The Property Imperative Weekly To 27 May 2017

Are First Time Buyers really under the affordability gun? What will the impact of the surprising slowdown in residential construction be? And how will the bank levy play out in the light of this week’s ratings downgrades? Find out as you watch the latest edition of the Property Imperative weekly.

First, are first time buyers are really finding it more difficult to enter the property market at the moment? The most recent statistics showed there was a bounce in the number of buyers, and this has been attributed to low interest rates, stagnating property price growth and enhanced first home buyer incentives. This despite property investors beating other purchasers to the punch.

Genworth, the Lender Mortgage Insurer, changed their underwriting guidelines to include the First Home Owner Grant as an acceptable source if other true ‘genuine savings’ cannot be found. Genworth’s new conditions also places responsibility on the lender to ensure the borrower is eligible to receive a FHOG at the time of the application.

Demographer Bernard Salt’s jocular observation of young adults wasting money on smashed avocado has been put into perspective. Even if young Australian do give up extravagant brunches and put the funds towards saving for a house, it will take years, or even decades, to accumulate enough cash for the deposit and stamp duty on a home. A 20% deposit and stamp duty required to buy a house in Sydney is $159,000, based on new data from CoreLogic. That’s equivalent to 20 years’ worth of smashed avo.

But then again, do first time buyers really need a 20% deposit? Back in 2015, the Reserve Bank noted: “the deposit required of a first home buyer is more often in the 5–10 per cent range.” Whilst regulators have tightened the screws since then, there are still mortgages with below 20 per cent deposits to be found, according to data from RMIT’s Centre for Urban Research. Many of these rely on access to Lenders Mortgage Insurance, which of course protects the bank, not the borrower directly.

A report from Standard and Poor’s highlighted the risks in the Australian mortgage sector, and said that LMI’s might get squeezed by tightening lending restrictions and elevated claims, especially from loans in Western Australia and Queensland.

Our survey data on First Time Buyers indicates that there is incredibly strong demand for property, from both new migrants and existing residents. But that they are finding it harder to get funding, despite some grants being available, thanks to low returns on deposits, and low or no wage growth which is making it harder to save in the first place. We do see some lenders loosening their lending criteria for first time buyers with a saving history, but they are looking harder at household expenses, so overall funding is still harder to come by than a year ago. Our data shows this clearly, and our latest core market data is available now for paying clients.

So back to the Standard and Poor’s assessment of the housing sector, and their rating of the banks. Some were surprised when the ratings agency came out with an assessment before the latest round of house price data is out, but their latest assessment is finely balanced, on one hand calling out the elevated risks emanating from rising household debt and risks of a property correction, whilst on the other suggesting that recent regulatory intervention should help to manage the adjustment.

But overall, risks are higher and their revised credit profiles reflect this with more than 20 entities downgraded. Whilst the majors rating has not changed – reflecting the implicit government guarantee that their “too-big-to-fail” status gives them, and Suncorp remains at its current rating, despite a tough quarter; both Bendgio Bank and Bank of Queensland took a downgrade.

The consequence for these regionals is that funding costs just went up (and probably by more than a 6 basis point tax on the majors would have given in relative benefit). They have high customer deposits, but again the regional bank playing field is tilting against them when it comes to long term funding. This put the bank tax into a different light, as the Government argued the tax would help level the playing field.

In addition, the big banks came out with an estimate of the impact of the proposed tax. The budget papers estimated it would yield more than $6 billion over 4 years, based on a 6 basis charge on selected liabilities.  The banks say on an annual pre-tax basis they would pay around $1.38 billion annually, but only $965m post tax (as the tax would be an allowable expense). The Government confirmed the tax would be tax deductable.

So, the tax won’t deliver the planned revenue, and the 6 basis points benefit the regional banks might have been expected to see relative to the majors has been more than offset by the credit downgrades. This has led to calls to lift the tax to deliver the full planned value, and also extend it to large foreign banks operating here.

But there is a broader point to consider. The majors are protected by the implicit guarantee that if they got into financial difficulty, the Government would bail them out. S&P explained this is why they were not downgraded, but went on to say if Australia’s country rating fell, they would be. It seems clear that as the levy is making the implicit guarantee more explicit, (such that Macquarie who is caught by the levy, got a ratings upgrade, whilst others like Bendigo and Adelaide Bank did not); the reach of this implicit guarantee is in question. To put it sharply, would the Government really let Bendigo fall over; we think not. So the whole question of who has and who does not have this protection is in the air. This all has a direct impact on funding costs, and product pricing. So how this plays out will directly impact the interest rates paid by mortgage holders and to savers.  We think the need for a proper inquiry into the bank tax just got stronger. It’s worth remembering the UK’s approach to a bank tax took three goes to get right!

What seems to have been a late play for more revenue from the Government has descended into the complexity of bank funding and risk.

Finally, ten years on from the 2007 Global Financial Crisis, there were a number of good summaries of what we have learnt. One of the best was from the St. Louis Federal Reserve. They said the root causes of the crisis could be traced to excessive mortgage debt, sharply higher mortgage rates, an overheated housing market and a lack of broad oversight/insight.

Stepping forward to the current situation in Australia, it seems to me these factors are alive and well here. Household debt has never been higher, mortgage rates are set to rise further whilst incomes are squeezed, home prices are too high on any measure, and the regulators only recently started to react to the true impact of debt exposed households. This, in the week the latest personal insolvency data  showed a significant rise, not just in WA, but across the nation and residential construction slowed last quarter, suggesting the number of new starts will continue to fall.

There was an excellent research piece from institutional investment fund JCP Investment Partners, picked up in the AFR.  Their granular analysis of the mortgage sector (including leveraging our data), underscores the risks in the mortgage books, and explains the RBA’s recent change of tune on household finances. Critically, they showed that many households have very high loan to income ratios.

In the light of this, we think S&P called the market right, and it’s now a question of whether we will get an orderly adjustment or not. The jury is out, but the latest home price data is also suggesting a fall, despite ongoing high auction clearance rates.

At best, we remain on a knife edge. Check back next week for our latest update.

Household Finance Confidence Slips After Christmas Binge

We have released the latest edition of the Digital Finance Analytics Household Finance Confidence Index, to end January 2017 today, which is a barometer of households attitudes towards their finances, derived from our rolling household surveys.

The aggregate index fell slightly from 103.2 in December to 102.68 during January, but is still sitting above a neutral measure of 100, and the trend remains positive. However there are a number of significant variations within the index as we look across states and household segments. These variations are important

First, the state scores are wider now than they have ever been, with households in NSW the most positive, at 110, whilst households in WA slip further to 81. Households in VIC and SA also slipped a little, whilst households in QLD were a little more positive.

The performance of the property market is the key determinate of the outcomes of household finance confidence, with those holding investment property slightly more positive than owner occupied property owners, whilst those who are renting, or living with family or friends are significantly less positive. Whilst some mortgage holders have received or expect to see a lift in their mortgage rate, this is offset by strong capital growth in recent months. The NSW property holders, especially in greater Sydney are by far the most positive. Renters in regional WA, where employment prospects are weaker, are the least positive.

Looking in detail at the drivers of the index, we see a rise by 1% of households who are felling less secure about their employment prospects – especially those in part-time jobs – and more are saying they are under employed.

In terms of the debt burden, there was a 4% rise in those less comfortable about the debt they hold, thanks to rising mortgages, the Christmas spending binge and higher mortgage rates.

More household are saying their real incomes have fallen, up 3%, whilst those who say their costs of living have risen was up 8%.

To offset these negative indicators however, some households reported better returns from term deposits and shares, as well as a significant boost to capital values on their property. Those who said their net worth had risen stood at 64%, up 5% from last month.  The property sector is firmly linked to household confidence, and vice-versa.

By way of background, these results are derived from our household surveys, averaged across Australia. We have 26,000 households in our sample at any one time. We include detailed questions covering various aspects of a household’s financial footprint. The index measures how households are feeling about their financial health. To calculate the index we ask questions which cover a number of different dimensions. We start by asking households how confident they are feeling about their job security, whether their real income has risen or fallen in the past year, their view on their costs of living over the same period, whether they have increased their loans and other outstanding debts including credit cards and whether they are saving more than last year. Finally we ask about their overall change in net worth over the past 12 months – by net worth we mean net assets less outstanding debts.

New DFA Video Blog – Household Mortgage Stress and Defaults

Using data from our household surveys in this new video blog we discuss the findings from our latest modelling. More than 22% of households are currently in mortgage stress, and 1.9% of households are likely to default. Both are likely to rise next year.

 

So Where Will The Property Market Go In 2017?

Having looked at events in the Property Market in 2016, we now turn to our expectations for 2017. There are many uncertainties which may impact the market, but using our surveys and modelling as a guide, we can make some educated guesses.

First, mortgage rates will be higher by the end of 2017 than they are now. We have already seen the impact of the Trump Effect on capital markets, and these higher costs are already flowing into higher mortgage rates. This process will continue as banks fight for a share of the deposit market, and at the same time continue to build their capital buffers.  We think, on current trajectory rates could rise by more than half a percent, meaning the average repayment mortgage would rise by over $100 a month next year. Larger mortgages would rise by much more.

The RBA is unlikely to cut rates, and it is possible they may lift later in 2017 – but as the cash rate is disconnected from the mortgage rate, this is not necessarily such an important factor as in previous decades.

Many younger households are already using more than half their disposable income to repay their mortgage, and any increase will be very painful in a low income growth environment. We do not expect real incomes to rise at all next year, despite the rising costs of living and higher mortgage repayments.

As a result, we expect mortgage delinquency rates to continue to rise. There will be specific hot spots in the mining belts of Western Australia and Queensland, and we also expect to see problems emerging in the high-rise areas of Melbourne and Brisbane.

Households with a variable rate interest only loan will find their repayments rise more, with a half percent rise in rates translating to a monthly rise in repayments of $146. This illustrates the two problems with interest only loans, first they are more leveraged, so sensitive to rate changes, and second, households still have to find a way to repay the capital. No surprise therefore that the regulators have been forcing the banks to ensure interest only loan holders have a repayment plan, something which many currently do not possess. One third of borrowers could be impacted.

Mortgage finance will still be available, although we expect to see further tightening in underwriting standards, meaning that households will need larger deposits, and will not be able to borrow as much. Remember that our banks rely on mortgage book growth to sustain their business models, so the supply will not be turned off. We also expect to see ongoing lending from the non-traditional banking sector. Recently some of these players have been extending credit – at higher interest rates – to non-conforming loans, and foreign investors. This will continue. Regulation of the non-bank sector needs to be addressed.

We expect property investors to continue to pile into the market, especially in the eastern states, so the volume of investment loans will continue to rise. A high proportion of these will be interest only loans. Given the current tax settings, where negative gearing and capital gains assist investors, many see this as the best investment option, including those in a self-managed super fund.

We expect momentum in owner occupied lending will slow, as the rate of refinancing eases. In the first part of the year, we expect a rise in the volume of fixed rate loans, as households decided to fix at a rate lower than the market’s expectation. But beware, most fixed loans already imply a hike in rates, so many of the best deals have already gone. More households will turn to mortgage brokers for assistance, and we expect they will grow their market share to well above fifty percent.

Foreign investors will still be attracted to the market here, and migration will continue, so we expect to see ongoing support to prices in the main markets of Sydney and Melbourne and they will remain above long term fundamentals.

First time buyers will continue to be squeezed from the market, thanks to higher underwriting standards and flat incomes. A proportion of these households will choose to go direct to the investment sector as a result.

But net-net, demand will remain strong, auction clearance rates will be elevated, and property in many places will be in short supply.

As a result, we think home prices will in most centres continue to rise. We are certainly not anticipating a dramatic fall. This is because supply of new property is likely to slow in line with the fall in building approvals.

There will be specific areas across Australia however where prices are likely to fall. We expect further weakness in Western Australia and Queensland, and also in the apartment markets in Brisbane and Melbourne, as well as across a number of regional centres. But the core Sydney market, and houses in the broader Melbourne and Brisbane markets will remain strong.

We are expecting underemployment to become an important thematic next year. Many households, even those with multiple jobs, are not getting the levels of income they need to maintain their lifestyle. Whilst the core unemployment rate is unlikely to rise significantly, cash flow with be a major issue for many households. As a result, we do not expect to see any significant growth in personal credit – other than in the short-term credit sector, where online origination will stimulate demand. Household mortgage stress will continue to rise.

A number of factors are likely to weigh on household financial confidence next year. Rises in mortgage repayments, flat incomes and rising costs will all take their toll. However, ongoing property price growth, higher returns on bank deposits and higher stock market prices will counteract the drag. We expect property investors and home owners in the eastern states to remain quite bullish, despite depressed rental income growth. However, in WA, QLD and some regional centres, and among those living in rented accommodation, confidence will be significantly lower.

Banks will largely be able to buttress their profits, thanks to improved margins and low levels of mortgage default. As a result, we think the majors will mostly be able to maintain their payouts to their shareholders at current levels. Regional banks will remain under severe pressure, and we are not convinced that their drive to move to advanced capital models will be a panacea. We will also know the required final capital settings from Basel. We expect banks will need to hold more capital, and the benefits of advanced capital models be further reduced.

So in summary, expect higher mortgage rates and delinquencies to slow the property market a little, but momentum in the major centres is unlikely to stall completely because the banks need mortgage book growth to sustain their businesses. As a result, we expect household debit to be extended further.

Finally, a word on the broader economy. Housing momentum is not sufficient to replace the drop-off in mining investment, and given the reluctance of businesses to invest in growth, we think overall growth will still be sluggish. We might get a free kick from higher commodity prices – if they continue – but we do not have a realistic path to sustained growth. This structural issue needs to be addressed, and soon, if in the longer term the property market is to not go into a spiral of decline.  However, we do not think 2017 will be the start of that down cycle.

The 2016 Property Market In Review

Today we start a short series which will review the property market in 2016, and then look forward to 2017. We will start by looking at demand for property, then look at property and funding supply, before examining the risk elements in the market for both property owners, lenders and the broader economy.

Remember that there is more than six trillion dollars invested in residential property in Australia, three times as much as in the whole superannuation system, and close to a third of households rely on income from property, either directly or indirectly, (from rents, or jobs in the sector across construction, maintenance and management), to say nothing of the capital two thirds of Australians are sitting on thanks to strong recent price rises. So what happens to property really matters.

Property Demand

We start with demand for property. The latest data from our household surveys shows that demand for property is very strong. Two thirds of households have interests in property, and about half of these have a mortgage. Owner occupied home owners are a little more sanguine now, but property investors, after a wobble earlier in the year, are still strongly in the market. In addition, there is still demand from overseas investors, and migrants. Overall demand is now stronger than at the start of the year. This is reflected in continued high auction clearance rates, especially down the east coast.

First time buyers are finding it difficult to compete with cashed up investors, and with incomes static and tighter underwriting standards, it is harder than ever for them to enter the market.  Down traders – people looking to sell and release capital – are active, and are in the market for smaller homes, and investment property. Households seeking to trade up are also active, driven by the expectation of ongoing capital gains. Investors are attracted by the generous tax breaks, including negative gearing and capital gains.  This despite rental incomes falling again, and the fact that about half of investors are underwater on a cash-flow basis, though bolstered by continued capital gains.

So overall demand is strong, and it has not yet been impacted by the rising mortgage interest rate bias that we have seen in the past couple of months.

Property Supply

Turning to property supply, there have been a significant surge in new building, mainly in and close to the central business districts in Melbourne, Brisbane and to some extend in Sydney, though here new building is more widely spread. Well over two hundred thousand new properties are coming on stream and more than half of these will be high-rise apartments. That said forward approvals are slipping now, so we may have passed “peak build” in the current cycle.

We are also seeing significant subdivision of existing residential land, and a rise in new house construction as well. The average plot size continues to fall, but we still place larger buildings on these smaller plots.

In Sydney and Melbourne, the amount of housing on the market is not meeting demand, though this is not true in some other markets – for example in areas of Western Australia and Queensland, especially in the mining belts. The Reserve Bank is concerned about the impact of potential oversupply in apartments in the main centres.

Finance Supply

Turning to finance supply, Households can still get mortgage finance, but in recent times there has been a significant tightening of underwriting standards. Interest rate buffers are now higher than they were, income flows are being examined more critically, and lenders who are making interest only loans, which account for about one third of transactions, are looking for greater precision as to how the capital will be repaid later. Foreign investors are finding it harder to get a loan from the major lenders, although a number of smaller banks, and other non-traditional lenders are more than willing to do a deal. In addition, foreign income is now under greater scrutiny, following a number of recent frauds.

Overall credit growth is a little slower than a year ago, but at above 6% is still well above inflation and income growth. Within the mix, recently, investment mortgages have been growing faster than owner occupied loans. Household debt has reached an all-time high, thanks mortgage growth, with the ratio at 186 percent of debts to disposable incomes, one of the highest ratios in the world. Low interest rates mean that currently the servicing burden is not currently too bad, but this would change quickly if rates were to rise, thanks to excessive leverage.  Household savings ratios are falling.

Whilst unemployment rates remain controlled, at 5.6%, the main issue for many households is that real incomes are just not rising, and as a result, some are finding it harder to make their mortgage repayments on time. At the moment mortgage delinquency is rising, just a little, but faster in areas of WA and QLD.

Recently the Trump Effect has led to a rise in US bond yields, and this has had a knock-on effect in the capital markets, lifting the rates banks must pay for capital. As a result, we have seen the yield curve move up, and banks have been lifting their mortgage rates – somewhat selectively so far – with investors taking the brunt, but the trend is widening. The recent RBA cash rate cuts are being offset by these rises, and we think it unlikely the RBA will lower rates again, so mortgage rates will continue to rise. We will discuss the possible impact in 2017 later.

Summary

So we can say that 2016 has been a positive year for those in the market, with sizable capital gains for many, significant transaction momentum and construction, and in line with the RBA’s intention part of the re-balancing of the economy away from mining construction. The cost has been, first higher home prices, as well as larger pools of debt and more households excluded from the market.  Banks have 62% of their assets in residential property, a high, and are more exposed to the sector than ever, despite holding more capital than they did. We believe regulators should be doing more, but only reluctantly, and lately, are they coming to the party.

Next time we will look at prospects for 2017.

Property Purchase Expectations Are Still Strong

Today we continue our discussion of the latest Digital Finance Analytics household surveys, which looks in detail at intentions to purchase property in the next 12 months. This includes data up to late July, so is clear of potential election impacts. The analysis uses a large sample size, so is statistically robust. We use a segmentation model to flush out the main differences between household types. This is described in our publication “The Property Imperative” which is available on request. These results will flow into the next edition later in the year.

We start with some cross-segment comparisons. First, we find that households are just a little less confident house prices will rise in the next year, compared with 12 months ago. However, around half of all households still believe price growth will roll on. Property investors are the most optimistic, whilst those seeking to sell-down, the least.

DFA-Survey-Jul-2016---PricesLooking next at whether households expect to transact, we find that investors are mostly likely to make a purchase, but there is a continued rise among those wanting to refinance. 40% of those seeking to refinance expect to do so in the coming year.

DFA-Survey-Jul-2016---TransactTurning to borrower expectations, first time buyers, those trading up, and portfolio investors are most likely to seek additional mortgage funding. In fact, as interest rates have fallen, demand is even stronger.

DFA-Survey-Jul-2016---BorrowThose saving to assist in a purchase are mainly confined to households who are yet to transact, or who are trading up. More than 70 per cent of first time buyers wishing to purchase, continue to save.

DFA-Survey-Jul-2016---SavingWe will look in more detail at the forces which are driving investors in a later post, but this summary chart gives a good flavour of what we found. Tax efficiency is the single most powerful driver, and property capital appreciation is also important. Together these are perceived to give better returns that from deposits (in this low interest rate environment).  Around 15 per cent of investors cited the low finance rates currently available.

DFA-Survey-Jul-2016---All-InvFinally, in this post, we look at which household segments are most likely to use a mortgage broker. Given that half of all new transactions are originated via this route, understanding which customer groups are most likely to reach of advice is important. Those seeking to refinance are most likely to transact via a broker.

DFA-Survey-Jul-2016---Broker Next time we will look at some of the more detailed segment specific analysis. But in summary, whilst property transaction, and lending volumes may be falling, there is still strong demand for property. This will provide ongoing support for prices in the coming months, and also suggests that households will be seeking deals from lenders. There is life in the old dog yet!

Latest DFA Report – The Property Imperative 5 – Just Released

The Property Imperative, Fifth Edition, published September 2015 is available free on request.

This report explores some of the factors in play in the Australian residential property market by looking at the activities of different household groups using our recent primary research, customer segmentation and other available data. It contains:

  • results from the DFA Household Survey to September 2015
  • a focus on underwriting standards and mortgage pricing
  • an update of the DFA Household Finance Confidence Index
  • a discussion of the impact of high house prices

Property-Imperative-5You can obtain a copy of the report, delivered via email here.

From the Introduction.

The Property Imperative is published twice each year, drawing data from our ongoing consumer surveys, research and blog. This edition dates from September 2015 and offers our latest perspectives on the ever-changing residential property sector.

We begin by describing the current state of the market by looking at the activities of different household groups using our recent primary research and other available data.

In this edition, we also look at current mortgage pricing dynamics and underwriting standards; update our household finance confidence index and discuss the impact of chronically high house prices over the longer term.

Residential property is in the cross-hairs of many players who wish to influence the economic, fiscal and social outcomes of Australia.

By way of context, the Australian residential property market of 9.53 million dwellings is currently valued at over $5.76 trillion and includes houses, semi-detached dwellings, townhouses, terrace houses, flats, units and apartments. In the past 10 years the total value has more than doubled. It is one of the most significant elements driving the economy, and as a result it is influenced by state and federal policy makers, the Reserve Bank (RBA), banking competition and regulation and other factors. Indeed the RBA is “banking” on property as a critical element in the current economic transition.

According to the RBA, as at July 2015, total housing loans were a record $1.48 trillion . There are more than 5.4 million housing loans outstanding with an average balance of about $243,000 . Approximately 61% of total loan stock is for owner occupied housing, while a record 39% is for investment purposes. Last month, more than half of new loans written were for investment purposes.

The relative proportion of investment loans leaped by nearly 2.5% to 38.9% thanks to a significant reclassification of loans by some lenders.

In addition, 39.7% of new loans issued were interest-only loans.

The RBA continues to highlight their concerns about potential excesses in the housing market . In addition Australian Prudential Regulation Authority (APRA) has been tightening regulation of the banks, in terms of supervision of lending standards, the imposition of speed limits on investment lending and has raised capital requirements for some banks . The latest RBA minutes indicates their view is these regulatory changes are slowing investment lending somewhat , though we observe that demand remains strong, and in absolute terms, borrowing rates are low.

The story of residential property is far from over!

Table of Contents:
1 Introduction 3
2 The Property Imperative – Winners and Losers 4
2.1 An Overview Of The Australian Residential Property Market 4
2.2 Home Price Trends 4
2.3 The Lending Environment 6
2.4 Bank Portfolio Analysis 9
2.5 Market Aggregate Demand 10
3 Segmentation Analysis 16
3.1 Want-to-Buys 16
3.2 First Timers 16
3.3 Refinancers 19
3.4 Holders 19
3.5 Up-Traders 20
3.6 Down-Traders 20
3.7 Solo Investors 21
3.8 Portfolio Investors 21
3.9 Super Investment Property 21
4 Special Feature – Current Mortgage Pricing Dynamics 24
4.1 Regulatory Context 24
4.2 Bank Reaction 25
4.3 Portfolio Implications 28
5 The DFA Household Finance Confidence Index 30
6 Who Benefits From High House Prices? 33
7 About DFA 35
8 Copyright and Terms of Use 36