Economists are talking of a Sydney housing bubble as mortgage rates fall to all-time lows and Australian Bureau of Statistics data released on Tuesday showed house prices in Australia’s capital cities continued to rise in the December 2014 quarter.
Sydney prices rose another 3.4 per cent, the ABS figures showed, while Brisbane and Melbourne recorded 1.4 per cent and 1.3 per cent growth respectively.
In the year to December, prices in Sydney increased 12.2 per cent, those in Brisbane by 5.3 per cent, and those in Melbourne by 4.5 per cent.
Mortgage Rates Fall
“Although we do not see a national housing bubble, we believe that growth in Sydney housing prices is currently running at an unsustainable pace.”
HSBC economist Paul Bloxham warned on Tuesday that “Australia’s housing boom may get bubbly” and that Sydney could face house price falls when interest rates rose.
“It is also possible to have too much of a good thing,” he said in a research note.
“Construction of new housing is welcome, but further housing price gains may present challenges. Recent cuts in mortgage rates to new all-time lows increase the risk of the housing market over-inflating.
“In response, the prudential regulator announced new mortgage guidelines in December 2014, to attempt to tighten lending standards. But since then mortgage rates have fallen further, as the Reserve Bank cut again. New prudential measures seem designed to allow the Reserve Bank room to cut rates further without excessive house price growth, but they remain untested.
“Although we do not see a national housing bubble, we believe that growth in Sydney housing prices is currently running at an unsustainable pace and that any future growth is likely to be met by housing price declines in future years, when interest rates do begin to rise.”
Mr Bloxham said that “at the least we now expect that Sydney housing prices are likely to fall when interest rates start to rise, which could be as as soon as 2016.”
Mortgage Rates Fall
CoreLogic RP Data figures for January, released last week, showed that Melbourne’s house prices grew the quickest in that month: 2.7 per cent. Sydney prices rose 1.4 per cent and Brisbane’s 0.6 per cent. Darwin, Adelaide and Perth all fell.
Geoff Schippers, a mortgage broker in Sydney, has had an increase in clients looking for homes to buy since the Reserve Bank dropped its benchmark rate to a record low last week.
“At least 70 per cent of my clients are now contemplating investing in a residential property or properties,” Mr Schippers, principal at Scout Finance, said. “A few months ago that proportion was very small. People who were sitting on the sidelines are now motivated to get into the market.”
Other economists also said a housing bubble could form. “The rate cuts by the banks will provide a real impetus for the property market,” Savanth Sebastian, an economist at Commonwealth Securities, said. “There is certainly a lot of risk in an asset bubble forming in property.”
However, Mr Sebastian said that while there was “certainly the risk” of a bubble, it was “certainly not in the short-term…it would have to be in the medium term if you saw a bubble and for a bubble you would have to see ridiculous growth in prices – we’ve only had substantial growth.”
Mr Sebastian said that unemployment and vacancy rates were low and interest rates were still falling. It was, therefore, “still too early” for a bubble.
Martin North, a Sydney-based principal at researcher Digital Finance Analytics, said: “Falling yields on deposits have triggered a hunt for assets and investors are doing that without understanding the consequences. While house prices are already full on any measure, the quest for yield is going to have a stimulatory effect into the property market and build more risk into the economy.”
But other economists dismissed talk of a bubble in the Sydney housing market and said prices were not about to go down.
“I don’t think there’s a bubble, although Sydney is a red-hot market,” said Andrew Wilson, the senior economist of Domain. “There’s no bubble, it’s still a strong market in Sydney with plenty of upside for prices growth.”
Michael Workman, senior economist with the Commonwealth Bank, also said a bubble was unlikely.
“I doubt it,” he said. “There’s still reasonable scope for price rises this year across most of the suburbs within 20 kilometres of the city. There reserve bank has cut interest rates once, it’s likely to go again pretty soon.”
The International Monetary Fund estimated in October that Australia had the most overvalued housing market after Belgium on a price-to-income basis.
CBA, the nation’s largest mortgage lender, is axing residential and commercial loans for self managed super funds amid growing concerns about regulatory problems, property market weakness and stricter capital adequacy rules squeezing returns.
The bank is set to announce it is pulling SMSF lending product, SuperGear, in a bid to “become a simpler, better bank and streamline our product range”, from October 12.
But the moves will shock mortgage brokers and financial advisers and make nervous property investors more jittery about the outlook amid falling prices, rising costs and oversupply, particularly for apartments in the inner suburbs of Melbourne, Sydney and Brisbane.
It is also being done during a period of increased regulatory scrutiny of leveraged superannuation assets, potential reputational risks to lenders and advisers from “high risk” single investment SMSF schemes, and lenders’ capital adequacy requirements.
“CBA has decided to withdraw its SMSF lending product that allows SMSF trusts to purchase both residentially and commercially secured properties,” a spokesman said.
“This is part of our strategy to become a simpler, better bank. We are streamlining our product portfolio and have decided to discontinue SuperGear.”
Support existing accounts
The bank said it will be writing to customers who hold a SuperGear loan outlining the changes.
It will continue to support existing loan accounts.
“We are seeing the writing on the wall for leveraged SMSFs,” said Sally Tindall, director of research for RateCity, which monitors rates for financial service products. “This calls into question the viability of the leveraged SMSF sector.”
Regulators fear problems arising from SMSF investors leveraging their superannuation to invest in a single residential property because of the lack of diversification and increasing dangers of loss in a falling property market where it is difficult to find tenants. Systemic risk is low because the loans are non-recourse, which means they are secured by the property.
The Australian Taxation Office and Australian Securities and Investments Commission are targeting the use of SMSFs to invest in property after a review revealed 90 per cent failed to comply with “best interests” tests and other legal obligations.
It warned the strategy of gearing through an SMSF to invest in property, which is heavily promoted by property seminars and “property one-stop shops”, is risky.
The one-stop shops typically involve real restate agents, developers, mortgage brokers, accountants and financial advisers.
A key finding of the David Murray-led financial system inquiry in 2014 was that leverage should be banned in superannuation funds to mitigate the risk of financial instability. The government rejected his advice and Mr Murray said that was a mistake.
Mr Murray, who was recently appointed chairman of AMP, the nation’s largest financial conglomerate, is expected to launch an internal review of its SMSF lending practices.
Banks are also believed to be quitting the sector because of increased capital adequacy requirements by the Australian Prudential Regulation Authority are squeezing profits.
The greater complexity associated with SMSF loans and relatively small size of the market are also disincentives, according to analysts.
“As banks are looking to streamline and reduce costs, these are the types of products that get reduced,” he said.
There are fears that legal restrictions – or caps – on how much an SMSF investor can contribute to their plans could cause a credit crunch for many borrowers and force fire sales of their properties, which becomes more likely as property capital values and yields slump.
This scenario could arise if the expense of renovating a property, or supplementing rental income, exceeded annual caps.
Lenders are also lowering their lending book risks by increasing scrutiny of borrowers’ income and expenditure in assessing their capacity to repay.
Other major lenders are also tightening their SMSF lending policies in addition to increasing rates on loans and other property-related credit.
Nearly $700 billion is held in SMSF funds by more than 1 million investors. During the past four years the number of members investing in property has increased from about 3.6 per cent to 6.9 per cent of SMSF fund assets.
Tighter regulations and slowing credit growth are forcing financial institutions, including Westpac and Suncorp, to increase their variable interest rates. These increases come when the drought and a weakening property market are reducing the prospects of continuing growth in key sectors of the economy.
As a result, the Reserve Bank has been reluctant to increase the official interest rates from the present historically low levels to more normal levels. With rates rising offshore and continuing political uncertainty, the cost of overseas short-term funding for our major banks has increased even though the official cash rate hasn’t changed.
The increased costs arising from the regulatory charges and the ongoing banking Royal Commission have also helped trigger the variable interest rate increases. Borrowers now face the unusual situation of rising interest rates when property prices are falling.
The prospect of major changes to the taxation of property investors isn’t helping investor confidence. But for those contemplating new borrowings the tightened regulations are limiting the amount that can be borrowed as well as lengthening the time needed for loan approval.
Both factors have been restricting the ability of potential purchasers to acquire properties and for vendors to achieve good prices. Given the importance of property construction to continuing strength in the economy, the Reserve Bank is unlikely to add to developers’ problems by increasing the official interest rate.
If anything, the Reserve Bank will face pressure to reduce the official rate to help the banks and property sector. The increase in interest rates for borrowers has been relatively small and can be financed in some cases by reducing repayments of principal. Borrowers who’ve taken advantage of lower rates to reduce their outstanding loans can make this choice.
One major bank has already responded to the slowdown in credit growth by informing existing clients about the possibility of reducing their minimum monthly repayments. However, taking advantage of this option increases the risks of being adversely affected by any future rate rises.
Indeed, the current interest rate increases are a warning that further increases are possible. Continuing to repay capital as quickly as possible is a way to reduce risks and build wealth even with investment loans where the interest payments are tax deductible.
Not paying off an investment loan makes excellent sense when there’s also an owner-occupied home loan in existence. In this case, paying off the home loan first reduces non-deductible interest outlays. When the only loan is an investment loan, paying off the principal still makes sense, especially when property prices are falling. Owning an investment property with little or no debt allows the owner to take a long-term view and sit out downturns in values or periods of vacancy.
Unlocking the equity in your home could help you purchase another. Chief executive of property advisory firm Property Mavens used her home’s equity to buy a Preston investment property. Picture: Lawrence Pinder
WE’VE all heard of the benefits of refinancing to get a better deal on your home loan, particularly a more competitive interest rate.
But what if refinancing could also help you buy an investment property?
“Borrowers may be able to refinance their existing home loan to access equity they may have built in their property, in order to buy an investment property,” Mortgage Choice chief executive Susan Mitchell said.
Refinancing with the aim of buying an investment property could allow borrowers to grow their wealth, according to Ms Mitchell, as, generally speaking, property was considered a safe asset class in Australia with decent returns over the long term.
“CoreLogic found that over the 10 years to June 2018, national dwelling values increased by over 40 per cent, a good return on investment,” she said.
But she cautioned there were a number of costs associated with refinancing, so it was important borrowers made an informed decision before jumping in.
The nuts and bolts
So, how does refinancing using equity work?
The Successful Investor managing director Michael Sloan explained that lenders would typically lend you 80 per cent of the market value of your home, less the debt you still owed against it.
“This is your usable equity as banks hold some back as security,” he said.
“So, say, for example, you have a $500,000 property and a $200,000 loan. Your usable equity will be $200,000,” he said.
As to what value investment property you could buy, Mr Sloan said a simple rule of thumb was to multiply your usable equity by four.
“But remember that one of the risks of property investing is spending too much,” he said.
“You need to buy well below the median house price ($742,000 in Melbourne, according to CoreLogic), in fact you shouldn’t be within $200,000 of it.”
Ms Mitchell said the figure depended on how much a lender determined a borrower could afford to repay.
“Available equity is important but the key factor a lender needs to consider is how much a borrower can afford,” she said.
“If a borrower does not have additional capacity to repay a proposed new loan, they may not be able to borrow, irrespective of how much equity they may hold,” she said.
Where do I sign?
And there’s the rub: having equity in your home is not a guarantee you’ll be able to access it.
“You can have a million dollars of equity but if you don’t satisfy the institution’s lending criteria, they are not going to loan you any money,” Mr Sloan said.
“The bottom line is they will take everything into consideration: for example, how many children you have, as the more you have the less you can borrow, your work situation and how much you spend on everything from your daily coffee to the tyres on your car.”
Lenders have also tightened their assessment procedures as a result of recent regulatory measures, such as The Australian Prudential Regulation Authority (APRA) imposing a 10 per cent benchmark in growth on investment lending last year.
This was introduced in a bid to curb activity in the housing market, Ms Mitchell said.
“These regulatory measures have resulted in lenders increasing their scrutiny of a borrower’s ability to service a loan,” she said.
“When deciding if an applicant can afford a mortgage, a lender will consider a borrower’s available ongoing income and from this allow for existing debt commitments and living expenses,” she said.
“Their decision will also factor in a buffer for potential increases in interest rates.”
But it’s not all doom and gloom. Ms Mitchell advised that borrowers could overcome the increased scrutiny by getting “financially fit”.
“Get out of debt, spend your money wisely and adopt a disciplined savings strategy to show lenders you can service a loan,” she said.
Air Mutual director Damien Lawler advised would-be investors to consult an independent broker who could access a range of lenders, which might have varying assessment procedures.
“Everyone is talking about the banks tightening up – which they are – but there are banks, particularly the smaller, tier-two banks, who are still lending,” he said.
And finally …
Mr Sloan said his No.1 piece of advice for would-be property investors was to play it safe and to have some funds in reserve if things go wrong.
“You should never buy (another) property if you have no extra money available to you after you settle, so you need to have a buffer. And protect what you are building with income protection and life insurance, if you have a partner,” he said.