Property Down Under Newsletter - 24th September 2022
The feature article of the week:
Below is our feature article for this week’s edition of the newsletter.
This is the article we found most interesting to read, and the one we think is a “must read” for all our readers.
Our key takeaways:
Housing affordability is now at record lows due to increased interest rates.
For affordability to improve either rates or property prices need to come down.
RBA is forecasting more interest rate hikes going into the end of the year.
Barrenjoy Chief Economist Jo Masters thinks that record high dwelling price to income ratios will decrease as house prices decline.
Barrenjoy said ““In the next three to six months we expect the rise in interest rates to outweigh falling house prices, driving the cost of servicing a new mortgage to new highs,”
Barrenjoy’s model points to a 25% fall in Sydney house prices.
Our Take:
Housing affordability is measured by taking the price of a home and dividing it by the average household income in that particular postcode.
At the moment, Sydney home prices are trading at >15x incomes near record highs.
The second measure is to take the mortgage repayments a household makes and to then divide it by the average disposable income of households in that particular postcode/state.
This has already risen from a pandemic low of ~34% to now sit at ~49% across NSW.
As interest rates rise this second metric becomes a whole lot worse, the only way for this metric to improve is for the RBA to start reducing its cash rate (and in turn decreasing mortgage rates) OR for property prices to fall.
Our view is that as rates rise, property prices will continue to fall so that these metrics start to return to the long term averages.
Other Mainstream media 📰
Housing market will return to balance in 2024: Stockland CEO (AFR)
Super funds excited by housing opportunities: Chalmers (AFR)
The suburbs where pandemic gains will soon be wiped out (AFR)
RBA Sees Rates Getting Closer to Normal Settings, Minutes Show (Bloomberg)
China Mortgage Boycotts Grow as Home Buyers Regroup Online (Bloomberg)
Why should you care:
Our theory is that property prices are largely dictated by the flow of NEW credit into the housing sector.
This means that for property prices to increase, the average size of a new loan and the amount of new loans being written need to increase.
The chart from the RBA shows how increasing rates impact borrowing capacity for new and existing borrowers.
Our takeaway:
The 2.25% increase in the cash rate since May has impacted maximum loan sizes.
So far the 2.25% increase has been fully passed through to mortgage interest rates and has reduced a borrowers' maximum loan size by ~20%.
Because the assessment rate also applies to any existing debt, the decrease in borrowing capacity is even larger for prospective borrowers who have existing debt, such as property investors
Our expectation:
We think that it is actually relatively easy to predict the direction in which house prices will move, simply by calculating the flow of credit into housing.
We think that the ~20% reduction in borrowing capacity (a lot more for those who are already levered) will lead to a correction of at least the same amount across the Sydney and Melbourne markets.
If we see rates get to the ~3.6% level, then the chart above shows that borrowing capacity could be reduced by up to ~60%. This would mean property prices could fall by the same amount.
Our base case view is that a bottom in the property market isn’t reached until prices have fallen by at least 25%, the above chart suggests to us that it could be a whole lot worse though.
The key indicator we are watching is credit growth for housing which was down ~8.5% month-on-month for July. If we see this number continue to fall then prices are likely to continue falling.
Watch this space.
Great analysis of the current state of the property market. This correction is shaping up to be the one that future generations will compare all other corrections too. Up until now it has been the rout that occurred in the 1890's.