Investment Property – Page 4 – Digital Finance Analytics (DFA) Blog

Property Investors Still Hot To Trot

Continuing our analysis of the latest DFA household surveys, we look at the investor segment. You can find our segment definitions here. We start by estimating the number of investors in the market. Overall, there are 2.16m households with investment properties, up from 2.01m in 2014. The growth is explained by the entry of increasing numbers of first time buyers, and more down traders becoming active.

We also see the continued rise in the number of portfolio investors – households with a portfolio of investment properties, to nearly 200,000. A significant proportion will have more than five properties. Around 75% of portfolio investors expect to transact within the next 12 months, 49% of solo investors and 52% of down traders.

First time buyers are increasingly going direct to the investment sector, with more than 50% of first time buyers in Sydney following this path. We have explained why this is occurring in a recent video blog.

The latest motivation data suggests that appreciating property value, and tax effectiveness remain the main drivers to transact. They are also influenced by low finance rates, and the ability to get better returns than from deposits. A rising number of investors are now relying on rental income for future living expenses, this is especially true among down traders, who need higher returns than bank deposits. Some barriers to transact do exist, the main issues are that they have already bought, and are not considering another purchase (38%), that prices are getting too high (20%) and some concerns about the changing regulatory environment – leading to availability and price of finance (22%). But concerns about rising interest rates, budget changes and RBA warnings are relatively low. We did note a slight rise in those unable to get finance – the main reason was that the transaction LVR was too high to meet current underwriting rules.

Finally, we continue to see a rise in property purchased through superannuation. Tax efficiency and appreciating property values, backed by low finance rates are key. We think that about 5% of transactions are now within superannuation.

So it reconfirms that property is really just another investment asset class, and many are using the current gearing and capital gains tax breaks quite logically. As we have discussed before, this is distorting the overall marker, and excluding many potentially willing owner occupied purchasers from the market.

RBA Says Negative Gearing Should Be Reviewed

In the RBA’s submission to the Inquiry on Home Ownership, they argue that negative gearing for investment property should be reviewed, because it has the potential to raise risks in the market, lift prices and distort the market.

Housing, particularly owner-‐occupied housing, receives preferential taxation treatment in many countries, and Australia is no exception. Australia’s taxation system is also relatively generous to small investors in buy-‐to-‐let property compared with some other countries, because investors can deduct losses from their investments against wage income as well as other property income, and because capital gains are taxed at concessional rates. However, there are some other countries where the tax preference for investor property is even stronger than in Australia.

Geared investment increases with age and income, though we should be cautious, as the ATO data is of course income for tax purposes, post offsets.

The Bank believes that there is a case for reviewing negative gearing, but not in isolation. Its interaction with other aspects of the tax system should be taken into account. The ability to deduct legitimate expenses incurred in the course of earning income is an important principle in Australia’s taxation system, and interest payments are no exception to this. To the extent that negative gearing induces landlords to accept a lower rental yield than otherwise (at least while continued capital gains are expected), it may be helpful for housing affordability for tenants. It is worth noting, however, that the interaction of negative gearing with other parts of the taxation system may have the effect of encouraging leveraged investment in property.

Interesting given the UK budget announcement last week to reduce negative gearing there, for the same reasons. So, is economic logic and political positioning pulling in two different directions? The evidence that removal of negative gearing would drive rents up is shaky at best, and the weight of argument is definitely for reform.

You can hear my thoughts on ABC Radio National’s AM Programme this morning.

UK Budget Emasculates Negative Gearing

This week the UK Chancellor, George Osborne delivered his latest budget. One strong theme was the need to reduce the bias towards buy-to-let property investors against owner occupied purchasers. Currently, landlords can claim tax relief on monthly interest repayments at the top level of tax they pay of 45 per cent. Mortgage interest relief is estimated to cost £6.3billion a year. Buy-to-let lending has accounted for more than 15% of mortgages taken out – compared with 50% of new mortgages in Australia. The UK has seen the proportion grow by 8% in recent years.

“First, we will create a more level playing-field between those buying a home to let, and those who are buying a home to live in. Buy-to-let landlords have a huge advantage in the market as they can offset their mortgage interest payments against their income, whereas homebuyers cannot. And the better-off the landlord, the more tax relief they get. For the wealthiest, every pound of mortgage interest costs they incur, they get 45p back from the taxpayer. All this has contributed to the rapid growth in buy-to-let properties, which now account for over 15% of new mortgages, something the Bank of England warned us last week could pose a risk to our financial stability. So we will act – but we will act in a proportionate and gradual way, because I know that many hardworking people who’ve saved and invested in property depend on the rental income they get. So we will retain mortgage interest relief on residential property, but we will now restrict it to the basic rate of income tax. And to help people adjust, we will phase in the withdrawal of the higher rate reliefs over a four year period, and only start withdrawal in April 2017”.

So now, this will change, in a move which will ‘level the playing field for homebuyers and investors’, according to the Chancellor, the amount landlords can claim as relief will be set at the basic rate of tax – currently 20 per cent. The change will be tapered in over the next four years. The expectation is that as a result more first time buyers will be able to enter the market.

The Bank of England recently said it would monitor buy-to-let lending more closely, and analysts are concerned about the potential impact should UK rates rise, even with the current incentives in place. A record of a June 24 meeting of the BoE’s Financial Policy Committee shows the bank asked staff to gather evidence for the government consultation later this year, and to look at what action it could take before gaining further formal powers. Last week the Bank of England warned that a surging buy-to-let market could pose a risk to financial stability as landlords are potentially more vulnerable to rising interest rates.

This mirrors concerns raised by the Reserve Bank of New Zealand who cite considerable evidence that investment loans are inherently more risky:

the fact that investment risks are pro-cyclical
that for a given LVR defaults are higher on investment loans
investors were an obvious driver of downturn defaults if they were identified as investors on the basis of being owners of multiple properties
a substantial fall in house prices would leave the investor much more heavily underwater relative to their labour income so diminishing their incentive to continue to service the mortgage (relative to alternatives such as entering bankruptcy)
some investors are likely to not own their own home directly (it may be in a trust and not used as security, or they may rent the home they live in), thus is likely to increase the incentive to stop servicing debt if it exceeds the value of their investment property portfolio
as property investor loans are disproportionately interest-only borrowers, they tend to remain nearer to the origination LVR, whereas owner-occupiers will tend to reduce their LVR through principal repayments. Evidence suggests that delinquency on mortgage loans is highest in the years immediately after the loan is signed. As equity in a property increases through principal repayments, the risk of a particular loan falls. However, this does not occur to the same extent with interest-only loans.
investors may face additional income volatility related to the possibility that the rental market they are operating in weakens in a severe recession (if tenants are in arrears or are hard to replace when they leave, for example). Furthermore, this income volatility is more closely correlated with the valuation of the underlying asset, since it is harder to sell an investment property that can’t find a tenant.

Reaction from the UK has been predictable, with claims the changes will put rents up, slow new property builds, and lead to a deterioration in the maintenance of existing rental property. In addition, some claim it will lead to landlord deciding to sell their property, releasing more into the market. Finally, there is debate about the comparison between investors and owner occupied property holders – Homeowners are not running businesses nor do they pay capital gains tax, for example, on disposal of their property.

That the UK is taking steps when 15% of property is buy-to-let should underscore the issues we have here when 35% of all mortgages are for investment property, and more than half of loans written last month were for investment purposes. This is bloating the banks balance sheets, inflating house prices, and making productive lending to businesses less available. The UK changes provides more evidence it is time to reconsider negative gearing in Australia

Australia Becoming a Nation of Landlords – AFR

The AFR report cited research provided by DFA from our household surveys.

Australia is becoming a nation of landlords as record-high real estate prices force house-hunters into buying and renting investment properties rather than becoming owner-occupiers, analysis of purchases reveals.

Property investors are also becoming younger and more likely to own several rental properties, with the number of investors with more than five properties having increased by 35 per cent in the past 12 months, from 175,000 to 272,000, according to research by Digital Financial Analytics.

For the first time since records began, more first-time buyers are expected to be investors rather than owner-occupiers by the end of this year, heralding a major change in the nation’s home-owning culture, the research reveals.

The big increase in property investment is “a tower of dominoes”, said Martin North, principal of Digital Financial Analytics, a research firm that works for big banks and financial services companies.

“The question is whether fundamentals like a shortage of supply being soaked up by tenant demand will get us out of jail,” he said. “I think we probably have enough disequilibrium between supply and demand to support the market for the next couple of years.”

Mr North’s research highlights the number of first-time property buyers who rent the property and then remain at home with their parents or live in a communal arrangement with friends.

During the same period, the number of want-to-buys, first-time buyers, refinancers, up-traders and down-traders remained about the same.

The number of loans to first-time buyers fell in all states and territories except Tasmania during the March quarter, according to government statistics.

Loan spruiking widespread

Financial advisers are routinely being offered commissions of between 5 per cent and 10 per cent, or fees of $25,000, to encourage investors to take out limited-recourse loans to buy apartments.

Alternatively, finance brokers, who often work with developers, have been encouraging the widespread use of non-bank interest-only loans using the equity in the investor’s home as security and borrowing about 20 per cent of the value of the investment property to cover the deposit and purchase.

Rental income from the investment property is expected to cover all costs and any capital growth is then leveraged to buy the next property.

Interest-only loans only require repayment of the interest on the loan over the rolling five-year borrowing term.

Mario Borg , a finance strategist at Melbourne-based Strategic Finance who owns 10 properties and estimates his worth at more than $10 million, disagrees that portfolio investors are exposed to excessive risk.

Borg believes attractive properties where people want to live will always find a tenant and is confident the right financing structures will protect portfolios from market corrections. He never allows the loan-to-value ratio to drift above 50 per cent of the portfolio’s value and maintains a credit limit of 80 per cent of the portfolio value to cover any unforseen events.

Christopher Foster-Ramsay, owner of Foster Ramsay Finance, says investors need to be aware of the risks, particularly if prices begin to fall.

“Many want to live the dream without understanding what they are potentially getting into,” he said.

By any international standard, such as loan-to-income ratio or gross domestic product-to-house prices, the nation’s bill for house buying is about 30 per cent above the long-term trend.

Home Loans Up, Mix Changing, APRA

The Australian Prudential Regulation Authority (APRA) today released Quarterly Authorised Deposit-taking Institution Property Exposures for the March 2015 quarter.

Quarterly ADI Property Exposures contains information on ADIs’ commercial property exposures, residential property exposures and new housing loan approvals. Detailed statistics on residential property exposures and new housing loan approvals are included for ADIs with greater than $1 billion in housing loans.

ADIs’ commercial property exposures were $234.2 billion, an increase of $15.1 billion (6.9 per cent) over the year. Commercial property exposures within Australia were $193.3 billion, equivalent to 82.5 per cent of all commercial property exposures.

ADIs’ total domestic housing loans were $1.3 trillion, an increase of $107.1 billion (9.0 per cent) over the year. There were 5.3 million housing loans outstanding with an average balance of $243,000.

ADIs with greater than $1 billion of residential term loans approved $82.3 billion of new loans, an increase of $8.5 billion (11.5 per cent) over the year. Of these new loan approvals, $51.9 billion (63.0 per cent) were owner-occupied loans and $30.4 billion (37.0 per cent) were investment loans.

Looking in more detail at the data, looking first at the portfolio data, we see the rise on the value of home lending across the ADI’s and the rise in the proportion of investment loans in the mix. High LVR’s fell a little.

The mix of loan type shows a continuing slow rise in interest-only loans (28.9% of all loans) and offset loans (32.3%), and a slight fall in loans with redraw (77.1% of loans).

Across the portfolio, the average balance on interest-only loans is the highest, at $315,000, whilst reverse mortgages sat at $94,000.

Turning to approvals by quarter, we see a steady rise in approval volumes, with 37% by number investment loans. Remember that earlier APRA showed that more than 50% of loans by value were for investment loans, so we again see evidence that investment loans are larger by value.

Looking at LVR bands, we see a slight fall in loans over 90% LVR (from 14% to 11%) a slight rise in the 80-90% band, (from 16% to 22%). So the regulators influence is showing though to some extent.

Finally, we see that third party loans by volume (not value) fell from 45% to 42% this quarter. Interest only loans accounted for 42% of approvals. Low doc and loans outside serviceability were low.

So overall, we see buoyant loan growth, supported by rises in investment lending and interest only loans. We will be watching the data next quarter as the Regulators tighten the screws. We think the property worm is about to turn.

Latest Edition Of The Property Imperative Released Today

The Property Imperative, Fourth Edition, published April 2015 is available free on request. This report which summarises the key findings for our research into one easy to read publication. We continue to explore 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. Specifically we look at the property investment juggernaut and how we are becoming a nation of property speculators. It contains:

results from the DFA Household Survey to end March 2015
a focus on first time buyer behaviour and overseas property investors
an update of the DFA Household Finance Confidence Index

PropertyImperativeLarge Go here to request a copy.

From the introduction:

This report is published twice each year, drawing data from our ongoing consumer surveys and blog. This edition dates from April 2015.

The Australian Residential Property market is valued at over $5.4 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, Banking Competition and Regulation and other factors. Residential Property is therefore in the cross-hairs of many players who wish to influence the economic fiscal and social outcomes of Australia. The Reserve Bank (RBA) has recently highlighted their concerns about potential excesses in the housing market is on their mind, when considering future interest rate cuts.

According to the Reserve Bank (RBA), as at February 2015, total housing loans were a record $1.43 trillion , with investment lending now at a record 34.4%, and representing more than half of all loans made last month. There were more than 5.2 million housing loans outstanding with an average balance of about $241,000. Approximately two-thirds of total loans were for owner-occupied housing, while one-third was for investment purposes. 36.9% of new loans issued were interest-only loans. This report will explore some of the factors in play in the Australian Residential Property market. We will begin by describing the current state of the market by looking at the activities of different household groups leveraging recent primary research and other available data. We also, in this edition, feature recent research into first time buyers and foreign investors; and look at household finance confidence.

ABC Business Does Banks And Property

The second in a series of segments on Australian Property was aired tonight by the ABC. The discussion centered on the banks exposure to property. You can read the online post here. The video includes comments from DFA.

Latest DFA Survey – Investor Motivations

Continuing our series of updates from our latest household surveys, today we look at the latest investment property trends. Looking at solo investors first (using the DFA segmentation) we see the main drivers to transact relate to the continued potential for appreciating property values and the tax efficient nature of the investment. We also see an expectation of higher returns than deposits. This all explains why property investment is so hot. It is, from an investment perspective, for many, the best game in town. The average age for a first time property investor continues to fall, and now stands at 38 years, partly reflecting the rise of first time buyer investors, as we featured recently.

Turning to potential barriers which may stop investors transacting, current prices are not seen as a critical issue – only 18% said this was a turn-off. Whilst 45% had already transacted, there is still significant potential for further purchases, especially in the Sydney and Melbourne markets. We also see that whilst there is some recognition of potential changes to regulation (relating to LVR hurdles, interest only, and gearing), less than one third of investors are worried by this. Finally, only 15% were worrying about potential budget changes, we saw a spike after the budget last year, we may see the same again in our post budget survey. Nearly half expect to select an interest only loan.

Investing via a super fund is still a minority sport, though some investors are getting advice from internet forums, or mortgage brokers. We estimate about 3.5% of SMSF have an investment property in their fund, and a further 3% are actively considering this investment route.

Those who are thinking of a SMSF transaction continue to be attracted by tax efficient outcomes and appreciating property values. These drivers match the broader investment sector quite well as we showed above.

Finally we look at portfolio investors. This is becoming an ever more important sector, because the capital gains and imcone from current properties are being used to leverage further investment, to crease a self-sustaining (some would say critical mass) proposition. The proportion with a holding of 10 properties or more is steadily increasing. Again, these investors are driven by tax efficiency and appreciating property values and also an expectation of better returns than deposits. One trend we detected in this segment is the rise in the number of portfolio investors who now see property investment as their main source of income, it has essentially become their job.

Next time we will look at some of our other segment findings.

Urgent Action Required To Boost Business Lending

Today the data from RBA and APRA showed the strength of lending in the housing sector, and only 33% of lending is business related. This over-emphasis on property investment in particular is a systemic problem, and must be addressed if we are to drive growth in the right direction. Business needs more focus.

To illustrate the point, the mix between business lending and housing (both owner occupied and investment) is worth examining from 1990 onwards. Back then, business lending accounted for about 65% of all lending. Today it is 33%. As a result we know from our SME surveys that many businesses are finding it difficult to get funding on reasonable terms. On the other hand, we see lending for housing, and especially investment lending inflating the banks balance sheets and house prices, but this is not truly productive.

Its time to impose additional controls on investment lending, and to re-balance lending towards businesses who will be able to generate real economic growth for the country. The current situation, where household net worth grows…

… thanks to over-high house prices is not sustainable when it is powered by ever more household debt.

HouseholdRatios2

From our surveys, a quarter of households are less comfortable with the amount of debt they have compared with 12 months ago.

Any further interest rate cuts without these measures would be irresponsible.