Market comment: Sydney property sees tighter credit, falling prices, rising mortgage rates

Sun, 15 Jul 2018

Market comment: Sydney property sees tighter credit, falling prices, rising mortgage rates
The end of the 2017-18 financial year has come with a wealth of statistical data about house prices, and the property market experts are poring over the numbers to make their predictions for the balance of 2018 and beyond.

Their conclusions are broadly that house prices in Sydney have dropped about four to five per cent since their peak and will slip further before the end of the year, by at least another two per cent or possibly more. Because these are ‘average’ figures, it really means that some parts of Sydney will fall more than others, and as always, some parts of the city will defy the trend and rise.

According to figures from ANZ Research, in Sydney’s CBD and inner south house prices have fallen by 13.6 percent since their peak in June last year, while Ryde and the inner west have seen falls of just over 10 percent since August and March 2017 respectively.

On the city’s North Shore, property values have fallen by 8.7 percent, while the Northern Beaches have recorded a 7.5 percent drop since June last year. The inner south west, Parramatta, Blacktown and the Baulkham Hills/Hawkesbury regions, have all recorded falls of between 5.9 and 6.8 percent.

"Tighter finance conditions and less investment activity have been the primary drivers of weaker housing market conditions, and we don't see either of these factors relaxing over the second half of 2018," CoreLogic head of research Tim Lawless said in a Reuters release.

He said the pullback in demand was due to a combination of tougher rules from regulators, lenders and tighter borrowing standards resulting from findings of widespread malpractice on loans and financial advice by the Banking Royal Commission.

BIS Oxford Economics is one of several experts predicting a further slowing of the housing sector in its new report ‘Residential Property Prospects 2018 to 2021.’ The report says that house prices will fall by another two per cent over the 2018-19 financial year, and the median price will remain below its peak of June 2017 for the next three years before modest rises in 2020-21.

The report also said that apartment prices, previously supported by investor demand, will show a decrease of four per cent in the financial year just ended, and fall a further three per cent in 2018-19.  

The report’s author, Angie Zigomanis, who is Senior Manager – Residential Property at BIS Oxford Economics, told Domain’s Allison Worrall that the chance of a major price correction was being lessened by low interest rates and a relatively stable economic environment. Nevertheless, there’s no doubt a correction is happening.

The report’s view of an Australia-wide property price correction has been echoed by Macquarie Bank, UBS, AMP, Capital Economics and the ANZ Bank, among others. Although they agree that weakness in housing prices will continue for some time, they differ in their estimates of both the amount and the duration of the decline.

Deloitte financial services partner James Hickey described the slowdown as a healthy pullback from unsustainable levels of recent years: "When placed into perspective, the strong lending growth of the 2013 to 2016 period was never going to be sustainable in the long term," Mr Hickey said. "The market recognises the need to take stock and find a new sustainable base for the long term."

ANZ Bank has recently predicted Sydney property prices will drop about 10 per cent from their late-2017 highs, while AMP chief economist Shane Oliver sees an even greater drop of 15 per cent top-to-bottom. Macquarie Bank’s economists Justin Fabo and Ric Deverell say that Sydney prices will fall ten per cent overall, but that “despite almost daily negative headlines in the mainstream media, the rate of adjustment has also been relatively orderly.”

Credit is the key

The ANZ Bank admitted that the decline in Sydney house prices had outgrown its earlier expectations. ANZ senior economist Daniel Gradwell said the rate of price decline had recently accelerated in Sydney and previous forecasts that the market would have "stabilised" by now have been revised.

"Additional headwinds are possible, such as the shift away from interest only loans," he said. "There could also be further tightening of credit as the impact of the current regulatory focus on mortgages flows through into lender behaviour. All of this suggests that the fall in house prices will be quite a bit larger than we previously expected, with recovery coming later."

The ANZ Bank’s June housing update said the present price cycle is being driven by tighter credit rather than higher interest rates: “Higher interest rates in 2019 are expected to be an additional headwind, though rate hikes will only occur if the housing market has broadly stabilised.

"We note that Australia has had six previous episodes of declining housing prices since 1980, with the peak-to-trough range of 2½ per cent to 8 per cent. Nearly all previous corrections occurred following interest rate rises, a drag unlikely to be repeated anytime soon in this cycle."

At its July meeting the Reserve Bank left the cash rate on hold at its record low of 1.5 per cent for the 23rd consecutive month. The RBA board had earlier noted that loan approvals to investors and owner-occupiers had eased, consistent with a decline in demand for credit as well as with lenders tightening their own requirements.

"Falls in housing prices in Melbourne had been concentrated in inner-city areas, whereas the declines in Sydney had been more widespread," the board said. It also noted that housing prices were still 40 per cent higher in Sydney and Melbourne than at the beginning of 2014, and auction clearance rates in Sydney and Melbourne had fallen to their lowest levels in a number of years.

The RBA’s head of economic analysis, Dr Alex Heath said that she expected demand for housing to remain strong overall because population growth was also likely to remain strong: "Housing price growth has been strong until recently in Sydney and Melbourne, where population growth has been strong," Dr Heath told a conference at the Urban Development Institute of Australia in Wollongong on Thursday.

"Given that housing accounts for around 55 per cent of total household assets, we are paying close attention to these developments," she added.

The ABC’s David Chau points out that Sydney has seen prices rise by 85 per cent since 2013, with investors driving prices to record highs: “In 2013 a Sydney house typically cost about $650,000 while today the average house in Sydney will set buyers back about $1.2 million.

“Its median house price hit a peak of $1.2 million in June 2017 and has since declined (to $1.1 million) due to the banks' tighter lending policies, mandated by the Australian Prudential Regulation Authority (APRA),” he said.

On the positive side, the Westpac Melbourne Institute index of consumer sentiment recently indicated that home buyer demand is recovering from its recent low. The number of consumers who say now is a good time to buy a home has risen substantially in the past year.

The index has recovered from its low point of 90 in May 2017 to 105.7 this June. A reading of 100 means equal numbers of pessimists and optimists.

This index is still below long-term averages, but it is now clearly ahead of last year's lows. And the sharpest increase in sentiment has been in NSW, the least affordable market. Deloitte Access Economics director Michael Thomas told AAP that Australia’s residential market was still largely supported by solid underlying demand.

“Taken together with the outlook for interest rates, slowing house price growth moderating the prospect of further capital gains, (and) restrictions on lending such as on interest-only loans and loans to investors as well as to lending to foreign investors, we expect a period of moderation rather than an abrupt adjustment,” Mr Thomas said.

Today’s falling prices are strongly influenced by the availability of credit. Banks are not willing to lend as much as they were a few years ago; they are more closely scrutinising how much money borrowers need to live on, and as a result are taking longer to approve loans.
This is largely because the royal commission into the financial services sector has sent a chill through the banking sector, and bank lending practices have become the subject of particular scrutiny. This has had a dramatic impact on lending standards.

UBS analyst Jonathan Mott told the Herald’s Clancy Yeates that he estimated if banks assumed more realistic living expenses, the maximum amount they would lend customers would be about 30 to 40 per cent less than today. This would cause housing credit growth to come to a near standstill.

Four in 10 loan applicants, including borrowers financing existing property loans, are now being rejected because lenders have increased their scrutiny of applicants’ capacity to service a loan, according to analysis by Digital Finance Analytics.

However, despite the banks’ tightening their loan requirements, the Commonwealth Bank's chief economist Michael Blythe is optimistic that the market won't see a major drop from current levels. The factors that historically drive large downward moves in housing, including rising unemployment and rising interest rates, are "either not present or still a fair way off," he said.

RBA rates stable, but…

According to the Financial Review survey of leading economists covering the final three months of fiscal 2018, the Reserve Bank of Australia is not expected to hike interest rates until 2019 at the earliest. This is a significant change from three months ago, when economists had been forecasting two interest rate hikes in that period.

The economists surveyed also felt that Australia's population growth will continue to support demand for housing: "Strong population growth is preventing house prices from declining too far," commented Stephen Roberts at Laminar Capital.

But another economists’ survey has a different opinion. The BusinessDay Scope survey is Australia's longest running and is compiled from forecasts of 26 leading Australian economists. 23 of the 26-person panel expect interest rates to climb by the middle of 2019. Four of them said rates would rise more than once.

The Reserve Bank isn’t the only institution that can raise mortgage rates. Citigroup forecasts that the rising cost of funding will force Australia’s major banks to increase their mortgage interest rates, saying it expects the banks to begin lifting their mortgage rates by an average of eight basis points by September.

Until the global financial crisis, Australia’s retail banks took their cues to raise or lower their lending rates from the Reserve Bank's interest rate cycle. But Citi now says that Australia’s banks are likely to raise mortgage rates out-of-cycle to the RBA due to higher wholesale funding costs as well as the regulatory pressures resulting from the banking Royal Commission.

JP Morgan's chief economist Sally Auld says that the political cost of raising interest rates wouldn’t be "too high" for the big four banks: "What that [view] ignores is the fact that they're businesses with a clear commercial imperative; at the end of the day, they care about their margins and preserving it," she said.

They have to "make a call on whether the political heat they'll get is any worse than the cost to margins of not lifting rates," she added.

The ANZ Bank's chief executive Shayne Elliott told ABC's The Business last month that banks may have no choice but to raise their mortgage interest rates independent from the RBA’s prime rate settings: "The reality is we have to run our business. As long as we make decisions responsibly, ethically, looking at all the stakeholders, we'll make decisions as appropriate for the time."

BoQ's acting head of retail banking, Anthony Rose outlined the principal reason for out of cycle rate hikes: "Funding costs have significantly risen since February this year and have primarily been driven by an increase in 30 and 90-day BBSW (bank bill swap rate) along with elevated competition for term deposits," he said.

Interest-only loans

One fly in the housing price ointment is the need for home owners with interest-only loans to roll them over to principal plus interest.  It’s estimated by the RBA that over the next three years 200,000 interest-only home loans worth something like $360 billion will need to be refinanced, meaning higher monthly mortgage repayments that borrowers might find difficult.

Interest-only loans became popular in Australia largely because of the country’s negative gearing taxation benefits. Property analyst Pete Wargent told that a major driver of these loans was the ability to claim a tax deduction on the interest paid: “It’s smart investing from a tax efficiency point of view but the issue is that so many people are doing it.”

By 2015, interest-only loans had grown to almost 40 per cent of Australia’s outstanding housing credit. While there’s a great deal of debate on just how much this massive refinancing will affect property prices, at least the Sydney market has risen substantially since the period in which these interest-only loans were made. 

The federal government, the Reserve Bank and the Australian Prudential Regulation Authority (APRA) became concerned about possible consequences of these loans in 2017. They took action to limit them to a maximum of 30 per cent of all mortgage loans, as well as encouraging lenders to make interest rates higher on these loans.

Interest-only loans have now fallen by almost 60 per cent since APRA’s limits on them began in March 2017. "The outstanding stock of [interest-only] loans has now slumped $93 billion year-on-year [-16 per cent] with interest only-loans making up 31 per cent of all mortgages, down from 39 per cent a year ago," UBS analysts wrote in a note to clients.

UBS economist George Tharenou told ABC News that, although the switch from interest-only to principal and interest (P&I) loans was a modest 0.1 per cent, or $1.6 billion, of nominal income across the economy, it hit individual borrowers harder: "For individual households the [around] 35 per cent increase in repayments is significant.

"With $120 billion of interest-only loans expected to mature every year for the next three years, this is likely to remain a modest negative for consumption, but the larger risk is from 'stressed selling' as some households struggle to meet the higher repayments" Mr Tharenou said.

"The kind of nightmare scenario is where a lot of people need to sell at once, and that's when you see a kind of fire sale mentality, and could see very significant downward pressure on prices," said Professor Richard Holden from the University of New South Wales Business School.

Chinese investors pull back

Chinese investments in Australian property have been important drivers of prices for Sydney houses and apartments as well as land for development. However, recent changes to investment regulations by authorities in Australia and China have seen Australia’s share of China’s global spend fall 11 per cent to $US10.3 billion ($13.5b) in 2017, according to a report by KPMG and the University of Sydney.

The NSW Treasury had been warned in an expert’s report that imposing new taxes on foreign investors could have a "large negative impact" on investment in Sydney's real estate. The warning also suggested that the new taxes would have little impact on Sydney's house prices because foreign investors account for just 5 per cent of residential sales.

The Foreign Investment Review Board’s (FIRB) latest annual report shows that approvals for residential purchases by non-Australians fell by 67 per cent over the 2015/2016 financial year because of the combination of state-based taxes, increased fees and tighter capital controls.

In 2017, the Australian government increased fees for foreign buyers applying to buy property by 10 per cent, and last year NSW also doubled its stamp duty surcharge from 4 per cent to 8 per cent for foreign buyers. Treasury data revealed by the ABC shows that in June 2017 foreign buyers purchased 4,000 homes in a race to sign contracts and avoid the eight per cent duty. In July, when the new tax took effect sales fell to just 70.

From this year foreign investors will also pay an annual two per cent land tax on their properties. However, Michael Zhang, head of JLL’s China Desk in Australia says that Australian real estate is still a ‘key destination for Chinese capital’.

“There has been a notable shift in the scale and type of investment into Australian real estate. Investors and developers are becoming more selective in acquisitions, with mandates increasingly geared towards higher quality investment assets and well-located sites with less planning risk.’’

The FIRB report shows that Sydney has remained the number-one destination for all commercial real estate capital, which was mainly residential development (44 per cent), offices (30 per cent) and mixed-use sites (9 per cent) deals in 2017.

Greenland Australia managing director Sherwood Luo says that while Thailand, Vietnam and Japan are growing competitors to Australia for Chinese capital in the field of residential development, Australia remains a strategic investment destination because it is “a very stable and transparent environment”.

This year's NSW government’s budget papers acknowledged that foreign investment is falling, predicting just 2,000 foreign purchases in 2018-19. When questioned about the falling levels of foreign investment, a Treasury spokesperson said the market impact was "relatively small", adding that commercial operations were not affected.


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Home prices fall for ninth month as tighter lending bites,’ Reuters, Sydney Morning Herald, 2 July 2018
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‘Are economists saying the Sydney and Melbourne markets are going bust? Not really,’ Chris Kohler, Domain, 25 June 2018
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