Merrill Lynch says property slowdown will hurt negatively geared investments

Merrill Lynch says property slowdown will hurt negatively geared investments
Prateek ChatterjeeApril 17, 2016

Australians' love affair with property investment could be tested by the continuing slowdown in home prices, and that investors may be second-guessing the validity of negatively geared investments, according to Bank of America Merrill Lynch.

According to the bank, this may be the last property price boom Australians will see for many years, according to a recent article in the Australian Financial Review.

March data shows that median capital city prices rose just 0.2 percent, with annual growth decelerating to 6.6 percent year-on-year. These figures are down from a July 2015 peak of 11.6 percent year-on-year and 11.9 percent in April 2014.

"A period of weaker price growth or outright modest declines is likely to become entrenched over coming years," Merrill Lynch said in a note to clients. 

"We'd expect that such a period could severely test Australians' long love affair with property investment."

Record low interest rates, while initially prompting new entrants into the property market, has left few marginal buyers following the extended period of these conditions.

While diminishing house price growth has not overly knocked household spending or confidence, the bank sees significant oversupply exacerbating the apartment sector in the next 12-18 months, particularly in Brisbane and Melbourne's central districts.

"This will likely be of concern to new investors in this market," the note reads.

"Yet this development is not expected to materially [affect] price performance of detached housing but may [hurt] sentiment towards the property market overall."

Though the bank expects these pockets of apartment price weakness to lead the further deceleration of price growth and building approvals, it doesn't expect this to spill over into the detached housing market, although prices will continue to decelerate over the course of the year.

That said, the over-supply issue could take years to resolve, particularly as falling Australian immigration numbers slow population growth.

Those with negatively geared investment properties may find they need to hold onto these properties for longer to realise adequate capital growth.

"In addition, over this period, they are likely to face regulatory risks from both sides of politics," said the bank, referring to taxation statistics suggesting that, among the 2 million landlords in 2013-2014, one in six individuals were eligible to pay tax, a potential target for government tax policy.

However, thanks to the low interest rate environment, the average rental loss per landlord has declined from $11,000 in 2010-11 to $8,700 in 2013-14.

RBA governor Glenn Stevens recently said that a moderation in house prices was helpful.

The last time the RBA cut rates was in February and May of 2015, and Merrill Lynch argues the property market was one of the only beneficiaries, as price growth leapt in the following months.

Merrill Lynch thinks it unlikely the RBA will cut rates soon, unless a material rise in unemployment jolts the Australian economy.

"It is our view that only a material rise in the unemployment rate should force the RBA's hand - not a, likely transitory, deceleration of inflation or as an attempt to manage the exchange rate," the note reads.

But it's the promise of a slowing growth asset that weighs on the bank's thinking.

"If dwelling and in particular apartment price appreciation is difficult to come by over coming years, new investors may increasingly question the validity of their negatively geared investment," the bank says.

As such, Merrill Lynch remains wary, citing high indebtedness combined with extraordinary monetary policy globally as the reason appetite for property may be diminishing.

"With household income growth soft, the reduced ability to borrow, or at least no further extension of it, will weigh on prices," the bank says.

"This most recent boom in dwelling prices is likely the last one we will experience for some time."

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