Sky-high prices are making residential property a tougher proposition for investors, especially self-managed superannuation funds. From here, the market could turn any of three different ways.
Australia’s housing market has made a habit of defying financial gravity. While property prices in the US, UK and other developed countries have cycled between boom and bust, in Australia each upsurge in values – and there have been a few in recent decades – has been followed by a slowdown that has somehow avoided turning into a rout.
It’s a well-established pattern, but there are those who believe the latest leap in Sydney and Melbourne house prices is a prelude to a US-style property market crash. It’s not hard to see why some homebuyers, investors and people with property in their self-managed superannuation fund (SMSF) are increasingly nervous.
Since December 2008 – the depths of the global financial crisis (GFC) – average capital city house prices in Australia have climbed more than 40 per cent and gone even higher in Sydney, the nation’s biggest city. According to the Australian Bureau of Statistics, the cost of residential property in Sydney has soared more than 63 per cent in little more than six years.By some estimates, the average price for a house is now A$1 million.
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The breakneck pace of these gains is causing alarm. Australia’s federal Treasury secretary, John Fraser, and many others talk of a “housing bubble”, and Glenn Stevens, governor of the Reserve Bank of Australia (RBA), has described some house prices as “crazy”.
In an attempt to take some steam out of the market, banking regulator the Australian Prudential Regulation Authority (APRA) has prodded lenders into increasing interest rates for investor loans.
“If we get job losses across the economy, I’d be staggered if we didn’t see double-digit house price declines.” Gerard Minack, formerly of Morgan Stanley
This makes the property question particularly tough for SMSFs. Australia’s superannuation rules mean SMSF members can’t use an SMSF investment property themselves or lease it to family members, so making a capital gain is the main reason for investing in real estate.
For now, though, many residential property buyers seem undeterred. After rising by 3.1 per cent in the first three months of the year, Sydney house prices accelerated between April and the end of June to register close to a 7 per cent three-month gain. Whether this is just the last upsurge before an inevitable ruinous fall or reflects underlying economic forces that still have a long way to play out is the subject of intense debate. Here are three scenarios for the medium-term future.
Scenario 1: Growth, growth, growth
By one reading, soaring house prices – particularly in Sydney and Melbourne – are a rational response to sustained low interest rates.
Investment returns are high
In a controversial analysis unveiled in July, RBA senior research manager Dr Peter Tulip says that far from being inflated, Sydney homes are actually 30 per cent undervalued. Rather than showing irrational exuberance, Tulip says, Sydney homebuyers are making a reasonable calculation that the long-term cost of borrowing makes buying a more attractive option than renting.
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The theory has been heavily criticised. But even those who don’t subscribe to Tulip’s analysis say there are good reasons why investing in Sydney and Melbourne property, even at current prices, remains a good bet. Angie Zigomanis from consultancy BIS Shrapnel is one of them.
Population trends are right
The BIS house-price story is not about investment returns but population movement. When Sydney prices last surged a decade ago, they helped drive an exodus from the city as young homemakers were lured elsewhere – some by cheaper property in cities such as Brisbane and Melbourne, others by jobs being generated by the mining boom.
This time around, Zigomanis says, the demographic forces are working in reverse. Construction jobs in the resource-rich states of Queensland and Western Australia have mostly dried up, while employment in services and manufacturing – much of it concentrated in Sydney and Melbourne – has picked up.
Changes in attitude have also played a part. “The most mobile segment of the market, 20- to 30-year-olds, are not looking for a surf and sand lifestyle anymore. They are looking instead for the cafes and coffee lifestyle offered by Melbourne and Sydney,” says Zigomanis.
It has meant that despite rapidly rising property prices, population growth in New South Wales (NSW) and Victoria has blossomed, while sagging in resource-rich states. ABS figures show Victoria’s population rose by 1.8 per cent last year, helped by a net gain of 9300 people from the other states. Meanwhile NSW’s population climbed 1.4 per cent to reach 7.56 million, a net gain of 103,000 people.
Investors want property
Population growth goes some way to explaining why house prices in Sydney and Melbourne are going up. But it is hard to see how this alone could result in the double-digit increases now appearing. Much has been made in recent months of strong investor interest in property, including strong interest from offshore markets such as China.
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The most recent RBA figures show borrowing by property investors growing at an annual rate of 10.7 per cent, the fastest pace since just before the 2008 crash and virtually double the pace of lending to owner-occupiers. Given equity market wobbles, it’s not hard to see the attraction to investors of a market registering 7 per cent price gains.
The dollar has fallen
The investment appeal is particularly obvious for those coming from offshore, as the softer Australian dollar has amplified their purchasing power.
Between May 2013 and June this year, the Australian currency fell 27 per cent against the US dollar. That offset some of the 40 per cent jump in Sydney house prices over the same period. Market Economics managing director Stephen Koukoulas says the shift in the exchange rate has meant that for offshore buyers, Melbourne and Sydney property is still “cheap”.
Scenario 2: Prices cool gradually
There are, however, plenty of ways to imagine the current price-friendly atmosphere changing.
Bond prices may drift back up
If you see the property market as responding rationally to financial signals, you might expect that changes on the financial markets could drive prices gradually down over the years ahead. Tulip’s RBA analysis, for instance, ties housing prices to the bond market – and if bond yields gradually rise, that suggests housing prices might gradually fall.
Experts such as Shane Oliver, chief economist at AMP, cite low inflation, low growth and central bank demand as keys to bond yields. At some point those things will change, they say. “Ultimately, super-low and in some cases negative bond yields are not sustainable,” wrote Oliver earlier this year.
Authorities are slowing bank lending
Bank regulator APRA has already told banks to slow the pace of housing investor credit growth to below 10 per cent. It has also told them to hold more capital for each property investment loan. However, economists such as Rob Ellis of Property Insights are sceptical that APRA pressure on the banks to wind back investor loans will have more than a marginal effect in cooling the market.
Property supply may catch up with demand
Experts including Ellis, Koukoulas, Zigomanis and Applied Economics director Dr Peter Abelson believe the most crucial factor affecting future property prices will be housing supply.
Abelson, who has researched movements in Australian house prices going back several decades, says tight supply of new housing and pent-up demand from purchases that were deferred in the depths of the GFC have helped create the conditions for the current price spike. But the high prices, in turn, are encouraging more houses to be built. That, combined with a slowdown in population growth, will see prices moderate.
There is some evidence this is already happening. Building approvals in Australia have grown strongly in the past three years, including an 8.6 per cent gain in the 12 months to June, driven in large part by a massive 16.3 per cent jump in apartment activity.
Combine this with reduced immigration – net overseas migration was down 15 per cent to 184,000 people last year – and Koukoulas believes you have the ingredients for a cooling property market.
Scenario 3: From boom to bust
There are fears that if property prices slow or go into reverse, a rush to the exits could turn what should be a mild correction into a rout.
No reason for a bust …
Since 1970, there have been four major spikes in Australian house prices. On each occasion, there has been a consequent downturn in which values have slipped by as much as 10 per cent. None of those four price downturns developed into the sort of crash that saw US property prices plunge 30 per cent during the GFC, leaving millions of mortgages under water. However some economists think the conditions are ripe for such a collapse over the next two years.
Former Morgan Stanley chief economist Gerard Minack told ABC TV in June that “if we get job losses across the economy, I’d be staggered if we didn’t see double-digit house price declines”.
Minack, however, is in the minority. Koukoulas does not expect a big housing price fall any time soon. “For there to be a complete Armageddon scenario, you need a major RBA rate hike, something like 100 basis points. For that to happen, there would need to be a major spike in inflation or employment,” he says. “At the moment, I cannot see the RBA hiking interest rates for a year or two or three.”
The capacity of buyers to ride out the downturn and avoid a forced sale rests on their ability to service their mortgage, and on this count the fact that investors are driving much of the market activity could help mitigate against a crash. Generally, investors are considered to have greater financial resources than many owner-occupiers, making them better placed to weather a downturn. As Koukoulas points out, rates of delinquent debt and mortgage arrears are very low.
… but busts happen anyway
While there are plenty of reasons why a rout shouldn’t happen, it’s worth remembering the lesson the US Federal Reserve took from the 2008 crisis. In a landmark speech at the start of 2010, the then Fed chairman, Ben Bernanke, admitted that a sort of feedback loop of rising home prices, easier lending, financial innovation and homebuyer confidence could create the perfect climate for a bubble – where prices go foolishly high and then fall dramatically.
Such a loop, first described by economist Hyman Minsky in his “financial-instability hypothesis” in the 1960s, is largely a matter of irrational investor psychology. It was also considered unlikely until 2008. Now it’s part of the official explanation for the crisis.
It’s also worth considering that economists still don’t thoroughly understand what determines the “right” housing price. Even within the RBA, models like Tulip’s developed only after prices had already risen, often despite the central bank’s efforts to stop them. So while few people expect Australia’s property boom to turn to bust, it would be foolish to rule it out.
Countdown to a bust?
2003: APRA pressures banks to curtail risky lending.
November and December – the Reserve Bank of Australia (RBA) announces consecutive rate hikes.
2004: February – the RBA announces that “sentiment about the property market has softened”.
2007: August and November – two rate hikes by the RBA push the cash rate to 6.75 per cent.
2008: February and March – cash rate rises to 7.25 per cent.
15 September – Lehman Brothers declares bankruptcy, fuelling the financial crisis.
October 2008 – April 2009 – RBA slashes cash rate from 7 to 3 per cent.
2010: 29 March – RBA governor Glenn Stevens flags concerns about property prices.
20 April – the International Monetary Fund (IMF) warns
of the risk of a property bubble.
2013: 21 November – the IMF cautions of the risk of Australian property prices “overshooting”.
2014: 7 March – Stevens warns property investors that “prices don’t just rise, they can fall”.
24 September – Stevens says “new lending to investors [is] out of proportion”.
2015: 1 June – Treasury secretary John Fraser says Sydney “unequivocally” has a housing price bubble.
10 June – Stevens says of Sydney property prices: “Some of what’s happening is crazy.”