping into savings or using credit facilities to meet mortgage payments has risen to 22 per cent following a series of out-of-cycle rate rises from the banks.

Mr North said the number of households experiencing some level of financial stress would rise to 26 per cent in the case of a 50 basis-point rise. If they were to rise by another 100 basis points the percentage would rise to 31.1 per cent.

Big four data supports warning

Data published by the big four banks supports the warning from the RBA with anywhere between 20 and 40 per cent of big four bank mortgage holders just a misstep away from missing a mortgage payment.

ANZ and NAB, which measure the percentage of mortgage holders who do not have buffers of one month or more, count 61 per cent and 27.7 per cent of their customers respectively in the non-buffer bracket.

Commonwealth Bank and Westpac, which use a less stringent buffer measure to include any additional repayment and factor in offset accounts, put 23 per cent and 28 per cent of customers in the RBA’s danger zone.

Annual result data from the banks shows that the percentage of customers who do not have sufficient buffers have worsened by between 2 per cent and 3 per cent over the last 12 months alone.

The worsening position of households has been attributed to rising healthcare and energy costs combined with out-of-cycle rate rises and flat incomes.

Mr North noted that much of the data on households was predicated on the HILDA data which had a lag of several years.

“We have always had households that struggle to make mortgage payments,” Mr North said. “So the intriguing question for me is why have they woken up now? It could be that the governor has taken a different view on household debt.”

‘This thing’s gonna blow’: Top economists’ interest rate warning

From The Sydney Morning Herald.

Deloitte Access Economics’ quarterly business outlook, released today, predicts the official cash rate of 1.5 per cent will climb slowly in 2018 and 2019 to reach 3 per cent in the early 2020s.

The Reserve Bank was well aware “interest rates are now a massively more potent weapon for slowing the Australian economy than they’ve ever been before”, the forecaster said.

It noted Australian families have overtaken the Danish in recent months to become the world’s second most indebted households after the Swiss, relative to income – a consequence of “dangerously dumb” house prices.

Director Chris Richardson told Fairfax Media a crisis could be averted if, as he predicted, interest rates rose slowly and steadily. But cheap credit and high leverage still posed risks.

“In global terms our housing prices are asking for trouble,” Mr Richardson said, arguing many workers have found their homes make more money each day than they do. “That’s kind of God’s way of saying: this thing’s gonna blow.”

Sydneysiders were particularly vulnerable, Deloitte found, having benefited enormously from low interest rates but now witnessing “silly prices” that continued to grow – a “rather worrying development” in Deloitte’s eyes.

“The seeds of future slowdown are already well and truly sown. The better that NSW looks now, the greater the troubles that this state is storing up for the future,” the outlook warned.

“The joy of rising wealth eventually gives way to the pain of servicing gargantuan mortgages. Interest rates are beginning to rise around the world and although official interest rates in Australia may not follow suit until 2018, that augurs badly for the disposable incomes of Sydneysiders.”

Martin North, principal of Digital Finance Analytics, expressed concern Australia could be heading for a version of the US sub-prime mortgage crisis that preceded the Global Financial Crisis.

The parallels involve spiralling household debt, stalled incomes, rising levels of mortgage stress and interest rates that are on the way up.

Mr North’s modelling shows 669,000 families (or 22 per cent of borrowing households) are in mortgage stress. That would rise to 1 million households, or one third of borrowers, if interest rates rose by 3 percentage points.

But the main factors in Mr North’s reckoning are the static nature of wages and the rising tide of under-employment.

“This falling real income scenario is the thing that people haven’t got their heads around,” he told Fairfax Media.

“Unless we see incomes rising ahead of inflation and under-utilisation dropping, any increase in interest rates is going to have a severe impact on [people’s] wallets and therefore in discretionary spending and therefore on growth.

“I have a feeling we are meandering our way, perhaps a little bit blindly, into a rather similar scenario to the US.”

Mr North said mortgage stress was not only an issue for battlers and people on the urban fringe, but increasingly affected more affluent, highly leveraged households.

He dismissed the possible solutions put forth by Treasurer Scott Morrison as “political theatre” and invoked former prime minister Paul Keating by arguing Australia may be heading for “the correction we have to have”.

“I’m not sure that there are other levers that are available,” he said.

The Deloitte report also poured scorn on cutting immigration to boost housing affordability, an idea backed by former prime minister Tony Abbott among others.

London Housing Market Takes A Bath

At the end of 2016 we reported that the formerly invincible London home market had suffered its biggest crack in years, when home prices plunged the most in six years according to Rightmove via Zero Hedge.

Asking prices in London dropped 4.3% in December with inner London down 6%.  Meanwhile, the most exclusive neighborhoods, like Kensington and Chelsea, recorded even sharper declines at nearly 10% as home buyers migrated to cheaper areas of the city.

While it was unclear what was the catalyst: whether post-Brexit nerves, China’s crackdown on capital outflows, the ongoing depressed commodity market, or reduced migrations by wealthy Russian and Arab oligarchs, what is obvious is that the slump has continued, and according to the Royal Institution of Chartered Surveyors, its price balance for the city fell to the lowest since February 2009 last month, plunging to minus 49, which means that a greater percentage of agents reported drops in March.

Still, as Bloomberg reports, more respondents than not still expect prices in London to rise over the next year, the report showed. they may be disappointed.

Speaking to Bloomberg, Samuel Tombs at Pantheon Macroeconomics said that the London measure tends to represent the prime market rather than the city as a whole. The slump in the gauge tallies with other reports of sellers in central London having to cut prices to close deals.  Nationally, the RICS price index stayed at 22 in March, though the expectations for both values and sales over the next year weakened. New buyer inquiries and sales were stagnant, with the most expensive properties among the worst performers, according to report.

While buyers – especially those relying on mortgages – remain largely locked out of the market because of high prices, nervousness about Brexit and the U.K. outlook, price downside according to realtors may be “limited because of the continued shortage in the supply of property to buy, with estate agents’ listings reportedly at a record low.”

Which is odd because a cursory check reveals not only that there is a glut of high end properties, many of which have been on the market as long as a year, but that despite huge discounts as high as 40%, nothing is moving, and just this one listing service has no less than 124 pages of properties – at 15 properties per page – with price declines in Kensington and Chelsea alone, up from “only” 53 pages when we last looked at the same website back in December.

“High end sale properties in central London remain under pressure, while the wider residential market continues to be underpinned by a lack of stock,” said Simon Rubinsohn, RICS chief economist. “For the time being it is hard to see any major impetus for change in the market, something also being reflected in the flat trend in transaction levels.”

Tracing The Rise Of Mortgage Stress

We updated our mortgage stress models recently, which showed that around 669,000 households are in stress, which represents 21.8% of borrowing households.  Those results are a point in time view of households finances. The RBA also said that one third of households have no mortgage buffer.

Today we take a longer term view of the rise of mortgage stress, which is driven by a combination of larger mortgages, flat incomes, higher living costs and rising debt.

The first chart tracks household debt to disposable income from the RBA, as well as mortgage rates, the cash rate and both CPI and wage growth.

Stress levels rose consistently through the  early 2000’s as debt and mortgage rates rose, to reach a peak of 19%, when the cash rate was 7.25%, the average variable mortgage rate was 9.35% and the household debt to disposable income sat at around 170. Those with a long memory may remember that we were warning about this trend in the 2000’s.

But then the GFC hit, rates were cut, and mortgages rates fell sharply to 5.8%. However the debt to disposable income ratio only fell a little to 168.

Lower rates stoked demand for property, so prices started to rise, and mortgage rates moved higher, then lower as the RBA used housing to try to fill the gap left by the mining sector moving into the production phases.  Household debt to disposable income has since moved higher to a new high of 189 and is still rising.

During more recent times, mortgage stress and household debt has been moving up – and the latest stress data shows an acceleration as income growth all but stalls, and costs of living keep going, mortgage rates are rising.

To look at this in more detail, here is the same data, but with CPI and wage growth now mapped to stress and the cash rate. The fall in wage growth is significant, and this has now become one of the main drivers of stress.

My point is, nothing has suddenly changed. The inexorable rise in household debt, especially in a low wage growth scenario was obviously going to lead to issues (see our posts from 3 years back!) and so the RBA’s apparent volte-face is a welcome paradigm shift, but late to the party. Perhaps the New Governor had a different perspective from the previous incumbant!

Of course the question now is, can this be managed without a property correction?  Probably not.  Read our definitive guide to mortgage stress here.

One final point. In the recent Financial Stability report, the RBA used HILDA data to argue that household financial stress was not too bad.  But the data is not that recent, latest from 2014 and 2015, and since then our surveys highlight that some more affluent households are also being squeezed, especially as mortgage rates rise, and their incomes stall; they are highly leveraged.

The HILDA Survey also includes questions on financial stress experienced by households over the previous year.  There was a broad-based decline in the share of households experiencing episodes of financial stress between 2001 and 2015 (the time span available in the HILDA Survey). Nonetheless, households that were highly indebted in a particular year had a greater
propensity to experience financial stress. For instance, households that were highly indebted in 2002 were more likely to experience at least one incidence of financial stress in all other years compared with households that were less indebted in 2002 (Graph C5, right panel). The result also holds true for other cohorts. This suggests that a greater share of highly indebted households face financial difficulties and are more likely to be vulnerable to events that affect their ability to repay their debt, such as income declines or increases in interest rates.

Overall, these data highlight that highly indebted households can be more vulnerable to negative economic shocks and pose risks to financial stability. In particular, highly indebted households are less likely to be ahead of schedule on their mortgage repayments and they are more likely to experience financial stress, hence could be more vulnerable to adverse macroeconomic shocks. The consequent effects of this stress on the broader economy may be exacerbated by the disproportionately large share of investor housing debt owed by highly indebted households. Hightened investor demand can contribute to the amplification of the cycles in borrowing and housing prices, particularly when this investment is highly leveraged. Nonetheless, HILDA data also show that much of the debt held by highly indebted households is owed by households with high income and wealth, who are typically better placed to service larger amounts of debt.


HIA Housing Affordability

Turning falling home prices into good news is quite an art, but one which HIA managed in their release today!

The latest HIA Affordability Report indicates that there has been a steady improvement in housing affordability during the opening months of 2017.

The largest improvement in housing affordability during the March 2017 quarter occurred in Perth (+5.6 per cent), followed by Hobart (+5.3 per cent) and Sydney (+5.0 per cent). Smaller gains in affordability affected the markets of Brisbane (+0.6 per cent) and Melbourne (+0.4 per cent). Of the capitals where affordability declined, the biggest fall was in Canberra (-7.2 per cent) followed by Adelaide (-4.0 per cent) and Darwin (-0.1 per cent).

The HIA Affordability Index results for the March 2017 quarter indicate that conditions are most challenging in Sydney, which has the lowest score (57.5), followed by Melbourne (70.7) and Canberra (78.5). The fourth most difficult capital city for affordability is Brisbane (86.8) with Darwin in fifth place (89.5) and Adelaide in sixth (90.5). By a wide margin, Hobart (113.9) remains the most affordable capital city in Australia followed by Perth (99.5).

“During the March 2017 quarter, the HIA Affordability Index improved by 1.9 per cent – and is 1.2 per cent better than this time last year,” commented HIA Senior Economist, Shane Garrett.

“The improvement in affordability is mostly due to a reduction in the national median dwelling price during the March 2017 quarter,” said Shane Garrett.

“Despite these latest results, housing affordability remains a significant challenge. There are good ways to improve affordability – and bad ways. The right approach to tackling affordability is through continuing
to secure the delivery of an appropriate supply of new homes and to reduce the barriers and costs involved in doing this,” explained Shane Garrett.

“With respect to delivering better housing affordability outcomes over the longer term, this week’s comments by the Treasurer in relation to leveraging private investment for affordable housing stock are very welcome,” concluded Shane Garrett.