- Predictions of a housing market bubble have run rampant this year. Fingers have been pointed in all directions, including the role of loose monetary policy, negative gearing and even the Chinese. In apparent defiance of the macro concerns raised by regulators, house prices continued to rise over August, up 11.2% for the year. But not all indicators remain positive and the end may be nigh. This may prove problematic, particularly if negative gearing leads to substantial negative equity.
Here we go again
- Combined capital city dwelling values are up 11.2% over the year. On one extreme, Sydney peaked the scales at 16.2%, while Canberra posted a meagre 1.4%. Thanks go to the PM for the latter, and scarcity the former.
- Interestingly, RP Data shows that buyer demand across the country has levelled out for the year, however transactions remain 10.8% higher than a year ago.
- The enduring heat in the market has meant that auctions largely remain the chosen form of sale across the country. Although they have come off extraordinary highs earlier in the year, clearance rates are sitting around 70%. Not a bad record for winter.
The only hard fact is finance
- The value of housing finance commitments soared this year. With interest rates at historic lows there is little wonder why. RP Data expects finance commitments to level for both owner-occupiers and investors in the near term. Indeed, there is only so much debt one can take on. As the graph below clearly shows the surge in commitments has come largely from investors.
- Investor demand cannot solely be explained through low interest rates, or the potential for rental yield. As the graph below clearly shows, rental markets have been relatively soft while the values of homes have risen. This raises the question: if not for these things, what is driving demand?
Negative gearing overwhelmingly positive for investors until it’s not
- All those in the investment property game know that interest expenses on investment properties are tax deductible. Any marginally thoughtful investor would realize that an interest only loan maximizes that deduction. Indeed, 64% of loans to investors are interest only, which is more than double those taken by owner-occupiers.
- The problem with interest only loans in a heated market is the risk of negative equity –the situation when the price of the house declines while balance owing stays the same. Considering the substantial growth in prices over the last year it is fair to suggest that there is not long until prices will head in the other direction.
RBA to the rescue
- After a year playing the market down, the RBA’s Financial Stability Review suggests that there are a number of risks posed by the sheer magnitude of investor activity in the market. Indeed the Review clearly noted that further speculative demand could ‘amplify’ the property price cycle and increase the potential for prices to fall.
- The problem for the RBA is the effect that such a price fall will have on household wealth and spending. They indicate that these effects will not be contained to those involved in speculative activity alone and will have broader ramifications for the economy.
- The RBA sees these risks to be so serious that they have started to engage with APRA to reinforce sound lending practices of banks. This is a change in direction for the RBA and reflects the seriousness to which they take the risks. Some have suggested that the RBA should go further and implement macro prudential policies that can stymy the destructive potential of a speculative property market. If this occurs it will signal a turn back to the policies thrown out during the hey-day of deregulation in the 1980s and we will have come full circle.
- The Australian property market has had a good run, pushed along by a heady mix of tax incentives, low interest rates and a penchant for owning. While the RBA has spent the majority of the year talking down the market, it has finally and publically conceded that risks exist. With a blunt instrument like monetary policy, the RBA has little power to turn the tide of speculative investment. Other measures are necessary but macro prudential policies will achieve little without addressing the incentive to speculate in the tax system. Is it time to finally say goodbye to negative gearing?
This update does not constitute financial advice and should not be relied upon as such. It is intended only to provide a summary and general overview on matters of interest and it is not intended to be comprehensive. You should seek professional advice before acting or relying on any of the content.