Without a doubt, you’re all aware of the booming residential property market we’ve had for the last few years now. We’ve purposely left the word “bubble” out of our opening sentence, and you won’t see it again in this piece, as the word “bubble” means different things to different people and its original intended meaning has been lost over the years.

So where are we at with regard to national and capital city property prices and what moves are likely from the authorities to curb the current boom?

Nationally, a recent publication in the Australian Financial Review showed house price movements since the end of 1995 and the end of 1999 for Australia, UK, NZ, USA, and Canada.

The same publication also showed house price growth in those same countries since the GFC.

On the Australian capital city front, Sydney and Melbourne have grown the strongest since both the GFC and the November 2010 price peak.

This run has continued so far in the 2014 with Sydney prices up 11.5% year to date and Melbourne not far behind at 11%. In contrast, mining exposed cities Perth and Brisbane have growth at 0.3% and 2% year to date. Auction clearance rates in Sydney have consistently been over 80% in the year so far.

The more concerning is trend that speculative investors now account for as large a share of new housing finance flows (above 40%) as they did during the 2002 and 2003 boom that caused the RBA so much grief. The share of risky “interest only” loans has surged to 43.2% in June, making up around 30% of new mortgages and roughly 60% of new investment loans. This is all in addition to the increase proportion of lending by the banks on a fixed-rate basis – what happens if interest rates are markedly higher than we currently expect when these fixed rate periods come to an end?

In contrast to all this doom and gloom, the household saving ratio remains elevate at levels last seen during the GFC and the early 1990s, interest paid as a percent of household disposable income continues to fall, aggregate mortgage buffers (ie. how far ahead mortgage holders are on their loans) amount to 2 years’ worth of pre-paid interest; and the 90 day arrears rate on home loans is very low at 0.60% or less.

To date, the RBA and the Federal government have maintained that the residential housing market isn’t in a bubble and that house price growth has been sustainable. However, the RBA changed their stance swiftly this week stating that it was worried about the build-up in speculative investment activity to levels exceeding those reached in the last boom in the early 2000s. They also indicated that they have been in talks with other regulators (APRA) to introduce “speed limits” on credit creation.
 

Speed Limits

Whilst we are not residential property experts and cannot forecast whether house prices will rise further or fall, we can shed some light on the potential “speed limits” the RBA and APRA (the banking regulator) are now exploring.

  1. RBA raising rates – the RBA raising rates earlier and quicker than people expect would seriously curb house price growth. The RBA wants to curb excessive growth and growth in certain areas / pockets, so in this scenario rate rises are likely to be slow and steady, but earlier than people expect.

  2. RBA placing “friendly” (private) phone calls to bank CEOs and/or instigating “macroprudential” measures (publicly) – whether a friendly nudge by the RBA or public policy, measures would include limits on loan-to-valuation ratios; limits on debt repayments to borrower income or loan size to income; forcing lenders to lift the interest rate buffer test they use for loan serviceability; placing high risk weights on particular types of loans in particular geographical areas; forcing banks to reduce the number of loans to certain individuals and to certain geographical areas, etc.

  3. APRA forcing banks to lift their capital requirements – this is likely to come out as part of the Financial System Inquiry. There’s been a lot of press from the banks that they are more than adequately capitalised, but given the increasing size of their residential mortgage books and their current all-time low provisioning for bad and doubtful debts, they may not be as adequately capitalised as they think in a severe housing market downturn, in which case they will be bailed out by taxpayer funds (something the government wants to minimise).

  4. APRA forcing the banks to increase the risk weighting they currently assign to loans – extraordinarily, banks have been able to “self-assess” the riskiness of each loan they grant and assign their own “self-assessed” risk weighting to a loan. For example, a $1,000,000 loan assessed at a 15% risk weight, means that only $150,000 is used to determine the capital required to be held by the bank. Risk weights vary globally, but the average is circa 30-35% mandated by a regulator (ie. no self-assessment).

  5. Revamp of the negative gearing and capital gains tax discount benefits currently available to property investors – the government could remove negative gearing on residential property altogether or could reduce the amount of the negative gearing benefit to an end investor. They could also remove the 50% capital gains tax discount for properties held longer than 12 months, or more likely, only allow the 50% discount to be applied for properties held longer than 5 years. The government could also increase stamp duty.

  6. Levy on foreign buyers of Australian residential property – it’s been speculated in the press that $1,500 levy on foreign buyers of Australian residential property would raise circa $400m. Whilst $1,500 is likely in sufficient to curb foreign buying demand, a percentage levy based on the purchase price (ie. 3% or 5% of the purchase price) may do the trick whilst raising much needed funds for the Australian economy.

Of these potential measures, we think points 3 and 4 are highly likely, and that 5 is more than probable, though any changes to negative gearing and the capital gains tax discount are likely to be phased in over time. Point 6 is also possible, but not favourable on a political foreign relations front.

The RBA is highly unlikely to raise the cash rate simply to curb house price growth as it would hurt other parts of the economy which are only just starting to recover and would also put a pause on the Australian dollar falling further. The much talked about “macroprudential” measures are broadly unlikely at this point given the mixed feedback and data from the recent attempts made by the UK and New Zealand, and the potential to hurt first home buyers even more. However, some targeted measures are possible.
 

What does this mean for housing prices and the banks?

If we are correct, the growth in housing prices will slow, but house prices will still grow, just at a more reasonable and steady pace as the RBA cash rate remains lower for longer. For housing prices to fall off a cliff, we would need a massive spike in unemployment and/or a massive spike in inflation and/or China to fall off the same cliff. These are all unlikely at this point. The RBA wants to curb excessive growth and speculation, not bring the property to its knees given the benefits of the wealth effect (ie. steady rising prices encourages homeowners to spend and invest thus benefiting the overall economy).

If we are correct, the profit growth banks have enjoyed since the GFC will stagnant as they will be required to curb the growth in their lending and hold more capital on their balance sheet to protect themselves from housing price falls.

 

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