What lies beneath: Investor driven growth cycle heightens underlying risks

The current value growth phase across Australia’s combined capital cities is nowhere near as strong as other growth phases over recent times.  Although home values are rising, they are doing so at a much more moderate pace than during previous growth phases. 

Home values are higher now than they have been in the past however, a different market characteristic now is that investors represent a much greater portion of the market. This could potentially heighten the risks associated with a downturn in the current growth phase.chart 1

19 months ago, the combined capital city housing market reached a low point following a -7.7% fall in home values.  Since that time, capital city home values have recorded total value growth 10.3% to November 2013.  In comparison, over the 19 months from the beginning of 2001 home values rose by 31.3%.  From the start of 2007, home values were 13.7% higher 19 months later from the beginning of 2009 home values were 19.8% higher 19 months later.  So as you can see, home value growth in this phase has been much more moderate, however, home values are also higher.

Interestingly, values were still growing after 19 months in 2001/02 however, values had begun to fall by this point in 2007/08 and 2009/10.  In 2007/08 the market was beginning to plunge into the financial crisis and aggressive interest rate cuts were not yet enough to stimulate higher demand and subsequent higher home values.  In 2009/10 low interest rates and the First Home Owners Grant Boost (FHOGB) stimulated the growth in the housing market however, once the stimulus was removed and interest rates started to rise we saw the rate of value growth fall and eventually turn negative.

In the current growth phase we have not as yet seen interest rates rise and there has been no other external stimulus such as the FHOGB, and values are still rising after 19 months.  A feature of the market in this growth phase compared to the previous three growth phases highlighted is that a greater proportion of demand is being made up by investors; of course investors were a part of the market in the previous growth phases however, owner occupiers held greater prominence than they do currently.

So is this market being fuelled purely on investment speculation?

Not quite. Currently, there is a comparatively higher proportion of investment activity in the market when compared to the previous growth phases.  Over the 19 months from January 2001, investors accounted for a month-to-month average of 32.2% of the value of total housing finance commitments. 

From January 2007 investors accounted for a month-to-month average of 34.8% of all housing finance commitments and from January 2009 they accounted for a month-to-month average of 32.7%.  From May 2012 to September 2013 (latest data available) investors have accounted for a month-to-month average of 35.9% of all housing finance commitments.  The level of investor activity throughout the current growth phase is not abnormally high but it is certainly elevated compared to the previous three growth phases analysed. 

Across this growth phase investment levels are not abnormally high they are escalating.  In September 2013, investment finance commitments made up 37.3% of all housing finance commitments which were the highest proportion since May 2004 (37.5%).

chart 2

As I see it there are two potential pitfall of the current heightened level of investment in this market growth phase.

Firstly, data suggests that investment activity is highest within New South Wales, Northern Territory and the Australian Capital Territory.  Anecdotal evidence suggests that offshore investment activity is particularly strong in Victoria. 

If we assume that the state-wide data is a proxy for the capital city markets, we gain some valuable insight into the characteristics of investors.  In Sydney, home values have already risen by 15.9% from their May 2012 low. In Melbourne home values are now 8.6% higher than their low in May 2012.  Darwin values are 15.9% higher than their low in January 2012, while in Canberra, values have increased by just 3.1% from their January 2012 low.  Values are still trending higher in Sydney and Melbourne. In Darwin value growth has moderated while in Canberra values are falling. 

My point is that if investors are chasing capital growth, in all likelihood and based on timing, they have already missed the best opportunity.  If investors are focused on rental return, yields have trended lower across each of these cities over the past year.

chart 3

Secondly, a potential future weakness for the market is that some investors may not necessarily be ‘committed’ to the asset class.  Meaning that if value growth was to slow or start to fall are these investors invested in residential property for the long haul, or will they choose to exit the asset class just as quickly as they have entered? 

My opinion is that if they aren’t committed then there is potential risk associated in the future where a significant supply of investment grade units may come to market when investors may be looking to exit poor performing assets.

One final risk of course is a rise in the unemployment rate.  Official government forecasts are calling for unemployment rates to peak at 6.25% by the middle of next year.  To date, the unemployment rate has been trending higher at a fairly moderate pace and was recorded at 5.7% in October.  If this rate was to rise to 6.25%, it would be the highest unemployment rate since September 2002 (higher than any time during the financial crisis). 

If we were to see investors look to exit their investment properties such as they did in 2008 in line with an escalation in mortgage arrears, we could see weakening home values much like what occurred in 2008.  

Chart 4

Overall there are always risks associated with the housing market, or any market for that fact.  We have no doubt that the Australian Prudential Regulation Authority (APRA) are regularly analysing these risks and liaising with the banking community to ensure these potential risks don’t turn into a reality for the market.

Cameron Kusher is senior research analyst at RP Data.


Cameron Kusher

Cameron Kusher

Cameron Kusher is senior research analyst at CoreLogic RP Data.

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