First, capital controls imposed in China in early 2017 made it more difficult for citizens to withdraw money out of the country. Second, Australian banks reduced the loan to valuation ratio required by non-residents, which meant that overseas buyers needed a 40% deposit to be able to obtain a loan. Third, the Australian Prudential Regulation Authority (APRA) imposed restrictions in March 2017 to force lenders to limit new interest-only lending to 30% of home loans. Fourth, the NSW state government doubled stamp duty fees payable by non-residents (from 4% to 8%).
In 2018, the headwinds continued. Banks began to significantly tighten lending criteria to all borrowers in response to the damaging Banking Royal Commission revelations. Moreover, the opposition Labor Party proposals to limit negative gearing and halve capital gains tax concessions created more negative sentiment for the housing market, especially since polling suggested that they were likely to win government.
This combination of events, coupled with a surge in supply following years of new apartment construction, proved to be a perfect storm for residential property. According to CoreLogic the Sydney median home price has fallen 14.5% since its peak in July 2017, the biggest fall on record.
Yet after two years of falls, there are finally some encouraging signs that the worst may soon be over.
First, the surprise election victory by the Coalition has improved sentiment as Labor’s policies were widely expected to be negative for house prices. Auction clearance rates, a reliable indicator of demand, have rebounded in recent weeks to the mid-high 60% range (the highest since April 2018).
Second, APRA has flagged lowering the minimum interest rate serviceability buffer from 7% to a level to be determined by banks and other lenders. (This is in addition to APRA’s decision in December to lift the limit on interest only lending to 30% of home loans.) For the past four and a half years, APRA has required banks to test prospective borrowers against the higher of either an interest rate of 7%, or a 2% "buffer" over the loan's actual interest rate, to ensure they could meet repayments if rates rise. The proposed changes are likely to increase the maximum borrowing capacity for a given borrower.
Third, and perhaps more importantly, the RBA has just reduced interest rates to unprecedented lows in response to subdued growth and inflationary expectations. Lower interest rates traditionally encourage borrowing, which should support house price growth. Fourth, population growth has been increasing at an annual rate of 1.6%, which will help to absorb excess supply.
While we believe a combination of these factors will provide some support to house prices, gains are likely to be tempered by supply imbalances in some suburbs and persistently high debt levels. Indeed, the chart below shows how house price growth (6.5% pa) has outstripped wage growth (3.7%pa) since 1994 by a large margin.
Source: Australian Bureau of Statistics
If wages aren’t growing at the same rate as house prices, then the only way that the difference can be funded is via an increase in debt – and that is exactly what has happened as shown by the chart below.
Household Prices and Household Debt (Australia):
Source: Reserve Bank of Australia
In conclusion, we believe house prices will soon bottom out, but a strong rebound is unlikely. This is because very high levels of household debt will limit upside and continue to pressure household balance sheets in the foreseeable future.
Copyright © 2019. The information provided is not personal advice. It does not take into account the investment objectives, financial situations or needs of any particular investor and should not be relied upon as advice. While the information is provided in good faith and believed to be accurate and reliable at the date of preparation, we will not be held liable for any losses arising from reliance thereon. We recommend investors consult their personal financial adviser to discuss suitability and application to their individual circumstances. Advisors at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFS & Credit Licence number 336950.