The one thing that could stop the house price party

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The prospect of rising interest rates and the implications for a hot housing market takes Lucerne Investment Partners Executive Director Michael Houghton back to the fire sales of the early 1990s.

"I was working for a bank at the time and had to go and literally take the keys off people to their house and then stand there at an auction and watch them crying over in the corner while you're just saying, 'I'll take any price — just someone buy it, please'."

The huge recent increases in median property prices in capital cities and even regional areas are not sustainable, he believes. A rise in interest rates could stop the party.

Houghton offers the example of a loan written at 2 percent, where interest rates rise to 3 percent. "There's a 50 percent increase in your borrowing costs as soon as that happens," he says. "That's where an impact on house prices could come from."

That said, Houghton explains in this interview why he doesn't expect "a big-bang outcome" and why any housing bargains will come from only the most distressed borrowers with unsustainable leverage.


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Edited transcript

Australian residential property: what are the main drivers of price from here?

One of the things that we keep looking at as residential owners of property is how much is my house price going to go up? 20% in the last year has been the number, predominantly.

The median house prices in most capital cities and even regional areas now have gone on a tear, and it's not, in my opinion anyway, sustainable.

I think the federal treasurer last week was making statements about that, and APRA has reacted by those macroprudential measures that you've spoken about.

But so long as interest rates are low, so long as people can continue to afford to borrow, so long as they've still got access to capital, then that's going to drive house prices because that's something that people understand. If you're comfortable with it, you understand it, you've got aspirations, wage growth is stagnant, sure.

But inflation, likewise, is starting to creep up. You want to be in a growth asset if you're going to be in an inflationary environment as well, and property does tick that box. I think my concern more than anything about house prices is going to be what happens when interest rates rise, because that's what's going to be the stress test.

It's one thing for APRA to say increase the way that a bank assesses a loan.

Essentially, I think that rates at present about 5.7%, is the stress test rate that they typically use. That might go to, say, 6.0%, 6.25%. I haven't seen what the number is yet.

But in reality, that's what you get stress-tested for. Then you go out and you get your loan at 2%. Interest rates go to three, there's a 50% increase in your borrowing costs as soon as that happens.

So I think that's where the concern will probably come, and that's where an impact on house prices could come from. It's probably going to be in a lot of segments. I don't think it'll be particularly targeted to one segment.

In the event of an interest rate rise, do you see a property sell-off happening?

Banks are better at handling that, and banks are the primary lender to residential homeowners. So what we've seen in the GFC, it was the same situation and also a couple of years ago that you referred to, that banks are more willing to work with people, work with homeowners, in particular, to see how they can help them manage through that process.

Because you don't want to end up in a situation, which I actually did work through in the early '90s, and I was working for a bank at the time and had to go and literally take the keys off people to their house and then stand there at an auction and watch them crying over in the corner, while you're just saying, "I'll take any price. Just someone buy it, please."

I think we're beyond that now, and I think the banks, in particular, are more interested in preserving their own capital base because it is a pretty highly leveraged capital base they've got.

I think working with investors is also far better for everybody because it does smooth the pricing then of houses. Therefore, I don't particularly see it being an extravagant big bang type outcome.

Sure, there's going to be prices that people go, "Wow, I got a bargain." But overall, they're going to be the really stressed cases, and they might be too highly leveraged and there was really not much you could do about it. But for those that are just struggling with a payment, I don't think it'll be that bad.

The other thing you have to remember is, banks ... or house prices generally, but particularly banks who are the primary lender to house prices, once they make a residential home loan, they don't go and reassess the value.

It's not like a share market where every second someone's telling you what that share is worth. Nobody drives past the house, stops out the front, and there's a billboard up there with the price going up and down, depending on what that person thinks of it.

So I think that's another factor that does help smooth house price behaviour overall. It's also something else that probably gives you comfort that if you're in some difficulty, you can work through it and you've got time on your side. Essentially, nobody knows you're in difficulty unless you tell them.

Within the laggard sectors, where are you finding opportunities?

It's finding a theme or geography or an asset class that either isn't receiving a lot of attention or one that still has the opportunity to receive a lot of attention.

ESG is one of those ones that's getting a lot of pages, a lot of words written about it at the moment. It's something that we're looking at as well, and we'll be investing in.

For us, and we've said this recently, it's not about investing in ESG for the sake of it. We want to find something that's meaningful, something that actually is contributing to the cause and the motivations that are true to label.

That's much harder than it is to just say that you are doing that particular thing. But we've found a couple of really good ideas.

The way that they're looking at it is, companies and also regions, and they're really interesting in so far as it may be a company that you wouldn't necessarily associate with being ESG, but it's the way that they're actually now rehabilitating the company, therefore focusing on cash flows and where those cash flows are being generated from

 That's really interesting for us because that's the sustainable, ongoing piece that's going to be really important.


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