The Property Market: Eight Key Facts that Investors Should Know
We have often remarked that one of the great constants of life in Australia is commentary on property. House prices, in particular, attract more than their fair share of pundits and self-appointed experts. The last two years in particular have seen the property conversation reach new heights of feverishness. The usual suspects have been around with their usual predictions of doom. And some new faces have entered the fold, offering apparently expert analyses of credit processes, regulation and market dynamics.
In our view, the hyperventilation is rarely worth the paper it’s written on. And we do not say this as property ‘bulls’. At La Trobe Financial, we’re lenders, so we’re more disposed to see the downside risks than the upside opportunities. But long experience has taught us to look beyond the hype to facts ‘on the ground’. Property is a market, like any other. It can go up and it can go down. At some point, Australia might even experience a market crash. But, structurally, the property market in Australia is built on very solid foundations. We have good demand for housing via consistent strong population growth. We have a well-regulated property sector and a strong and certain legal system that gives both buyers and lenders the certainty required to make long-term investments. We have a well-regulated and successful bank and non-bank system that has proven resilient to significant headwinds. And we live in a dynamic and vibrant society that has produced almost three consecutive decades of uninterrupted economic growth. Don’t forget that, with all of the economic headwinds that we face, we have persistently solid employment levels and a record infrastructure pipeline progressively coming on board.
So, with that background, this edition of Investment Enews provides eight key facts about the property market that investors should know in July 2019.
1. Property is a staggeringly big part of your investable universe
Most investors know that property has an important role to play in an economy. But few realise how extraordinarily large it is as an asset class. The residential property sector alone is a good case in point. There are 10.3 million dwellings in Australia worth $6.1 trillion. Those figures alone dwarf the combined totals of the entire superannuation system ($2.8 trillion) and Australia’s stock market ($2.0 trillion), which is itself inflated because 37% of shares are owned by superannuation funds. When you add $988 billion of commercial real estate, it is easy to see that property is far and away Australia’s largest asset class.
Digging a bit deeper into the numbers, we can see that Sydney and Melbourne comprise about 40% of residential dwelling stock but (on account of higher average property prices) hold about two thirds of total housing debt. A rapidly growing population (1.6% p.a. or around 400,000 people, means that demand for dwellings is growing at around 180,000 dwellings p.a. nationwide. Mean dwelling prices across Australia are $633,000 and median prices are $530,000. This is truly a broad and deep market that offers a range of investable opportunities in both ownership and as part of property-secured credit strategy, such as those offered by La Trobe Financial.
2. Beware of commentators bearing simplifications - there is no single housing market!
It is always tempting to simplify. Simplifications make for easy headlines and straightforward commentary. But housing price performance has always varied depending on local conditions and sectoral shifts in the economy. For example, recent newspaper headlines have focussed on the average national dwelling price decreasing by 6.9% over the last twelve months. But did you know that this decline has been centred on more expensive dwellings and that housing values at the affordable end of the market have seen little decline, if any? The chart below makes this point outstandingly clear.
This obvious, but overlooked insight is one that has a significant influence on La Trobe Financial’s investment strategies. By obtaining valuations at an individual properly level before approving a loan, La Trobe Financial develops deep insights into the local market and the characteristics of the specific property in question. That gives significant resilience to the portfolios we build.
3. Sentiment in the sector has shifted markedly…
A key indicator of property market sentiment is auction clearance rates. From mid-2017, when Sydney and Melbourne house prices began to decline, auction clearance rates took a significant downward turn. However, as the graph below shows, especially from the time of the surprise federal election result, auction clearance rates have lifted materially. Now – a word of caution – sales volumes remain low and clearance rates are not back at boom-time highs. Nevertheless, auction clearance rates remain a good indicator of market momentum and are indicating that a genuine shift in sentiment is occurring.
4. And that is reflecting in consolidation in housing prices – it appears that the floor has been reached.
The month of June was a notable one. For the first time in eighteen months, Sydney and Melbourne saw month on month house growth. Sure, the increases were modest – low single digits on an annualised basis – but given that the two capitals are down from their peaks by 14.9% and 10.9% respectively, the first month of positive growth is significant indeed. Remember too that, despite the experience of the last eighteen months, five year price increases for Sydney and Melbourne are a very respectable 18.8% and 23.7% respectively.
Now, whilst a single month of data does not mean a trend, in our view there is more than mere statistical noise going on here. Since the start of 2019, the rate of decline in Sydney and Melbourne has been slowing month on month. The June result was simply a continuation of that trend. And when it is added to the pickup in auction clearance rates, we see multiple data points converging on a single trend of consolidation of house prices in Sydney and Melbourne.
It should be noted that this recovery in Sydney and Melbourne is being met with a downward shift in house price performance in Brisbane, Adelaide and Hobart. What’s more, there has been a continuation of the long-term value decline in Darwin and Perth. Remarkably, Perth house prices are now at levels last seen in 2006 – just one more indication of the extent of the post mining-boom slump in our western capital.
5. Housing credit formation is low – largely because of low investor activity
There has been an unusual level of commentary in recent times about banks and their approach to approving home loans (credit). Maybe that’s inevitable given the publicity generated by the Royal Commission. The fact of the matter is that housing credit is at very low levels. But this is almost entirely due to the drop-off in investor credit. As the graph below shows, owner-occupied housing credit is growing at low levels, but within historical ranges. It is investor housing that has fallen off the cliff and is even flirting with negative readings.
There are a few reasons why this could be the case. First, macro-prudential regulation from 2014 onwards meant that banks were effectively forced to slow down their investor lending book and to tilt away from loan products favoured by investors (e.g. interest only loans). So it seems likely that the supply of investor credit was restricted. At the same time, the federal opposition was proposing a series of measures that, taken in aggregate, would have made housing a less attractive investment option, so investors were less likely to take out a loan to purchase a house. In effect, investor sentiment (and therefore demand) was under attack.
These supply and demand factors, working together, have been very effective in stemming investor credit growth and have done so in every state. But where to from here? The election produced a surprise outcome and the regulator is busily unwinding much of its macro prudential regulation to return the market to a more normal setting. How long will this take to come into effect? Will auction clearance rates progressively begin to reflect in improved investor sentiment and credit formation? Certainly, some lenders are now targeting investor loans with attractive terms. Will this have the desired effect? The reality is that we are unlikely to get a clear indication on this from the numbers until late this year. In the meantime, investor credit numbers are going to remain a key ‘watch item’.
6. Housing construction levels are still high, but are about to fall off a cliff – a supply shortfall is coming
Population growth levels mean that there is an underlying demand for 180,000 new dwellings per annum. In recent years, a surge in construction activity in Sydney, Melbourne and Brisbane in particular has met that demand and even produced a small excess supply. This is one of the factors that has enabled the reduction in dwelling prices over the last two years. However, the dynamic is shifting rapidly. Residential approval and start numbers have collapsed, probably at least partly because of the reduction in investor credit. It has been well documented that this will have some negative flow-on effects for the broader economy, reflecting in lower investment, employment and consumption levels. However, it will also have a significant impact on house prices. As developers progressively complete and then sell existing construction works, there will be no new works coming on line. It is likely that we will start to see a structural supply shortfall re-emerging in twelve to eighteen months. It will not be long before we see the housing affordability headlines start to re-emerge as the key property talking point.
7. The burden of servicing a mortgage remains in line with long term averages
Speaking of housing affordability, and despite feverish commentary for almost two decades about Australia’s so-called housing bubble, the cost of servicing a mortgage for the average Australian borrower remains in line with long term averages. There are, however, two caveats on this point. Mortgage servicing is not the same as housing affordability. There is a real and signficant increase in deposit requirements in line with long-term increases in house prices. This makes it more difficult for new borrowers to get into the market. In addition, low interest rates are a clear and significant factor in restraining servicability burdens. Should they increase rapidly (which, by the way, is unlikely in the extreme given global and domestic economic conditions), servicing costs will increase accordingly.
8. The “interest only cliff” turned out to be a myth
Twelve months or so ago the property chattering classes were pointing to the level of interest only loans in the system that would have to convert back to principal and interest repayment terms in the forward years. They were claiming that this would result in ‘repayment shock’ that would drive up arrears levels and ultimately weigh heavily on bank performance and house prices. You might recall that we were sceptical about the likelihood of this occurring. The fearful commentary seemed to miss the following points:
As it happens, throughout 2018 the banks simply offered favourable terms to borrowers who agreed to convert early to principal and interest repayments. This resulted in about $40bn of voluntary early conversions to principal and interest terms for the big four banks alone. And this process is likely to continue throughout 2019. In short, the predicted (and, in some cases, seemingly longed for) bust was itself a bust.
Property & La Trobe Financial
For almost seven decades, La Trobe Financial has built high-performing, granular, mortgage-secured portfolios for its investors (both institutional and retail). At their heart, these portfolios reflect an unswerving conviction in the resilience of property-based credit. Today, we are proud to be the careful stewards of $8 billion in investment capital, including $3.6 billion in our Credit Fund. We emphasise diversified portfolios of low LVR loans and this has stood our investors in good stead across the economic cycle.
We offer a range of products to meet every investor’s needs and our industry-leading investment platform, La Trobe Direct, allows you to transact on your account at any time.
About La Trobe Financial
With A$8 billion of Assets Under Management (AUM), La Trobe Financial is Australia’s premium non-bank specialising in credit and wealth management. La Trobe Financial provide funding and investment solutions to a diverse range of 140,000 customers and have done so since 1952. 80% owned by Blackstone, the world’s largest alternative asset manager, with over US$545 billion of AUM worldwide. We are a proven and trusted investment partner for institutional and retail investors alike, operating Australia largest retail Credit Fund ($3.6bn AUM and 38,000 retail investors). We have over 66 years’ experience, managing investment mandates in excess of $17 billion since commencement.
La Trobe Financial has been a leading innovator in the non-bank sector for many years including, pioneering “Lite Doc®” lending in Australia in 1990, creating the first private Reverse Mortgage (Seniors Loan™) in 2003, launching the first hybrid wealth management-loan product P2C® (Parent-to-Child) to assist first home buyers in 2013, introducing a unique to market Aged Care finance solution in 2015, and being one of the first lenders to introduce a fully digital KYC and AML checking of borrower applicants for brokers in 2017.
La Trobe Financial Services Pty Ltd ACN 006 479 527 Australian Credit Licence 392385. La Trobe Financial Asset Management Limited ACN 007 332 363 Australian Financial Services Licence 222213 Australian Credit Licence 222213 is the issuer and manager of the La Trobe Australian Credit Fund ARSN 088 178 321. It is important for you to consider the Product Disclosure Statement for the Credit Fund in deciding whether to invest, or to continue to invest, in the Credit Fund. You can read the PDS on our website www.latrobefinancial.com, or ask for a copy by phoning us on 13 80 10.
This publication does not constitute financial advice and should not be relied upon as such. It is intended only to provide a summary and a general overview on matters of interest and it is not intended to be comprehensive. You should seek your own financial or other professional advice before acting or relying on any of the content. Copyright 2019 La Trobe Financial Services Pty Ltd ACN 006 479 527. All rights reserved. No portion of this may be reproduced, copied, or in any way reused without written permission from La Trobe Financial.