Market comment: Sydney property descends from the peak

Tue, 4 Oct 2016

Market comment: Sydney property descends from the peakThere’s a shortage of available housing stock as prices keep rising. We’re probably building too many apartments and not enough houses, and mortgage restrictions are impacting a slowing market.
 
The spring auction market has given every indication that it’s going to live up to its tradition as a season of good clearance figures and strong prices achieved.
 
If anything’s holding it back it’s a shortage of stock. Clearance rates have been around or above 80 per cent, but listing numbers remain considerably lower than they were 12 months ago, especially in high-demand areas near the CBD.
 
“Last year in August and September, there was too much supply,” said Belle Property Beecroft’s Nick Bedford. “This year it’s quite tight; there is nothing available.”
 
Investor numbers declined in early 2016, but since the July election they’ve returned to enjoy more certain taxation benefits while they take advantage of low interest rates.
 
Australian Bureau of Statistics (ABS) figures for July show that the value of investor housing purchased for rent or resale nationally rose by nearly two per cent over the previous month.
 
Domain Group chief economist Dr Andrew Wilson said the investor share of NSW residential lending is now 56.5 per cent: “I think there was underlying demand for investment properties and there’s been a fear of missing out.
 
“Numbers are now up to what they were before the peak of the market with investors looking towards higher yielding, low-priced properties,” said Dr Wilson.
 
Sales in the outer suburbs, subdued during the winter auctions, have shown a resurgence with higher results in terms of both clearance rates and prices being achieved.
 
Starr Partners chief executive Doug Driscoll told Domain that investors now make up almost half the number of all buyers in western Sydney: “There’s so much infrastructure proposed, the west has some solid buying,” he said.
 
This month has also seen key housing price statistics become a source of disagreement between the industry’s four main numbers compilers. Recent house price growth figures have shown fairly wide differences and analysts are now trying to work out which to believe.
 
CoreLogic has been the usual data source for the Reserve Bank of Australia (RBA) but it recently changed the way in which it gathers and analyses data, prompting the RBA to say in its August statement that "strong increases reported by CoreLogic were overstated as a result of methodological changes".
 
Data from CoreLogic for August showed a 1.1 per cent rise in home prices across the nation's capitals in August, bringing the increase in capital city home prices to 7 per cent year-on-year. Sydney’s rate of increase was even higher at 9.4 per cent.
 
CoreLogic's head of research Tim Lawless told ABC News Online that the boom was at its peak: "That's virtually half the rate of growth that Sydney was seeing last year, when values were rising at more than 18 per cent in Sydney on an annual basis.”
 
Economists at JP Morgan challenged the figures from CoreLogic saying their figures show home prices have been growing more slowly nationally than CoreLogic's index has suggested.
 
"This leaves us with the view that dwelling price growth has been running closer to 2 per cent nationwide this year, rather than the 8 per cent recorded by the CoreLogic hedonic index," said JP Morgan's Ben Jarman.
 
September figures from Residex showed a growth of 1.19 per cent in Sydney’s median house values from August last year to August 2016, with a growth in unit values of 3.75 per cent over the same period.
 
HSBC’s chief economist Paul Bloxham sought to clarify the reasons for the divergence.
 
"Compositional shifts in housing turnover are making it difficult to get a clear read on housing price growth but, importantly, housing loan approvals and credit growth have slowed," he said.
 
"One plausible explanation is that a greater amount of lower priced housing has been turned over recently. This fits with the fact that a lot of newly built apartments have been coming to market and apartments tend to be lower priced than detached houses."
 
Regardless of the discrepancies in growth numbers between the four major indicators, the RBA said they all showed a reduction in both housing loan approvals and credit growth which confirms the Sydney market is cooling.
 
Down from the peak
 
The Housing Industry Association (HIA) says the housing industry construction cycle has now peaked and it expects the next two years to see a continuing fall in new housing sales.
 
“New home construction has been the kingmaker of the Australian economy, but the cycle has peaked,” the HIA’s chief economist Dr Harley Dale said following the release of the Association’s July report.
 
“The short term outlook for healthy levels of new home construction remains intact – calendar year 2016 will be a record year for new dwelling commencements, but the situation could look very different from next year,” he said.
 
The HIA’s report showed that new home sales slumped 9.7 per cent nationally in July, dropping to their lowest level since July 2014. The NSW drop was 6.2 per cent.
 
Dr Dale added a note of caution about ‘sensationalising’ the statistics: “We would do well to remember that this down cycle is following a record high that is some 24 per cent higher than the previous (1994) peak and that there is an unprecedented degree of uncertainty this time around as to how the next few years of new home building unfold.”
 
Paul Sheard, chief economist at ratings agency Standard & Poor’s, told the annual Australian Banking & Finance magazine’s ‘Breakfast with the Economists’ that the country was at risk of thinking that housing prices would continue to rise.
 
“I don’t get the impression that we have a housing bubble here yet ... but I would say that Australia must beware of the narrative that because prices have never fallen they can never fall again,” he said.
 
Westpac’s chief economist, Bill Evans, told the Breakfast audience that “we shouldn’t be too negative,” noting that while the $200bn liquid natural gas development boom was slowing, it was being offset by $90bn of state infrastructure spending.
 
Shane Oliver, the chief economist at AMP, agreed saying that the Australian economy had been surprisingly resilient and flexible. The post-mining boom drag was bottoming out, he said, and sectors including education and tourism were benefiting from the lower dollar.
 
In an interview with The Australian Financial Review, retiring RBA Governor Glenn Stevens said that he has had ‘some discomfort’ about rising Sydney house prices, but also noted that housing remains an important stimulant of economic activity.
 
“It’s not without risk, and it certainly gives me some discomfort, but then we’re balancing that against the other obligations we have to pursue.”
 
Mr Stevens admitted that the lower interest rates of recent years had contributed to rising Sydney housing prices: “Most of the domestic effects of cheap money comes through the household sector - higher house prices than otherwise, more borrowing than otherwise, wealth effects, lower saving rate, etc.” he said.
 
“It’s probably not that surprising that parts of Sydney are leading the charge, because this economy is leading the country at the present time.”
 
A two-speed market
 
CoreLogic’s Cameron Kusher says that over the past 12 months house prices have outperformed unit prices across Australia: “House values have increased by 7.2 per cent compared to a 5.5 per cent rise in unit values.
 
“With a record pipeline of units under construction we would expect that growth in unit values will continue to underperform that of houses for the foreseeable future.”
 
Mr Kusher says that compared to last year there is a low volume of fresh stock for sale, with Sydney’s offerings down nearly 21 per cent on last year.
 
“The low level of new stock becoming available for sale appears to have been a key driver of the ongoing strength in the Sydney and Melbourne housing markets over recent months.”
 
The Ai Group/Housing Industry Association's monthly Performance of Construction Index shows that house building across Australia has contracted while apartment building has continued to expand.
 
"Very weak conditions in the house building sub-sector overshadowed the positive news for apartment building, commercial construction and engineering construction in August and pulled the broader construction industry down for the month," Ai Group policy head Peter Burn commented.
 
The Ai Group’s report noted that the new figures followed a decline in private sector house approvals in July, indicating there would be a further softening in house building activity in coming months.
 
Towering problems ahead?
 
Apartments are proving to be a very distinct category of the housing market with a 23 per cent jump in approvals of new apartments, townhouses and semi-detached homes in the month of July according to figures from the ABS.
 
In NSW, monthly approvals of multi-unit dwellings rose by almost 50 per cent to 5,104 from 3,442 in June causing some economists to again raise the question of whether developers are building too many apartments.
 
"Is this increase in approvals today led by demand or by supply?" UBS economist Scott Haslem asked in the Australian Financial Review. "If it's led by demand, then we're all okay. If it's led by supply, there may be cheap apartments to buy in the next few years."
 
Economic forecasters BIS Shrapnel have already called the turning point of the apartment building frenzy.
 
According to its ‘Building in Australia 2016-2031’ report, national dwelling commencements are estimated to have reached their peak over 2015-16 and will begin to decline from this level in the coming year.
 
“After recording strong growth during the past four years, we estimate that total
dwelling starts reached an improbable 220,100 in 2015-16, an all-time high,” said Dr Kim Hawtrey, Associate Director at BIS Shrapnel.
 
“From this level, national activity is forecast to begin trending down over the following three years, with the high-flying apartments sector leading the way down.”
 
It’s not hard to see why many of those with an overview of the Sydney property market perceive there’s a potential for serious problems over the next two years.
 
Towers of apartments in choice locations near public transport have been created to provide purchasing opportunities for overseas investors whose goal is primarily to shift wealth to a ‘safer’ country rather than leave it at home.
 
Many of these expensive developments have already been constructed. Others are rapidly taking shape floor-by-floor while still more are little more than a cleared block of land with an impressive website to market units off-the-plan.
 
It was a bit surprising in September when a Washington DC-based body called the International Strategic Studies Association (ISSA) issued a dramatic warning that “changes in local banking policies” could see foreign direct investment in Australia’s property sector “decline markedly”.
 
“This will profoundly impact the Australian government’s ability to fund major programs in the defence and civil sectors,” it said in an article titled: “Australia Risks Strategic Setback from a Significant Foreign Direct Investment Drop Due to Changes in Bank Policies.”
 
How long do we have before the banks’ tightened restrictions precipitate a collapse in the property market? “About six weeks” according to ISSA whose article appeared on 12 September, meaning by the time this article reaches its designated place on ‘Market Comment’ there are about two weeks left before some sort of property market Armageddon.
 
Or maybe not. Naturally, a number of Australian market analysts disagree with ISSA. NAB chief economist Alan Oster described ISSA’s prediction of an imminent collapse as “garbage”.
 
“One of the big problems of apartments is [that for] most of them, we don’t know who’s funding them,” he said. “If the big banks don’t know who’s funding them, then the bottom line is, basically the main risk is somewhere else.”
 
Mr Oster told The Australian’s Frank Chung that the issue of settlement risk was “probably further down the track” in 2017-18. “The idea that the banks, who might own 20 to 30 per cent max of these apartments, will somehow crash the market is silly,” he said.
 
‘Big 4’ reduce lending
 
However, a report in September by advisory firm Credit Lyonnais Securities Asia (CSLA) says that Australia's housing cycle has peaked and a ‘correction’ in apartment prices could lead to defaults among developers and a contraction in construction activity
 
“The squeeze from lenders continues, albeit recent actions indicate it is highly targeted towards foreign investors and apartment-focused lending,” CLSA said.
 
“Regulation aimed at foreign buyers (and we expect more to come) will also create an impact. While there has been an official crackdown on capital leaving China, it appears to be less of a constraint than we thought 12 months ago.”
 
If support for construction of new apartments dries up, postulates the report, it could cause dwelling prices to fall sharply and even lead to a recession in the ‘worst case’ scenario. And it will all begin, says the report, with apartment buyers failing to settle on their pre-construction purchases and foregoing their ten per cent deposits.
 
An article in The Australian quoted Albert Callegher from ACM Finance, a specialist finance broker that provides top-up funding for property developers, who said CLSA’s prediction was already coming true.
 
“The small to medium developers doing projects between $2 million and $20 million, they’re going broke,” he told journalist Frank Chung. “I’ve had one client say to me he’s got one developer with over 2,000 apartments that can’t settle. We’re hearing it everywhere but it’s not making the news because you don’t want an avalanche.”
 
The voice of Australia’s richest man, billionaire property developer Harry Triguboff, can also be heard warning that a “very significant” number of Chinese buyers are now failing to settle purchases of their off-the-plan units. 
 
If this wasn’t bad enough, according to Mr Triguboff, a bigger risk is yet to come in the next new wave of developments. As apartment price growth stalls or goes backwards, he says, the risk of buyers walking away from their deposits also grows.
 
More warning flares are being sent skywards by global financial services firm UBS which says the growth in apartment supply over the past 12 months poses a danger to Australia’s banks.
 
A UBS statement noted that in that period residential approvals have hit a record 235,000, and 73,000 of those are for apartment buildings four-or-more storeys high.
 
UBS banking analyst Jonathan Mott told ABC News Online that it isn’t the big four banks - CBA, Westpac, NAB and ANZ - that have been funding the apartment boom recently.
 
"Data released by the Australian Prudential Regulation Authority indicates the major banks have significantly reduced this lending, with total exposures to residential commercial property held flat during the June quarter and up only 2 per cent over the last six months," Mr Mott said.
 
However, Westpac’s Lyn Cobley says her bank has seen settlements slowing but it’s what’s expected at this stage of the property cycle.
 
“We’re really comfortable with the portfolio and some developers now are taking the view that ‘I was going to build something but it’s not the right time of the cycle. I think I’ll leave it for a year or two and see what things are like then’.”
 
Foreign banks, principally Chinese, have effectively been funding the ongoing boom in apartment construction up to this point in time, but there’s no guarantee this flow of funds will continue.
 
Yet still they build. The number of multi-storey apartment buildings under construction in Sydney has more than doubled in the last few years to record levels, and as mentioned previously there are concerns this might create an oversupply that could cause a slump in property prices.
 
But for this to happen, say the analysts, there would have to be at least one ‘trigger’ that sets off a wave of selling. There are several contenders for this dubious honour.
 
The first mentioned is that foreign buyers who had paid deposits to purchase ‘off the plan’ apartments can’t get finance to complete their deals. This would create a pool of apartments that would have to be sold quickly.
 
The second, and probably least likely given global conditions, would be a sudden rise in interest rates that would raise the cost of loan repayments and could force many marginal purchasers to dispose of their properties.
 
This possibility can’t be completely discounted, however. US Federal Reserve Chair Janet Yellen spoke at a symposium on the 26th of August saying “the case for an increase in the federal funds rate has strengthened in recent months”.
 
The third possible trigger is a sudden rise in unemployment. It’s reasonably stable at around six per cent at present and there are no signs this is likely to change in the immediate future.
 
Affordability problems remain
 
Is there anything the government can do to make Sydney housing more affordable? The ever-rising level of prices in the greater Sydney area indicates that there’s not much anyone can do unless the market experiences major economic disruptions.
 
Herald journalist Elizabeth Knight outlined the problem: “Already, housing affordability is stretched and thanks to an extended four years of extreme price rises, first home buyers now make up a record low 10 per cent of demand for mortgages. Only six years ago, that figure was around one-third.”
 
Shadow treasurer Chris Bowen made headlines in September when he said, in an address to the McKell Institute in Melbourne:  "The inability of young people, in particular, to buy a home to accommodate them has reached, I say calmly and soberly, crisis levels. We are a nation that can no longer house its own children."
 
Planning expert and Committee for Sydney CEO Tim Williams says that in the housing market, demand is not driven by housing 'need' but by access to housing finance.
 
"Homes are unaffordable not because we are building too few but because the market is flooded with cheap credit," he said in a Sydney Morning Herald article.
 
"Increasingly access to this is being channelled to existing homeowners over first-time buyers, leading to many Sydneysiders owning two and three properties while the average 30-year-old cannot get into home ownership.”
 
It seems that our long-held view of laws governing supply and demand simply don’t apply in this market. No matter how many new homes come into the mix, prices still keep rising. House prices have risen by 40 per cent since 2011 and dwelling completions have rocketed upwards by 85 per cent.
 
Professor Bill Randolph, director of UNSW's City Futures Research Centre, says the state and federal governments are going about trying to make housing more affordable the wrong way.
 
"If they understood how housing markets actually worked, this would come as no surprise at all. The problem is you can't apply year 10 economic theory to a metropolitan housing market."
 
Economist and geographer Professor Peter Phibbs, takes up the thread: “With housing, because it's an asset market, as the price goes up it encourages buyers to get into the market because they can see the potential gain of holding an asset that's going up in value."
 
The professors and many other economists have long recognised that the housing market isn’t the same as the market for bananas or beans. One of the major distortions is the tax advantages for investors purchasing housing.
 
"Nobody has ever shown … that you can supply enough housing into a market to effectively make prices fall. New supply is two per cent of the housing market. Even if that doubled, what impact would that have? Most of us buy second-hand housing."
 
Professor Randolph says that we need to reset some entrenched ideas about how we provide housing, including encouraging investment in properties for long-term rental rather than resale for capital gain.
 
"It is a wicked problem," he said. "That's why most of our governments just rub their heads and walk away."
 
Sources:
 
‘Housing market really is cooling, HSBC says,’ Jessica Sier, Business Day, 27 September 2016
‘Slump in supply hikes up prices,’ Shayne Collier, Northern District Times, 28 September 2016
‘September Market Update,’ Eliza Owen, Residex, 25 September 2016
‘Lean times hit skinny skyscraper as ‘mum-and-dad’ developers hit funding wall,’
 Frank Chung, News.com.au, 24 September 2016
‘Westpac will ride out property challenges: Lyn Cobley,’ Michael Bennet, The Australian, 17 September 2016
‘Chris Bowen's blunt housing crisis prediction,’ James Massola, Sydney Morning Herald, 22 September 2016
‘RBA governor Glenn Stevens admits Sydney house prices cause him ‘discomfort’, Karen Maley, Australian Financial Review, 9 September 2016
‘RBA Holds Rates in September,’ Eliza Owen, Onthehouse.com.au, 6 September 2016
‘No stopping property prices as strong Sydney auction market lifts off for spring,’ Dr Andrew Wilson, Domain, 5 September 2016
‘The government says it has a plan to fix the housing affordability crisis. This chart suggests it doesn't,’ Inga Ting, Sydney Morning Herald, 5 September 2016
‘Foreign banks funding the apartment boom: UBS,’ Stephen Letts, ABC News Online, 3 September 2016
‘Housing bubble a ‘recession risk’, Frank Chung, News.com.au, 2 September 2016
‘Lending squeeze to be catalyst for apartment market correction: CLSA,’ Michael Bennett, The Australian, 2 September 2016
‘Apartment correction to cause Australia-wide recession: report warns,’ Simon Johanson, Sydney Morning Herald, 2 September 2016
‘Standard & Poor's economist warns Australian house prices can't be trusted,’ Martin Farrer, The Guardian, 1 September 2016
‘Building approvals jump in July: apartments up 23pc from June,’ Michael Bleby, Australian Financial Review, 30 August 2016
‘This might be the end of Australia's new home boom,’ David Scutt, Business Insider, 29 August 2016
‘Home prices continue strong rise in Sydney, Melbourne; fall in Perth, Darwin,’ Michael Janda, ABC News Online, 1 September 2016
‘Australia six weeks from a housing collapse, US report warns,’ Frank Chung, News.com.au, 12 September 2016
‘Expect more cranes: apartment glut to dampen market,’ Clancy Yeates, Sydney Morning Herald, 6 August 2016
‘August Property Snapshot Infographic,’ Cameron Kusher, Property Value Pulse, 14 September 2016
‘Apartment building expands while houses slow: Performance of Construction Index,’ Michael Bleby, Australian Financial Review, 7 September 2016
‘The house price souffle is rising again,’ Elizabeth Knight, Sydney Morning Herald, 17 September 2016
‘New multi-residential building to plummet 50 per cent by 2020,’ Media release from BIS Shrapnel, 1 August 2016