Nine housing graphs from the RBA on the 2014 property market
The Reserve Bank of Australian (RBA) recently noted households’ appetite for risk continued to increase over 2014.
The trend has been evident for the past year or so and is to some extent an expected reaction to low interest rates; housing price inflation and, more recently, competition amongst lenders on price have also played a role.
Accordingly, household credit growth has picked up, almost entirely driven by investor housing credit, which is growing at its fastest pace since late 2007 (Graph 1 below).
GRAPH ONE
The willingness of some households to take on more debt, combined with slower growth in incomes, means that the debt-to-income ratio has picked up a little in the past six months.
While this ratio is still within its range of the past eight years at around 150%, it is historically high and hence any further increases in household indebtedness would be taking place from an already high base (Graph 2 below).
Households’ ability to service their debt has been aided by ongoing low interest rates. The proportion of disposable income required to meet interest payments on household debt has stabilised accordingly, at around 9%.
Households continue to take advantage of lower interest rates to pay down their mortgages more quickly than required.
The aggregate mortgage buffer – balances in mortgage offset and redraw facilities – has risen to be around 15% of outstanding balances, which is equivalent to more than two years of scheduled repayments at current interest rates.
Prepayment rates and the proportion of borrowers ahead of schedule on their mortgage repayments are also high according to liaison with banks.
Part of this prepayment behaviour has been due to some banks’ systems not automatically changing customer repayment amounts as interest rates have declined, while in many cases households have not actively sought to reduce their repayments.
This might be a sign that household stress is currently limited, the RBA noted.
Households continue to take advantage of lower interest rates to pay down their mortgages more quickly than required.
The household saving ratio, although trending down a little lately, remains high at just under 10%.
Households’ aggregate balance sheet position has continued to improve in recent quarters: real net worth per household is estimated to have increased by 4% over the year to September 2014.
Outside of property investment, households have also shown some appetite for risk in their financial investments.
Retail investors have been attracted to the relatively high yields on non-common-equity instruments issued by banks (often referred to as ‘hybrids’).
These instruments are complex in nature and feature elements of both debt and equity.
The Australian Securities and Investments Commission has in the past issued public warnings about the risks involved in holding hybrid instruments and, as with any complex instrument, households should understand and take into account the associated financial risks.
GRAPH TWO
A Mortgage Choice survey shows a positive relationship between the share of households expecting further housing price inflation and the rate of price inflation in the current year; that is, expectations of future housing prices seem to be influenced by the recent past (Graph 3 below).
This tendency was stronger than average in New South Wales and Victoria at the end of last year, the bank noted. The risks associated with this behaviour are likely to be macroeconomic in nature if households were to react to declines in their wealth and any repayment difficulties by cutting back their spending.
GRAPH THREE
In an environment of historically low interest rates, rising housing prices and strong price competition in the mortgage market, there is some risk that households may attempt to take out loans that they would not be able to service comfortably if interest rates were to rise.
Lenders’ credit decisions and policies should be, and in Australia generally are, designed to prevent this.
As discussed in the chapter ‘The Australian Financial System’, to help mitigate this risk further, the Australian Prudential Regulation Authority’s (APRA) draft Prudential Practice Guide on mortgage lending emphasises that banks should apply an interest rate add-on to the mortgage rate, in conjunction with an interest rate ‘floor’, in assessing a borrower’s capacity to service their loan.
The lending behaviour of banks in this environment, including their adherence to prudent practices like the use of add-ons and floors in assessing serviceability, is particularly important; it is no surprise that APRA is keeping a close watch on this.
So far, it appears that banks’ lending standards have been holding fairly steady overall; while some elements or market segments have eased a little, others have tightened up a bit (Graph 4 below).
The share of loan approvals with loan-to-valuation ratios (LVRs) over 90% has trended down since early 2013 for both owner-occupiers and investors, though some of this seems to have shifted into the group of approvals with LVRs between 80 and 90 per cent.
Some institutions appear to be lending at high loan-to-income ratios and, overall, the average size of new loans has risen recently. Importantly from a household risk perspective, only a small share of new lending currently appears to have both a high LVR and a high loan-to-income ratio, which implies that few households are simultaneously exposed to the risks of falling into negative equity and facing difficulty making their loan repayments. Any increase from the current small share of new lending with both a high LVR and high loan-to-income ratio would, however, be undesirable and this configuration of lending continues to be closely monitored.
Another feature worthy of close monitoring is the aggregate interest-only share of banks’ new lending, which has continued to increase for both investors and owner-occupiers in 2014. This might be indicative of speculative demand motivating a rising share of housing purchases. Consistent with mortgage interest payments being tax-deductible for investors, the interest-only share of approvals to investors remains substantially higher than to owner-occupiers. According to liaison with banks, the trend in interest-only owner-occupier borrowing has been largely because these loans provide increased flexibility to the borrower. It does not necessarily mean that borrowers are taking on debt that they may not be able to service if both interest and principal repayments are made. Rather, some of these borrowers are likely to be building up buffers in offset accounts.
GRAPH FOUR
The commercial property sector is especially important from a financial stability perspective, given that it accounts for almost 30% of banks’ domestic non-financial business lending, the bank noted.
Historically, the sector has also comprised a disproportionately large share of banks’ non-performing loans.
Many of the dynamics discussed for the housing market are also relevant in the commercial property market, in part due to the role of residential property development in the sector. The attractive yields on Australian commercial property relative to returns overseas and on other asset classes have also added to these dynamics.
In particular, in the global environment of low interest rates and the consequent search for yield, the high yield on Australian commercial property has attracted strong investor demand, with a sharp increase in the total value of office, retail and industrial property transactions over the past two years (Graph below).
This demand has come from both domestic and foreign investors; the flow of foreign capital into the sector increased strongly over the past year. Foreign capital is also flowing into residential property development, particularly in the inner-city Melbourne apartment market.
The strong demand for commercial property continues to boost prices, especially for CBD office and industrial properties, despite weak leasing conditions and subdued tenant demand in some states. In particular, lower demand from government organisations in Brisbane and mining- related companies in Brisbane and Perth has weighed on conditions in these CBD office markets.
By contrast, the Sydney office market, where price rises have been greatest, has been somewhat shielded from the effects of weaker tenant demand, in part because withdrawals of property from the market (particularly the conversion of older office space to residential property) have constrained supply.
A substantial supply of office properties is under construction or being refurbished and is therefore expected to come online in the next couple of years in Sydney, Brisbane and Perth. Beyond this, industry liaison indicates that the current softness in tenant demand has led to some projects being delayed or cancelled, and building approvals have declined over the first half of this year. Supply-side pressure in the retail sector should remain limited, with the increase in construction activity over the past few years largely related to the refurbishment 80 and modest expansion of existing centres, and construction of‘large format retail centres (occupied by a single retailer).
One risk facing the commercial property sector is that a reversal in the strong growth in investor demand might expose the market to a sharp repricing. In particular, inflows of foreign capital could slow or cease once global interest rates start to rise or if conditions were to weaken in foreign investors’ home countries. The risk may also be exacerbated by further weakness in commercial property leasing conditions.
Another risk facing commercial property lending, especially lending for new property development, is tenancy risk – that is, the risk that the developer fails to secure tenants for their property and consequently struggles to meet their loan repayments. This risk is higher for developments with a lower precommitment rate. For office property, the strength in investment demand and relative weakness in tenant demand have contributed to a decline in the average precommitment rate, though available data for selected years from the early 1990s suggest it remains significantly higher now than it was in the lead-up to the severe market downturn in the early 1990s. By contrast, pre-sales currently remain high for residential property.
At this stage, the direct risk to Australian-owned lenders from these factors appears limited; liaison with industry suggests that office projects with lower precommitment rates are generally financed from developers’ own equity (or that of their investment partners).
GRAPH FIVE
The increase in household risk appetite is most evident in the continued strength of investor activity in the housing market. The momentum in investor housing activity has been concentrated in Sydney and (to a lesser extent) Melbourne: investor housing loan approvals are almost 90 per cent higher in New South Wales than they were two years ago and are 50 per cent higher over the same period in Victoria (Graph below).
As a share of approvals, both are back around previous peaks. By contrast, the momentum in the owner-occupier market appears to have slowed over the past six months or so, with loan approvals to owner-occupiers little changed.
Some potential first home buyers are likely to have been priced out of parts of the market by investors, who typically have higher incomes and are therefore able to bid up prices.
The broad-based reduction in grants to first home buyers for established housing since late 2012 has also contributed to reduced demand from these buyers.
GRAPH SIX
The risk of localised oversupply seems somewhat higher in Melbourne where there has been greater geographic concentration of building activity recently. Apartment construction in the inner city has been at high levels for some time and, given the time lags in completing higher density constructions, is expected to remain elevated for the next few years. That said, liaison suggests that construction in Melbourne continues to be driven by strong demand, including from foreign investors, with pre-sale levels remaining high.
The pick-up in housing prices and investor lending has been most pronounced in Sydney (Graph below). Construction of new dwellings has also recovered over the past two years, but this follows a reasonably long period of limited new supply. In addition, the pick-up in construction has been spread geographically in both the inner and middle areas of Sydney, and has also been for both higher-density (apartments) and detached dwellings. These factors reduce the risk that pockets of oversupply in particular regions or of a particular dwelling type will emerge.
GRAPH SEVEN
Despite the activity and housing price inflation in the Sydney and Melbourne property markets, rental yields have not declined to a significant extent
and vacancy rates in these cities remain fairly low (Graph below). However, rental yields may come under pressure if the momentum in housing price inflation continues. Households should therefore be mindful of the risks when making investment property decisions in these conditions.
GRAPH EIGHT
The characteristics and risk profile of households’ investment property exposures warrant close examination given the recent strength of investor demand for housing, according to the bank.
Investor housing loan approvals currently account for almost 40 per cent of the value of total housing loan approvals, similar to their share in the early 2000s, a period of rapid housing price inflation and strong investor demand (graph below).
As a result, lending to households for property investment currently accounts for around 20% of banks’ total lending. This box reviews households’ investment property exposures and resulting risk factors, using data from the Australian Taxation Office (ATO) up to 2011/12 and the 2010 Household, Income and Labour Dynamics in Australia (HILDA) survey – the latest data available from both sources.
Investor housing lending typically has attributes that differ from those of owner-occupier loans and that affect its risk profile.
Because interest expenses on investment property are tax-deductible, investors have stronger incentives than owner-occupiers to take out interest-only loans. In Australia, around 64 per cent of loan approvals to investors are interest-only loans compared with 31% to owner-occupiers. The typical interest-only period on these loans is around five years, though up to 15-year periods are also available. During this period, the loan principal is usually not being paid down, although liaison with banks suggests that some borrowers with these loans do make discretionary repayments. If the loan balance is not declining via principal repayment, it is more likely that it will exceed the property value (be in negative equity) if housing prices should fall. There is also a risk that the borrower could face difficulty servicing the higher (principal and interest) repayments after the interest-only period ends. To reduce this risk, banks assess borrowers’ ability to service the higher repayments.
Investor loans tend to have lower loan-to- valuation ratios (LVRs) at origination compared with owner-occupier loans. Part of this is likely to be driven by investors seeking to avoid the cost of lenders mortgage insurance, which is typically required for loans with an LVR greater than 80 per cent. Some institutions also have lower maximum LVRs for investor loans, partly to offset the risks from lower repayments noted above.
According to ATO data, the share of the population aged 15 years and over with an investment property grew steadily through the 1990s and early 2000s, before stabilising in the late 2000s at around 10%.
GRAPH NINE
