Property

Despite the natural desire to break down the housing market into soundbites and neat changes in median prices, sub-markets remain just as fractured and diverse as they ever were.

Population growth tends to be a political hot potato, but while the headlines have quietened lately, the ballooning Australia headcount has slowed barely at all, and this is leading to an enormous ongoing demand for housing in Melbourne, Sydney, and to a secondary extent south-east Queensland.

In August 2018, it was reported that Australia’s estimated resident population had surpassed 25 million for the first time; since that time it has already exploded to well beyond 25.4 million.

Meanwhile, new stock listings in Sydney are now tracking at close to decade lows, the credit squeeze is gradually easing, and mortgage rates are set to fall to fresh record lows.

In Sydney, there is thus increasing competition for a small volume of quality new stock listings, and buyers are returning from 2½ years on the sidelines with increasing urgency. Thus in the more highly sought-after suburbs, the bottom of the established dwelling market has clearly come and gone.

There does remain some potential for regulation related to household expenditure benchmarks to stymy the recovery, but the main shift to date has purely been in sentiment.

After a couple of years in the doldrums, buyer enquiries have suddenly torn higher post-election, which is set to kick off the next cycle for Sydney, followed by Melbourne. 

As we roll into a new financial year, here are 4 specific themes for investors to keep an eye on in the Australian residential property market through FY20. 

High-rise woes: Caveat Emptor!

First, a look at some of the sectors of the housing market facing elevated risks, starting with ‘high-rise’ apartment completions, with build-quality and safety concerns regularly hitting the headlines in recent weeks.

For years I've cautioned about the great surge in high-rise units being constructed in Sydney's inner south, Parramatta, and certain other pockets of the New South Wales capital. Similar trends have played out in parts of Melbourne and Brisbane, though the respective peaks came and went a little earlier in those cities.

If you've followed my analysis over the years then you'd recall the paradigm shift towards high-rise apartment approvals really began to hit its straps from around 2012, driven by low interest rates, Chinese capital flight, and the related surge of investors from the Chinese mainland.

Given that the annual peak for approvals in Sydney didn't happen until 2016 – and due to the lag effect inherent in high-density construction - one might expect any 'teething troubles' to continue for some time yet.

My main issues of concern for investors in this property type included that land-to-asset value ratios are routinely low, that almost by definition there's no point of scarcity in the product, and moreover these types of units are simply not proven performers.

What I hadn't anticipated quite so much was the reputational risk that's now gathering a head of steam as another new high-rise unit block was evacuated this week due to safety concerns.

This week it’s been Mascot Towers in the burgeoning airport district; last time it was the Opal Tower further out west at Sydney Olympic Park.

This appears almost certain to redirect demand back into the more established locations and property types. 

Caveat emptor!

Rental vacancies: The tail end of the construction boom

This has been a record multi-year stretch for apartment construction in Australia, and rental price growth has accordingly been very muted.

But even at this late stage of the boom and with the construction pipeline now shrinking fast there’s still little evidence of a structural oversupply of dwellings, according to the timeliest available figures from SQM Research.

The national rental vacancy rate ticked down from 2.3 per cent to 2.2 per cent in May 2019, with the trend now tightening in Brisbane (2.4 per cent), Perth (3.1 per cent), and notably Adelaide at just 1.1 per cent. The local rental market remains chronically tight in Hobart, with a vacancy rate of just 0.5 per cent.

Sydney’s vacancy rate also ticked down to 3.3 per cent in May 2019, but that’s now the equal highest in the nation alongside Darwin, and of around 75,000 rental vacancies nationally almost 24,000 were in the harbour city.

While apartment completions remain high at this point in the cycle, the pipeline is now falling away quite quickly, though, so any such glut of new units in Sydney is likely only to be a temporary issue, especially with population growth evidently still blazing along at very high levels.

Mortgage stress growing in WA and NT

There has been a good deal of early and voluntary switching from interest-only (‘IO’) loans to principal and interest repayments over the past year, and the mechanical IO reset no longer applies with the arbitrary caps on IO lending now removed. Nevertheless, there remains a historically high volume of IO loans falling due for reset over the following 12 months.

Market pricing for interest rates suggests that mortgage rates are heading lower - and possibly materially lower - so at the margin, this will act as a safety valve for many of the stressed borrowers.

The timeliest available figures via ratings agencies suggest low mortgage delinquencies have continued in Sydney, which is perhaps not surprising given that the state of New South Wales has added a monster +168,000 to total employment on a net basis over the past year, while the state’s unemployment rate has been tracking at around four-decade lows.

Delinquency rates have also remained low in rapidly expanding Melbourne, despite numerous cases of default related to recent land releases on the city fringe, and are very low in Tasmania and the ACT, at about 1 per cent.

Significant pockets of stressed borrowers are to be found, however, in Western Australia (30 plus day arrears are now above 3 per cent and rising), where there’s been a half-decade downturn in the housing market, and increasingly in the Northern Territory (now above 3.3 per cent), where the local economy is effectively now in recession.

Regional Queensland has also had more than its fair share of challenges since the peak of the resources construction boom, but a sustained rally in commodity prices has brightened the outlook a little for some regional centres.

Credit pressures are easing

As the shock impact of banking royal commission continues to fade, mortgage application processing times have sped up noticeably, and it’s interesting to consider how the new assessment rate for mortgages proposed by the regulator might impact ongoing lending trends.

A simple stylised graphic below shows that currently mortgages written under 4¾ per cent will generally be treated a bit more favourably under the proposed 250 basis points interest rate buffer. Following market pricing for cash rate futures - and assuming those rate cuts are broadly passed on by lenders - then the impact would be felt far more meaningfully for loans presently written under 5¼ per cent.

This makes good sense and appears likely to keep a lid on interest-only lending to investors (typically written at higher rates) while favouring owner-occupier homebuyers. It's been good to see a dynamic and pragmatic move.

An interesting addendum is that were interest rates to increase again in the future then a buffer of 250 basis points would constrain borrowing capacity should the proposed rules remain in place, though market pricing sees rates heading lower through 2019 and 2020.

We won’t see a return to Mum and Dad investors being able to build very large property portfolios due to the effective debt-to-income caps now in place, but there has been a significant positive sentiment shift since the surprise election result.

With a fresh rate cutting cycle now in play the downturn in Sydney’s established dwelling market has now passed, with Melbourne following about 6 to 9 months behind in its cycle. Brisbane remains patchy, with detached housing markets mostly faring better than the apartment sector.

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Jonathan Rochford

High quality analysis, as always from you Pete