The Property Dilemma: Factors of Fall.

Dinner tables, coffee shops, work places, churches and even the sporting field have now become places where the Sydney property market is discussed. The once somewhat secluded topic of investment strategies, property purchases and portfolios has been laid bare for all to see and consider. The somewhat ridiculous and ‘crazy’ (ABC, 11 June 15) property market of Sydney and Melbourne has raised concerns about a possible housing price bubble. More than a few occasions I have been asked whether I would buy, or whether I think the property prices will ever come down. As a Gen Y who aspires to enter the property market in the future these questions are extremely pertinent.

In my opinion there are 3 MAIN FACTORS to consider: National Economic Activity, Employment and Interests Rates.

National Economic Activity

Crucial to the heath of the economy is whether it is growing or shrinking. If the economy is shrinking this can lead to a recession. This has visible impacts upon industrial production, real income, wholesale-retail trade and employment. The technical indicator of a recession has traditionally been “two consecutive quarters of negative economic growth as measured by a country's gross domestic product (GDP)” (Investopedia, 2015).. GDP in the December quarter rose 0.5% and rose another 0.9% in the March quarter, which takes the annual growth rate of GDP to 2.5%, which is below expectations (ABS). This trend is in line with the Crispin Odey’s view that the recession is coming; it is just a matter of time.

Odey is not new to making bold macroeconomic predictions foreseeing the 2008 global credit crisis and piling into insurance stocks in the wake of the September 2011 terrorist attacks. On the back of such bold predictions, Odey’s hedge fund, Odey Asset Management has on average returned 14% net on its investments across its 22-year track record (AFR, 2015). With this track record it is worth listening when Odey speaks. Odey recently stated that the path to recession has begun with income, capital expenditure and rising unemployment hitting hard (AFR, 2015). He reasons that although the Reserve Bank of Australia is cutting rates, this is not enough.

If Australia is to experience a recession this will undoubtedly have an impact on unemployment.

Employment

Currently Australia’s unemployment is 6%(Trading Economics, 2015). If a recession was to hit resulting in non-localised job losses, that is where industries and sectors experience large job losses, then naturally where incomes diminish the disposable income diminishes and therefore the serviceability of mortgages would also diminish. Recent figures suggest that while owner – occupied loans rose 7.4% in 2014 investment loans grew 12.2% representing 45% of all new loans in 2014(Trading economics, 2015). Furthermore interest only loans represent 57.7% of the increase in mortgage debt by households in 2014. While the mortgage debt in Australia is $1.28 trillion (Business Insider of Australia, 2015) this is a concerning figure.

Saul Eslake, Bank of America Merrill Lynch chief economist, believes that dwelling prices will rise by 6-7% due entirely to leveraging. This entails that debt to income ratios will likely rise from an already record high of 152.8%(Business Insider of Australia, 2015). To make sense of this figure and place it into perspective, the Australian government was warned by credit rating agency, Standard and Poors, that if debt increased to 30% of GDP then it would run the risk of losing its AAA credit rating (Business Insider of Australia, 2015). Compare this figure to Australian household debt, which is 125% of GDP (Business Insider of Australia, 2015). In such a highly leveraged climate, a shock to the unemployment market by way of non-localised job losses could result in the unserviceability of mortgages. This could dramatically affect the supply and demand ratio.  

Interest Rate Rises

While non-localised job losses would cause a shock to the serviceability of mortgages, an interest rate rise of 0.5% - 1% could do the same. As the average home price in Sydney is $882 000(AFR, 2015), if a deposit of 20% is factored in with 80% borrowed then an interest rate increase of 0.25% could entail a repayment increase of $107 and a 1% increase would entail an increase of close to $400 per month (Combank.com, 2015). Although this represents a relatively small increase in repayments, it is this small increase when combined with the highly leveraged household debt market and negligible income growth, which could mean that mortgage serviceability becomes stretched for some households. The flow on effect could be that households opt to get out of mortgages rather than strain to repay them. This could ease the demand and supply relationship by restricting buyers through tighter mortgage serviceability requirements and providing extra supply of dwellings onto the market through sales and foreclosures.

It is these three factors that could well have an enormous impact upon the housing market in Australia, particularly in Sydney. The perennial question still stands, “do I buy in this market?” And the answer is not clear. While Saul Eslake believes that Australian dwellings are overvalued on a longer-term basis and that while unpleasant right now, when rates normalise in the future this will imply some “damaging economic consequences” (Business Insider of Australia, 2015) the timing around this prediction is unclear. What is clear is that if economic growth declines, unemployment grows and interests rates rise, the highly leveraged position of most mortgaged households in Australia will be tested.

While Eslake and Odey’s warnings are stark and decisive, to completely ignore them would be at ones own peril. It is through considered and informed decision making and planning that shocks to the global and local economy can be managed and absorbed.

If you would like to meet and discuss your personal, family or business position and ways to minimise the impact of any economic shocks please click below.