Rising interest rates drive big changes in the property market

Over the past year, at its peak the property boom had created 450 suburbs across Australia with a median house value exceeding $1 million. Sydney had the greatest number of suburbs joining the million-dollar club with 128 suburbs making the list. These included suburbs from the south-west (30 suburbs), outer south-west (15 suburbs) and the Central Coast (20 suburbs). 

CoreLogic’s Kaytlin Ezzy tells us that in the year to March 2022 a record 23.8 per cent of all homes that were sold traded for more than $1 million: “Sydney’s million-dollar markets are fairly widespread, with more than half (51.9 per cent) of all Sydney sales over the 12 months to May transacting at or above $1 million,” Ms Ezzy said. 

She also added a cautionary statement: “The value growth we have seen over the past couple of years has been quite dramatic, but it’s important to remember we are now in the downward phase of the cycle.”

Some areas are still showing gains but nothing like the massive increases of twelve months ago. CoreLogic figures show that home values are still higher than a year ago in some of the more affordable outer suburbs of Sydney despite the recent market slowdown. In Sydney, the biggest growth over the past year has been in parts of the Hills District, South-west, Central Coast and the Blue Mountains, CoreLogic’s latest Home Value Index found.

CoreLogic’s Tim Lawless says Sydney property prices overall are down 3 per cent from their peak in February this year: “In June alone, prices in Sydney were down about 1.4 per cent from May. We’re seeing the rate of decline in housing values gathering very clear momentum; The trajectory is already much sharper than in the previous decline in 2017.

“There’s still probably another potentially twelve months ahead of us in this downturn,” he said, adding that the market is in the “fairly early stages” of a decline, with the extent of falls contingent in part on how rapidly the Reserve Bank lifts its interest rate to counter inflation.

Mr Lawless told The Guardian that during the 2017-19 slump, the average house went from 24 days on the market to as many as 69 at the cycle’s lowest point. During their shortest time to sell last October, the average house was only 20 days on the market, but this has now risen to 29 days. 

“It’s a fairly gradual trend upwards, but it’s also a very clear trend,” Lawless said. “As homes take longer to sell, you see discounting rates start to become larger as vendors need to negotiate more. That will also be reflected in lower auction clearance rates as well.”

CoreLogic has calculated that the nation’s housing sales were $8 billion less profitable in the three months to March than in the December quarter when nominal profits of $38 billion were generated. The data collector says that falling volumes and declining prices demonstrate a weakness that is likely to continue in the established homes market, meaning the number of loss-making sales is likely to increase.

Market watchers are already making estimates of how long the prices downturn will last. Prop Track's Paul Ryan said the RBA’s rate rise in June and expectations of higher rates later in the year have already slowed property markets: "Conditions in the housing market have slowed rapidly, marking the sharpest slowdown in prices in more than 30 years.

"We expect continued price falls across the country until the uncertainty about the extent of interest rate increases is resolved — likely extending beyond 2022," he said.

Domain chief of research and economics, Dr Nicola Powell says the Sydney property market is becoming less competitive: “You’re getting a slowdown in the number of buyers, there are fewer buyers than there were, and the turnover isn’t as high. The supply also builds because the properties for sale sit on the market for longer. They’re taking longer to sell.”

A new term – FOOP, has come into our terminology, knocking FOMO out of the ring. It stands for ‘Fear of Overpaying’ and is used to explain buyers’ hesitancy in the current market. To avoid paying too much for a property they’re sitting on their funds and waiting to see which way the market goes.

Market activity levels are showing a fall of 44 per cent in property search volumes in NSW with a 38 per cent drop nationwide. Property listings are up, although not by a large amount. Domain’s figures show that Sydney listings are up 5.6 per cent while the average number of days a property stays on the market is going up.

Sydney’s auction clearance rate has fallen below 60 per cent in the past month – its lowest level in years but not as bad as its most recent low point in April 2020 when only 36.1 per cent of properties on offer were sold as public auctions were banned at the start of the coronavirus epidemic.

Commonwealth Bank head of Australian economics Gareth Aird believes the floor for clearance rates is not far off: “Generally, they will hit a floor. A lot of people that are selling will see the market is falling and accept a price they may not have otherwise to get the job done,” he told Domain.

Robert Bagala of First National Real Estate Hunters Hill, Gladesville and Ryde says that history reveals a pattern that may now be repeating itself: “The time when a purchaser will stall in making a decision to purchase will be at the early part of the interest rate rise cycle. Historically speaking, there’s always an element of adjustment immediately after,” he says.

“But I’m a big believer that this lull in the market represents a huge opportunity to purchase without that massive competition. Reflecting on similar occasions in history, we all agree those who purchase in these volatile or uncertain periods come out with far larger gains as opposed to those who wait or get caught up in the frenzy.”

He has a good point. Previous price downturns have often been less than half the duration of the preceding upswing. There has also traditionally been a greater percentage increase in price than the subsequent decline. Domain’s NSW Spotlight Report details how Sydney house prices rose 62.2 per cent from 2012 to 2015, dipped 2.7 per cent that year, then added another 18 per cent to the 2017 peak, and then fell 13.8 per cent in the next two years, according to Domain data.

Rates not going down soon

At its monthly meeting on 5 July the RBA raised its official interest rate by 0.5 per cent to a new rate of 1.35 per cent. This was the third month in a row that the rate has been increased, and there is a probability of further increases to come as inflation is expected to reach 7 per cent by the end of 2022. 

The most recent official rate increase if it is passed on in full to mortgage borrowers by lenders will add another $140 a month in repayments on a $500,000 mortgage over 30 years, according to calculations from financial comparison website Canstar. When this is combined with the two earlier rate increases in May and June, monthly payments on a mortgage that size have grown by more than $350, or another $4200 a year.
RBA governor Philip Lowe, speaking to the American Chamber of Commerce in Australia at a function in Sydney, said higher interest rates were necessary to slow spending that is adding to inflationary pressures: “As we chart our way back to 2 to 3 per cent inflation, Australians should be prepared for more interest rate increases,” he said. “The level of interest rates is still very low for an economy with low unemployment and that is experiencing high inflation.”

He does say our current economy is “fundamentally sound” thanks to low unemployment and strong household spending and he doesn’t believe Australia will have a recession in the near future: “I don’t see a recession on the horizon here,” he said, but he indicated the Bank would continue increasing its rate as necessary to combat inflation.

“The board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead. The size and timing of future interest rate increases will be guided by the incoming data and the board’s assessment of the outlook for inflation and the labour market,” he said in his July statement.

Rising interest rates will reduce the amount homebuyers can borrow to finance the purchase of a property. Modeling by RateCity shows that the average family of four, with one full-time working parent and a part-time working parent, would have had a maximum borrowing capacity of $871,400 in April, but could borrow only $805,900 after the May and June rate increases, even less now after the July increase. 

Westpac bank has calculated that, if the cash rate reaches 2.25 per cent as the bank is predicting, the same family’s borrowing power would be cut by $144,900 and reduced to just $661,000.

Like the RBA governor, federal Treasurer Jim Chalmers insists that there’s no recession on its way: “We’re not working on the expectation at this point of that risk occurring or eventuating. I’ve said a number of times, we have reason to be cautiously optimistic about the future of our economy, but first we have to navigate these difficulties which are right ahead of us,” he said.

CoreLogic research director Tim Lawless told News.com’s Frank Chung that he sees higher mortgage repayments combining with rising costs of living to form what he calls a ‘double whammy for indebted households’: “With underlying inflation moving sharply higher to be up 3.5 per cent over the year, the RBA’s heavy lifting on the cash rate still has some way to go, with interest rates likely to consistently rise through the second half of the year and into 2023.

“Higher costs for food, fuel and finance are likely to see household savings continue to taper as families funnel more of their income towards servicing their mortgage and funding essential costs of living,” he said.
 
Stamp duty still with us

Historically, stamp duty has always been unpopular. It was first introduced in 1865 when NSW ‘revenue stamps’ were applied by the government to anything dutiable - kegs, casks and crates as well as property. The rate of taxation was 0.5 per cent of the value of the property sold, but since then the average rate of stamp duty has grown incrementally to 5 per cent, sapping the economy and making home ownership more difficult.

For example, over the past twenty years Sydney’s median house price has risen 280 per cent, from about $418,000 to about $1.59 million. In that same time, the cost of stamp duty on that median-priced house has jumped 406 per cent, from about $14,300 to almost $72,400. This amount is usually financed as part of the funds borrowed by purchasers acquiring a property.

Premier Perrottet had hoped to do away with stamp duty entirely, trading it for a broad-based land tax, but then he realised that losing stamp duty revenues would for a while at least be a serious hit to his state budget, while there was also a rumbling among property owners that a land tax might not be as limited as had first been mooted.

The original plan for a land tax was for there to be an annual tax of $400 plus 0.3 per cent of the unimproved land value for homeowners, with investors paying a higher annual rate of $500 plus 1.1 per cent of the unimproved land value. Based on a property valued at $1.5 million, an owner-occupier would pay property tax for 13 years before it matched the upfront cost of stamp duty, and it would take six years for investors to match the stamp duty amount they’d escaped.

According to the most recent update to the proposed reforms before the state’s budget was announced, the top 20 per cent of NSW residential property prices wouldn’t have been eligible to opt in for land tax and would have continued to pay stamp duty, helping to reduce the anticipated decline in the government’s revenue. 

NSW Treasury estimated that an optional annual tax would collect about 20 per cent less revenue than is now received from stamp duty. This would have equated to a projected shortfall of about $2.5 billion a year.  Economic and political realities combined to reduce Mr Perrottet’s efforts to simply doing away with stamp duty for first-home buyers, and even then, with a series of preconditions for both purchasers and properties. 

The government’s First Home Buyer Choice scheme enables eligible first-home buyers who sign a contract to purchase a property in NSW on or after 16 January 2023 to opt in to paying the property tax instead of paying stamp duty. This will lower their upfront costs when buying a home and could reduce the time it takes for them to enter the market. The scheme is expected to commence on 16 January 2023.
 
Independent economist Saul Eslake said the consequences of the moderated stamp duty change would be minimal because many first home buyers would be purchasing under the $800,000 threshold which is the starting point for a stamp duty concession or exemption: “Any movement in that direction is progress, but it is a tiny step; a bigger step may have had a much bigger revenue cost than previously thought.”

Grattan Institute economic policy program director Brendan Coates commented: “It looks less like a tax reform and more like just another support for first home buyers, because it doesn’t actually really start the transition,” Coates told Domain. “The big economic costs of stamp duty are about whether you go and buy again and move again. That’s the point at which people’s housing choices are constrained because they don’t want to pay stamp duty on the second property,” he said.

Home ownership declines

The Australian Bureau of Statistics (ABS) has just released its findings from the 2021 national census, counting 10,852,208 private dwellings - well up on the 950,712 it counted in 2016. It was a bit of a surprise to discover that 1,043,776 of these dwellings were unoccupied, either holiday homes or investment properties.

Australian National University demographer, Dr Liz Allen said this number was higher than expected: “There are a number of reasons for that vacancy rate, but a lot of that is because people have multiple homes. And [some of] these are holiday homes in areas where people are living in caravans because bushfire and flooding has sent them out of their homes.

“We generally have high rates of vacant homes, census to census, but this is the highest we’ve seen. Home ownership is declining. This gives us a full grasp of the situation, particularly from a generational side of things,” Dr Allen said.

The ABS found that the share of Sydneysiders who own their own home outright has fallen from 39 per cent to 27.8 per cent since 2001. 61.1 per cent of homes in Sydney in 2021 were owned outright or with a mortgage, down 1.1 percentage points since 2016. 

Grattan Institute economist Brendan Coates said that Sydney’s home ownership rate had declined despite favourable conditions for home buyers, including historically low interest rates and various government support programs: “Housing is just so expensive that an increasing number of young Sydneysiders can’t afford to buy a home in their own city,” he said.

“Home ownership will continue to fall unless we fix the underlying drivers for why housing is so expensive in the first place. That means fixing land use planning laws and scaling back some [housing-related] tax breaks.”

Mortgage stress is on the increase too, according to another finding from the census. Those experiencing mortgage stress are defined as those who spend more than 30 per cent of household income to service a home loan – now one in five Sydney home borrowers, compared to about one in twelve borrowers in 2016. 

It’s not surprising that Sydney, with its market-topping property values, also has some king-sized mortgages with accompanying monthly repayments. The census found that the Sydney region’s median monthly mortgage repayment was almost $3,000 – that’s $1,100 more than the typical Australian mortgage. In many areas including Hunters Hill-Woolwich and Castle Cove-Northbridge, monthly mortgage repayments came to a median $4,333, or $52,000 a year, and that was before this year’s interest rate rises.

Results from the 2021 census have also shown just how variable in income levels Sydney’s suburbs can be. For example, the median family income in the Blacktown district was $2,252 a week, just a little higher than the national figure of $2,120. On the other hand, in Castle Cove-Northbridge and Greenwich-Riverview the median family income hit $241,000 a year while the suburbs of Balgowlah-Clontarf-Seaforth, Hunters Hill-Woolwich and Bellevue Hill were not far behind.

There’s also the matter of rental stress – experienced by tenants who spend more than 30 per cent of their income on rent. 41 per cent of people living in inner Sydney are tenants, well above the national share of 31 per cent. 

Domain’s latest Rent Report tells us that the median weekly rent for houses has risen by $20 a week, or 3.3 per cent to a record $620 in the June quarter, while units had an increase of $25 a week or 5 per cent in the same period, rising to $525 a week: “House and unit rents have jumped by more than 11 per cent each in the year to June, outpacing annual wage growth almost five times, in one of the biggest cost of living pressures to households already facing the high cost of petrol prices and other essentials,” he said.

The census found that a third of those tenants in Sydney are under financial pressure due to rental costs, compared to just half that number in the previous census five years ago. Almost half of all renter households in Fairfield Council are paying more than 30 per cent of household income to pay the rent, while that share is above 40 per cent in Canterbury-Bankstown and Liverpool council areas. CoreLogic figures show that capital city rents rose 9.1 per cent in the year ending June, so tenants’ stress levels won’t be reducing in the near future.

A Sydney Morning Herald editorial on 5 July summed up our present housing policy shortcomings: “Both major parties, at the state and federal levels, acknowledge housing affordability is a major problem. But this must now result in bold policies that deliver tangible improvements. Recent proposals to make housing more affordable have been far too timid.”

Developing trends

All the factors that are now active in the property market – from sky high property prices and rapidly rising rentals to a shortage of affordable housing, have combined to inspire a new set of trends that may well become important elements of Sydney’s future housing mix.

The first is the rise in the numbers of new duplexes and other forms of semi-detached dwellings. Approvals for duplexes, townhouses and terraces have increased by 24 per cent in NSW in the year to April, comparing to just a 5.4 per cent increase in house approvals in the same period. 

Figures from Domain show that the outer southwest region, incorporating Camden, Campbelltown and Wollondilly councils, topped the approvals list with a 204.5 per cent increase in semi-detached building approvals in the year to March. This region was followed by Baulkham Hills and Hawkesbury - up 155.4 per cent, the Central Coast - up 86.5 per cent, and North Sydney and Hornsby -up 57.9 per cent.

Housing Industry Association economist Thomas Devitt said the increase was driven by a number of factors, including affordability issues and the rental crisis: “Medium-density approvals will be supported by affordability challenges in the detached market and acute rental shortages,” he said.

The simple economics of duplexes were explained by Cooley Auctions auctioneer Michael Garofolo: “The builders have made the decision that if we carve this block into two, our profit margin is better. The popularity is being delivered by the people who are creating them,” Garofolo said.

“[For buyers] it’s an in-betweener, between a unit and a house. It feels like you’ve got your own block of dirt and your own home, which you do in essence. It satisfies the bedroom and bathroom requirements of a growing family,” he said.

Benjamin Mulae, a partner at McGrath Hunters Hill, said that the trigger for the duplex rising in popularity with builders and buyers was the introduction in 2018 of planning laws designed to fast-track medium density housing in NSW: “There were thousands of properties that were suitable for duplexes overnight. There was always demand for it, but it was hard to find sites that were suitable,” Mulae said. “The demand has been so high that people are getting just the approval through before building and reselling.”

The next developing trend to mention is build-to-rent, or BTR as it’s often called. It’s a market that’s expected to grow significantly with 40 projects now under construction with a worth estimated at $9.6 billion.

In the BTR model, the developer maintains ownership of the project once construction is complete. This typically involves large-scale apartment complexes owned by major investors with all the apartments rented out. According to research conducted by Cushman & Wakefield, there are currently 1859 apartments operating across six BTR projects in Victoria, New South Wales, Queensland, and Western Australia.

Cushman & Wakefield's director of metropolitan markets, Marcus Neill says the BTR sector in Australia has reached a turning point: "The number of constructed units is set to double each year to 2025 and grow nearly tenfold over the next five years.”

His company’s research found that 12,848 units are being built this year, as 14 major institutional investors including Mirvac develop 40 BTR projects. It said that the number of completed BTR apartments is expected to reach 15,977 by 2027, based on existing projects alone.

PropTrack economist Anne Flaherty said Australia has been slow to adopt the BTR model, which is already well established in the United States and Europe. She believes BTR could be the key to increasing rental supply: "There is a current undersupply of rental properties in Australia, and a growing recognition by government that more needs to be done.

"Australia's population is forecast to grow by 3.5 million over the next 10 years, and a growing proportion of the population are renters. Boosting the supply of rental accommodation is essential and removing barriers to entry for BTR developers could be part of the solution," she said.

Both the NSW and Victorian governments have introduced 50 per cent land tax reductions for the BTR sector to help establish these projects in those states, while the Queensland government has established a BTR program in partnership with that state’s construction industry.

The third developing trend is the ‘Essential Workers Homebuyer’ scheme that is targeted for trial in NSW. This is a plan to help such essential categories of workers as teachers, nurses and police officers, as well as single parents, buy homes in partnership with the NSW government. This kind of shared equity scheme is becoming popular with governments worldwide, including in the United Kingdom, where it is seen as less expensive in the long term than providing subsidies

The scheme involves the government taking a maximum equity contribution of 40 per cent for a new home, and 30 per cent for an established home. The maximum cost of the property has been set at $950,000 in Sydney and regional centres, and $600,000 in other parts of NSW. Applicants must have a minimum deposit of 2 per cent and be earning up to $90,000 for singles and $120,000 for couples. The trial will have seed funding of $740 million. 

Independent economist Saul Eslake said the scheme was similar to the shared equity proposal that federal Labor took to the election, limited to 10,000 places: “In NSW there’s a particular problem with essential workers not being able to afford to live close to the communities they serve and often having to commute long distances every day, so this will address that need.

“[The scheme] does represent an attempt to solve that problem. But participants need to be aware they’re sharing any capital gain with the government or, if interest rates continue to rise, any capital loss. But it is a way, too, for government to get some return on their investment, unlike with most of the first home buyer grants,” Mr Eslake said.

And finally, John McGrath of McGrath Real Estate has described what he terms the ‘co-primary home’ concept wherein homeowners who have moved away from the city during the pandemic to live in regional areas return partially to the city, purchasing a smaller property in town while they retain their regional property as well.

Naturally, most Australian homeowners can’t afford such second homes so the co-primary housing trend isn’t numerically a large segment of the market, but for those with the money the "pied-à-terre" (from the French "foot to the ground") which in the 1800s described an Englishman’s home away from home, seems to be enjoying renewed popularity. It could also help explain why the 2021 census found over a million unoccupied dwellings across Australia on census night.

Sources:

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