- Property Boom; leading to an increased risk of a future price correction, some attention seekers are calling this a “Bubble”
- Lack of affordability for First Home Buyers in central areas
- Rising household debt, primarily, dangerous exposure to high ‘investment purpose’ debt
This article touches on these issues, the 9 associated considerations, the possible deficiencies in the actions and opinions related to these issues, and a few arguably useful solutions.
With APRA’s restrictions on investment lending growth, many would say this has become necessary, possibly due to loose lending standards by the DTI’s (deposit taking institutions), and changes to bank investment lending policy in response, to try curbing the boom in property, it is perceived that affordability for investment lending will reduce. The concern here is that it will not solve the problem of the property boom in Sydney and Melbourne.
There are several other forces at play here that have and will continue to influence the property investment landscape as well, so a solution will require a multi faceted approach.
Some have the opinion that Sydney is fully priced now, ased on the projected growth over the next 3 years, i.e. BIS Shrapnel, rather than being over priced. IN the next 12 months whilst they may be further growth of 4-7% in the Sydney market, there may be a decline in growth in this market in in the following 2 years after that, mitigating this growth.
The Sydney market has also seen significant growth over the last 4 years, but APRA have waited until near the end of this cycle to actually take back some control. Some would say this is too little too late.
1. Lenders have also, seemingly, mismanaged the situation by exceeding acceptable capital adequacy levels as well, and are now clambering to reel this in through a number of ways.
Increasing rates on interest only loans secured against owner occupied properties and/or rates on investment loans, freezing approvals for investment loans, reducing LVR’s (loan to value ratios), abolishing discounts for larger loans, increasing qualifying rates on servicing calculators, servicing existing debt at a higher rate than the current rate or current repayments, these are some of the mechanisms through which DTI’s are implementing and/ or have implemented.
This will have impact on investors in a number of ways; impact on the affordability of some investors, it will price some investors out of the market. Investors will also be required to inject more equity or cash toward a property transaction, thus potentially reducing the equity available for more property investments. It is arguably a good thing that if investors are border line with the ability to service the loan on a lenders calculator now, they will surely fail servicing if rates went up in the near future, some suggest later in 2016.
In contrast to the DTI’s changes, there are several non-deposit taking institutions out there who do not take short term positions with deposits and do not, in contrast, take long term positions with term loans, and they are not controlled by APRA. There are no requirements placed on these non-deposit taking institutions to maintain any specific level of capital adequacy. Investors can still borrow up to 95% for investment debt, and some of these lenders will still service existing debt based on existing repayments, rather than a higher qualifying rate, so in fact, some lenders have not changed a thing thus far.
APRA’s influence does not extend to non-DTI’s, and there are plenty of them. Whilst this seems to now be a great opportunity/ loop hole for investors, and non DTI’s alike, the reality is, access to some of these non DTI’s can only be achieved through a mortgage broker, and there are a number of brokers who sadly, have such bad habits in their business model they generally only use the big 4 banks. This has led to these brokers lacking the necessary knowledge to assist an investor anyway, as they do not have solid relationships with these lenders; they are clambering to understand the policies of these lenders now.
There are three elements to affordability, but alas, many are quick to forget affordability mechanics. Price, Income and rate, what APRA are doing may be ineffective with higher income earners. With rates at records lows, it is still relatively easy for the higher income earners to continue to invest in these boom locations, it makes little difference to these investors if lenders add 27bps or 29bps to investor loans, Investors will also claim this as just an additional expense anyway.
APRA chairman Wayne Byers said recently, whilst speaking at the House of Representatives Standing Committee on Economics Inquiry into Home Ownership, the moves APRA have made were “common sense.” “Our objective has been to ensure that in the broader environment of high house prices, high household debt, historically low interest rates and subdued income growth – along with strong competitive pressures within the financial system – sound lending standards are maintained across the board.”
2. Foreign Investment
Tightening policy on foreign investment may be a more appropriate strategy; foreign investment numbers suggest that in Melbourne in particular, foreign investment makes up more than 20% of investment lending. Other figures show suggest that 1 in 6 property purchases have been from foreign investors in 2014.
John Symond from Aussie believes the APRA clampdown could actually be an advantage for foreign investors. Naturally it goes without saying that APRA’s cap on credit growth will do nothing to stem the tide of foreign investment, it will be completely irrelevant. Australia does survive on foreign injection of capital.
Chinese investors, rumour has it, can obtain a 100 year term loan on 1% interest rate, no wonder they can afford to buy so much property, they of course also have a great deal of disposable cash. Current potential loop holes in Australia allow for the registering of companies in Australia via a relative living here, mediums through which foreign investors can plough money to buy property, money that could be from dozens of friends, relatives and others.
The figures suggest Brisbane, Sydney and Melbourne; primarily Melbourne, could end up being a disaster for the inner city unit markets, I.e. CBD, Southbank and Docklands. Anyone buying in these areas for investment should be very concerned.
Mum and dad investors buying ‘off the plan’ apartments through property marketing companies have a great deal to fear, with one report suggesting there will be a 20 percent shortfall in both rentals and valuations. When combining this with body corporate costs, and competing against hundreds of other investors in these locations, the landlords will have to drop their asking rents as well, these properties could very well end up being overly negatively geared, and when rates rise, these investors could be dead in the water.
If China changes the rules of the game for their citizens, pandemonium could follow, in these high-density locations, with a massive rise in re-sales, and with this volume of properties, the 20% shortfall in value when buying could very well become a great deal higher.
3. People being responsible for their own actions, seeking advice
Many people in general may be incapable of acting in a prudent manner by monitoring, controlling or reducing exposure for themselves to future cost of debt, perhaps it is also, in many cases, their lack of responsibility by not seeking advice from someone representing the buyer, not the seller. It is very dangerous to borrow debt purely based on cost of debt now without considering cost of debt in the future if rates should rise.
There are many investors that have succumbed or been drawn into a property marketing companies spiel about how little an investment property may cost. Many of these firms may not carry out a stress test, I.e. factor in a 7% interest rate rather than 5% or lower. This could lose them a sale at the end of the day, but it would also be more responsible of them, yes it should be the consumers’ responsibility to understand this, but many people do need advice, and unfortunately they are far too often drawn to the wrong people masquerading as advisors.
Investors with less income are being a bit more protected also with APRA’s pressure on DTI’s, with these additional measures the lenders are now introducing, those lower income, or higher negatively geared investors that were border line with servicing on a lenders calculator may now probably fail servicing, and this could be a very good thing, because perhaps those people should not have been investing further to begin with.
4. Owner occupiers: emotion leading to inflated prices
Owner-occupiers, as distinct from first homebuyers, are also partly to blame for prices rising in many suburbs, for example Glen Waverley and Balwyn in Victoria, spiraling out of control.
These buyers often operate in an opposite manner to investors; they ignore facts and figures from a capital growth and cash flow perspective, because they want to live in the property. Their buying criteria are often controlled by emotion, with one of the driving factors being a good school, but they pay well over reserve or market price in order to secure a property within the school catchment area. These buyers, not negative gearing, not foreign investors, and not Australian Property Investors have been the catalyst for the property boom in some suburbs!
5. Banks acting responsibly
Is it the banks that have been too loose and irresponsible by exceeding limits that they are supposed to comply with? Perhaps it is. When it comes to borrowing for a mortgage the borrower will be asked what their living expenses are, this is the lenders job and/ or the brokers job to determine, depending who the borrower applies for a loan through.
Many owner-occupiers and investors alike can easily understate the true/accurate figure, thus making it easier to obtain a loan. Lenders should be more vigilant with this. The main problem has been that lenders have raced each other down with rates, with no regard for the wider consequences of their actions, let’s not forget, they are a business, they exist to make money, not to make a positive difference to society.
Lenders use the higher of one of the two figures below in their servicing calculators when it comes to living expenses.
a. What the client believes their living expenses are, and,
b. What the calculator uses as a default figure (HEM), based on the number of adults, couples, dependents connected with the application
The Household Expenditure Measure (HEM) is a measure that reflects a level of household expenditure for various family sizes; the main problem is that it does not necessarily represent true living expenses in a household. Some people smoke 2 packets of cigarettes a day, or have connected to the you beaut, upgraded pay TV packages, or their kids play every sport known to man, these are examples of how living expenses can quickly blow out of control.
6. Negative Gearing
Is negative gearing the problem? In part it could be, as it encourages speculative property investment, according to the RBA. The RBA also states that the ‘ability to deduct legitimate expenses incurred in the course of earning income’ is an “ important principle”.
It is also a principle though, that encourages more intelligent practices, such as good research, avoiding property marketing companies, seeking advice, and fact and figures analysis when determining which property may be worth considering. Reducing the risk typically associated with speculation can be better achieved through these more intelligent practices.
Further, it helps enable people to build wealth and a future for themselves, by making the cost of holding the property more affordable. It reduces the rent an investor would otherwise have to charge a tenant if it were not for negative gearing assisting with the holding cost of the property.
Some people within the ranks that believe negative gearing should be abolished have a reasonable argument, and some have merit, but there are some that are afraid of taking action toward their future, and yet others possessed with their own self-entitlement that believe the Government should be solely responsible for funding their retirement rather than themselves, these people consider removing negative gearing is a wise move as well naturally, but are just jumping on this bandwagon against negative gearing.
Negative gearing contributes to property being attractive which in turn supports the Australian economy. Punishing those that are trying to make a future for them selves is arguably wrong. Negative gearing could be used by first home buyers also, it improves the ability to service a loan, so they could purchase it, get a foothold on the property ladder, leverage off its growth over a period of time, then either move into it or use the growth in equity to buy in a different area. The Property Council of Australia supports this view of negative gearing assisting first homebuyers “as a more economical option”
7. Self-Managed Super Funds (SMSF)
Perhaps too many people have purchased with their Self Managed Super Fund (SMSF). This has been prolific, and the rise in investment borrowing is due in a big part to the ability for Super funds to buy property.
Many people have been able to buy two properties, rather than one, over the last few years, enabled by using their SMSF. One in their own name and one in SMSF, so there has been in some cases double the activity in the investor market than what previously could have occurred. Many though have been foolish in buying in their SMSF, by not having enough money in there, or not understanding their obligations, as two examples.
Thankfully lenders have started to realize some of these issues, they are either ceasing their appetite to lend to these structures, reducing the loan to value ratios to 70%, increasing the funds required to be evidenced in the SMSF from 150k in some cases to 300k, implementing a requirement for a buffer to remain in the fund, or completely disallowing all ‘new’ properties to be purchased in the SMSF structure.
This last point is important, almost every new property is being promoted in some way, somewhere, by a spruiker, some spruikers convince investors that it is a good idea to buy in an SMSF structure, for many, it simply is not.
Lending policy on this front will soon change for the better, become much tighter and responsible.
8. First Home buyers;
This is a contentious issue; some commentators out there have confronted the Y generation with the opinion that it is the first homebuyer’s attitude, which is the problem, one of having self- entitlement issues. Yes the market in many areas is rising, and it has become much more difficult for younger people to purchase within a more convenient distance to their family, friends, and places of work.
There are many suburbs where first home buyers can afford to buy in. Sydney of course is not one of them, nor are many of the surrounding suburbs of Sydney, and this is a major problem, but what is happening in Sydney should not be used as the benchmark of a lack of affordability for the rest of the country, like some are trying to do. Most suburbs in Qld, whilst they are rising well, they are still very affordable, i.e. under 400k. Many outer suburbs in Melbourne have not had the growth as inner suburbs and are priced below 400k. Campbell town, approximately 1.5 hours from Sydney by train, so this would be impractical for most, even though it is more affordable than much of the surrounding suburbs of Sydney. Penrith is 540k median price, more affordable but still 1.5 hours by train, Black town is only 55 minutes by train roughly, and is 575k median price approximately.
Most lenders are still offering 95% loan to value ratio to owner occupied borrowers, some requiring no genuine savings. Some lenders accept gifts and other loans to be used toward ‘funds to complete’ (the difference between the purchase price and the loan amount). Then there are costs like stamp duty, if the first home buyer purchases a new property, they dramatically reduce the amount of stamp duty that they otherwise would have had to pay.
Some younger people are saving money by living at home, this would be better than renting if they wish to save money, however, some lenders do consider ‘rent paid’ as genuine savings. It is fair to say that 5% ‘funds to complete’ plus stamp duty is a fair bit to save for some people if they are undisciplined or enjoy a certain lifestyle, but more so lately due to rising property prices.
No one has the right answer as to how to tackle the property boom, rising exposure to debt, or lack of affordability for first homebuyers. Postcode restrictions could be implemented by lenders, to restrict loan to value ratios for investors in certain postcodes to stem the investor activity.
The Government could rethink their responses. Is the Government capable though? This is a valid question given the fact that the federal treasurer blames lack of affordability/ or is in denial of there even being a lack of affordability, by having stated that people not having a good enough job is why property is unaffordable to them. Australia is not in a property boom, Sydney and parts of Melbourne are, and this perhaps is equivalent to a localized headache.
APRA is treating this symptom by effectively prescribing a lobotomy, rather than a more focused approach.
Foreign investors who break the law deserve to be punished, and thank fully the Government is taking a little more assertive stance on this now.
Perhaps this combined approach from Government toward foreign investors, APRA toward lending standards for investors, more people seeking better advice, and first home buyers getting their foot on the property ladder at least, if they start trying, the future of the Australian Property Market can continue to support those who wish to invest toward their future, but in a more considered and more appropriate manner.
Contrary to this, Morgan Stanley have suggested APRA’s actions and the Government clamping down on foreign investors may have an adverse compression affect on our housing market. However, unless interest rates rise and unemployment rises in Sydney and Melbourne, the broad-brush strokes of APRA will do little to address the actual problem we have in Australia, being Sydney and to a lesser extent Melbourne.