Since the second half of 2017, the major risks associated with the residential property market have significantly increased and will continue to do so into 2019.
This is according to RiskWise Property Research CEO, Doron Peleg, who says tighter lending standards, the result of the Banking Royal Commission, the fear of the potential changes to negative gearing and capital gains tax, political uncertainty, and unit oversupply, in conjunction with a sharp drop in dwelling commencements, could shape the entire landscape of residential property not only this year, but into 2020. Mr Peleg says unless demand for dwellings is boosted via intervention from the regulator or State and Federal governments, expect ‘a tough couple of years for most, but not all, of the property market in Australia’.
RiskWise recently released its Quarterly Risks & Opportunity Report which based its findings on major assumptions about the months to come, being that credit standards and restrictions would be either tightened further or remain at the current level, Labor would introduce changes to negative gearing and capital gains tax in the 2020 Budget after winning the upcoming Federal election, and the RBA would not increase interest rates at least until the second half of 2020, but more likely 2021. “We have entered unchartered territory as all these factors, the frequency that they are changing and the very sudden impact they are having on the property market is incredible,” he says.
“And it is very possible during the first half of 2019 there will be more dramatic developments and volatile changes that might further impact the market, including the unexpected win by the Coalition in the Federal election, major measures to boost demand, and an interest rate cut by the RBA.” He says credit restrictions had seen a reduction in the volume of loans of around 10 per cent and borrowing capacity of around 20 per cent, and this had a direct impact on dwelling prices due to the smaller number of qualified buyers, as well as those buyers having a smaller budget. While APRA has removed the 30 per cent interest-only lending cap, this is unlikely to have a material impact on the housing market, as banks are likely to continue to tighten credit standards both due to the Royal Commission’s findings, as well as to mitigate the risks associated with interest-only loans in a market where the majority of the properties purchased or re-financed are depreciating assets.
In addition, buyer sentiment has been hit as residential property, particularly in Sydney and Melbourne, are seen as a depreciating asset. While reports regarding the impact focus mainly on Sydney and Melbourne, many areas in WA and the NT have been particularly impacted due to already weakened housing markets following the end of the mining boom. “Another contributing factor is the fact many major lenders are no longer approving lending for residential properties against SMSFs, and this will have a direct impact, particularly on new properties, as a large proportion of investments are made through advisors and accountants and concentrated in new dwellings, meaning there should be fewer off-the-plan investors, and thus a lower volume of pre-sales and sales,” he says. “In addition, restrictions on foreign investor activity and fund transfers, and crackdowns by the Chinese government, means they are less prevalent in the property market.
“Meanwhile, RiskWise has already demonstrated fears of the potential changes by the Labor government (to limit negative gearing to new rental dwellings and to halve the CGT tax discount from the current 50 per cent to 25 per cent) have already impacted the market prior to the election. “Price reductions accelerated over the last quarter following the day of the Liberal leadership spill of Malcolm Turnbull by Scott Morrison on August 24. In addition, auction clearance rates have dropped below 50 per cent in both Sydney and Melbourne,” Mr Peleg says. “The risk of price reductions should remain very high at least until the second half of 2020. This adds uncertainty and impacts buyer sentiment.
Further, strong reductions in investor activity and sentiment indicates investors are now ‘timing the market’ – they only have to wait for the election results and the implementation of the taxation policy, and once a new low equilibrium point is reached, can act. “Investors now have a very clear notification well in advance regarding potential increases to out-of-pocket expenses due to the taxation changes, the equivalent to a significant and sudden interest rate increase of 1.15 per cent in the Sydney unit market.” Mr Peleg says there are a number of high-risk areas experiencing unit oversupply, while many unit building approvals are also suffering poor and often negative capital growth, with Brisbane CBD and Perth prime examples. This has also significantly increased the settlement risk for off-the-plan units, particularly in large unit blocks.
“More conservative risk-management practices by both construction lenders and developers are likely to result in a significant reduction of new units, at least until the end of 2019,” he says. “It is very likely that dwelling commencements will continue trending lower until there is absorption of the large stock of units. These are major factors in the industry, particularly in relation to pre-sales and sales as well as construction loans. With a large number of development approvals not proceeding to construction commencement, this area should be closely monitored. “Although there is a reduction in dwelling commencements, the reduction in the current stock will take time, particularly in areas with very high levels of supply of rental properties that only target investors.” Overall, Sydney is likely to experience continued price reductions with an estimated annual reduction of four to six per cent in each of the years 2019 and 2020.
Some regional areas, however, are likely to hold well. The prospects for the Melbourne housing market are negative with price reductions in the order of four to seven per cent for each of the years 2019 and 2020. However, a number of regional areas, in particular Geelong, present only a low level of risk and are projected to deliver solid capital growth both in the short and long term. Houses in the ACT present a relatively low level of risk for price reductions and are projected to deliver modest capital growth in the next couple of years. Houses are still enjoying, and likely to continue to do so, healthy capital growth while the unit market remains reasonable, although these do carry a higher degree of risk to deliver negative growth in the short term, particularly due to their reliance on investor activity.
The modest growth pace in the QLD housing market will continue although greatly vary across the state. Southeast QLD enjoys good population growth and healthy demand for houses. Other areas, such as Central QLD, are still experiencing poor demand for dwellings, very high vacancy rates and a very soft property market. Under normal conditions, it is expected that houses in South-East QLD will enjoy strong capital growth. However, a combination of credit restrictions and potential taxation changes take a lot of energy from this market. Therefore, in South-East QLD, only modest capital growth for houses is expected in the short term. A large number of areas, particularly inner Brisbane, are experiencing a very weak unit market often accompanied by oversupply and are likely to continue to do so for the foreseeable future.
The South Australian economy has shown some improvement however it still has a high-effective unemployment rate which leads to a very low population growth and soft housing demand. Therefore, due to the modest demand level, only modest capital growth is forecast for houses. However, houses in popular areas, such as Adelaide Central and Hills carry a low level of risk and are projected to deliver solid long-term return. Many areas are experiencing weakness in the unit market and significant oversupply, Adelaide CBD in particular, and this is projected to continue. In WA, the property market remains weak with negative capital growth for both houses and units. Units carry a very high level of risk due to the combination of oversupply, lending restrictions and low demand, particularly in central Perth.
Tasmania leads the country in investment serviceability with its high median rental returns and low average dwelling price. However, its outstanding growth rate is already showing signs of price growth deceleration and is projected to significantly decelerate in 2019 and further into 2020. The NT experienced poor population growth resulting in negative dwelling growth and a very soft property market. This, combined with a relatively high median household income, has resulted in the lowest price-to-income ratio in the country. With low population growth and below-average economic indicators, the NT still carries a high level of risk.
However, improved housing affordability slightly reduces the risk associated with houses from medium-high to medium. It is likely houses in the NT will deliver poor or negative capital growth in the short term although the risk is somewhat mitigated by the fact that more than 68 per cent are owner-occupied. The current supply of units, while not considered high in relation to population growth, still exceeds the low demand for them, particularly in areas with a high concentration of off-the-plan units.
According to CoreLogic, housing market conditions ended the 2018 calendar year on a weak note, with the rate of decline consistently worsening over the year. National dwelling values were down 2.3 per cent over the December quarter and a further 2.3 per cent over the March quarter; the largest quarter on quarter decline since the December quarter of 2008. In the three months to March 2019, the best performing capital city was Hobart (1.2%), the weakest performing capital city was Melbourne (-3.4%), while Sydney had the lowest rental yields (3.5%). According to the CoreLogic December home value index results, the downturn in Australian housing conditions accelerated through 2018, driven by consistently larger quarter-on-quarter declines in Sydney and Melbourne, together with a reprisal in Perth’s rate of decline and slowing conditions across the remaining capital cities and most regional markets.
The year finished with national dwelling values down 4.8 per cent, ranging from an 8.9 per cent fall in Sydney values through to a 9.9 per cent rise in values across regional Tasmania. Melbourne was down seven per cent, while values were also lower across Perth (-4.7%) and Darwin (-1.5%). According to CoreLogic head of research, Tim Lawless, the broad weakening in housing market conditions in 2018 highlights this slowdown goes well beyond the correction in Sydney and Melbourne. “Although Australia’s two largest cities are the primary drivers for the weaker national reading, most regions around the country have reacted to tighter credit conditions by recording weaker housing market results relative to 2017,” Mr Lawless says. “The two exceptions were regional Tasmania, and Darwin, where the annual rate of decline improved from -8.9 per cent in 2017 to -1.5 per cent in 2018.”
The December CoreLogic housing market results take national dwelling values down by a cumulative 5.2 per cent since peaking in October 2017. Values across the combined capitals are down a larger 6.7 per cent since peaking, while regional dwelling values have been more resilient to falls, down by 1.5 per cent. Although Sydney and Melbourne recorded the weakest conditions, the peak to current declines are much less severe relative to Perth and Darwin, where values have been falling since mid-2014. Sydney values are now 11.1 per cent lower relative to the July 2017 peak and Melbourne values are down 7.2 per cent since peaking in November 2017. The downturn has been running much longer in Perth and Darwin, resulting in cumulative falls of 15.6 per cent and 24.5 per cent respectively.
At the end of 2018, Sydney values were back to where they were in August 2016, while Melbourne values are back to February 2017 levels. Perth values are back to levels last seen in March 2009 and Darwin dwelling values are at October 2007 levels. Housing market conditions have also shown substantial differences across the broader valuation cohorts. The top quartile of the market, based on dwelling values, has underperformed relative to the lower quartile. Nationally, Mr Lawless said this trend could be explained by the weaker conditions in Sydney and Melbourne, where housing values remain substantially higher than other markets.
Melbourne’s top quartile housing market has led the way with dwelling values down 11.2 per cent over the year, while the lower quartile of the market has remained in subtle growth territory over the year (0.5%). In Sydney, upper quartile dwelling values are 10 per cent lower over the year, compared with a 6.8 per cent decline across the lower quartile of the market. “The stronger performance across lower value properties likely reflects both affordability challenges and lending policies focused on reducing exposure to borrowers with high debt to income ratios. These factors, as well as incentives for first home buyers in NSW and Victoria, are likely channelling market activity towards the lower range of dwelling values.” At a macro level, the Australian housing market delivered a consistent downwards trajectory throughout 2018; however, national dwelling values remain 22 per cent higher relative to five years ago.
The property market has been influenced by local economic and demographic factors, as well as tighter credit policies, which have contributed to reducing the availability of housing finance for prospective buyers. CoreLogic says the lack of credit availability is a key factor in the current housing market downturn and forms one of the major differences relative to previous declines where the catalyst for a turn in the market has typically been changes in monetary policy settings (interest rates) or an economic shock, such as the Global Financial Crisis or the recession back in the early 1990s.
Credit availability has been tightening, especially for investment purposes, since early 2015. Importantly, the second half of 2018 has seen a sharp reduction in the value of owner-occupier lending, which reflects a tightening of lending standards and a heightened risk assessment from lenders, as well as a modest lift in mortgage rates due to funding cost pressures faced by lenders. How will the lending environment change in 2019? APRA already wound back the 10 per cent speed limit on investment lending and its cap on interest-only lending. Additionally, the final report from the Royal Commission means lenders will remain conservative.
Those borrowers with large deposits, low debt relative to their income, and a strong serviceability position will be in the driver’s seat. Borrowers with less than a 20 per cent deposit and those with debt levels that exceed six times their income, will find it harder to obtain finance and will likely face a premium on their mortgage rates. If concerns about the decline in housing values and turnover grow among the Council of Financial Regulators during 2019, the market may see some changes to the current macroprudential settings in order to soften the housing market declines.
WHAT 2019 HAS IN STORE
CoreLogic expects dwelling values to continue tracing lower throughout the rest of 2019, led by further minor falls in Sydney and Melbourne, while other capital cities continue to lose some momentum. At the end of March 2019, the previous 12 months had seen a Sydney reduction in values of 10.9 per cent, Melbourne 9.8 per cent, and an already beleaguered Perth dropping another 7.7 per cent. The primary driver of the soft outlook is a continuation of the tight credit environment, which is likely to keep housing market activity at below-average levels and prevent some prospective buyers from participating in the market. Another factor likely to dampen housing market conditions is persistently low consumer sentiment with relation to housing market expectations.
In good news, however, the Australian Prudential Regulation Authority (APRA) just issued a letter to all authorised deposit-taking institutions (ADI) regarding APRA’s requirement for lenders to assess a mortgage on the ability of the borrower to repay at a mortgage rate greater than seven per cent. APRA is now proposing the following revisions to its lending guidelines:
- Remove the quantitative guidance on the level of the serviceability floor rate, i.e. seven per cent. APRA will still expect ADIs to determine, and keep under regular review, their own level of floor rate, but ADIs will be able to choose a prudent level based on their own portfolio mix, risk appetite, and other circumstances;
- Increase the expected level of the serviceability buffer from at least two per cent to 2.5 per cent, to maintain prudence in overall serviceability assessments; and
- Remove the expectation a prudent ADI would use a buffer ‘comfortably above’ the proposed 2.5 per cent, to improve clarity of the prudential guidance.
“The proposed APRA changes seem sensible given the interest rate environment with the expectation rates will fall from here and remain lower for longer. Furthermore, since 2014 it has become much more difficult to get a mortgage, which is partly because of this serviceability assessment,” Corelogic’s Cameron Kusher said. “In closing, while these changes are welcome and will help some borrowers that can’t quite access a mortgage currently to get one, it is unlikely to result in a rebound in the housing market.”
THE NEW UNIT MARKET IN SYDNEY AND MELBOURNE IS LOOKING RISKY
Slowing demand and higher supply in the multi-unit sector is playing out, which is likely to result in weaker conditions across the unit markets in Sydney and Melbourne where the new unit supply pipeline is the most concentrated. Demand is being negatively impacted by a range of factors including slowing migration rates, fewer domestic and overseas investors (key target markets for the multi-unit sector), low valuations for off-the-plan unit settlements, and overall tougher lending conditions. Outside of the capital cities lifestyle markets will likely remain in positive growth territory, while resource-driven markets continue to gradually recover after a crash in values Lifestyle markets along the coastline and hinterland locations adjacent to the major capitals have seen strong demand from a variety of market segments.
Cashed up buyers from Sydney and Melbourne have utilised their improved wealth position following the housing boom to purchase second homes and holiday homes, while baby boomers approaching retirement are positioning themselves in these lifestyle markets as well. Professionals are also taking advantage of high-speed internet services and efficient commuting times to work remotely. As the most popular coastal markets become unaffordable, demand may spread further afield.
This article was first published in the ANZPJ May 2019 edition. Visit the ANZPJ library to read past publications.