What’s new in the residential property market debate?

The debate surrounding residential property prices rages again – is there a ‘bubble’ or not and is the Reserve Bank of Australia (RBA) at fault or not? Historic bubbles can be distilled to four indicators: high prices, freely available and cheap leverage, high levels of indebtedness, and a plausible ongoing narrative as to why the situation should continue – all of which apply to Sydney and Melbourne residential property markets as far as we can see.

In our view, it’s important for investors to keep an eye on three areas – house prices relative to multiples of average income (a proxy measure for how expensive houses are), wages growth (a measure of ability to reduce indebtedness) and an absolute (rather than relative) measure of household indebtedness itself.

In Australia, house prices relative to income and household indebtedness are currently at or near all-time highs, while wage growth is at historically low levels – far from an ideal situation. So, what is new in the debate?

The most significant change is new rules imposed on banks to rein in residential property lending

Known as ‘macro-prudential regulation’, the rules imposed apply immediately and will:

  • limit the amount of interest-only loans to 30 per cent of new residential lending – within this, internal limits are set for loans with loan-to-value ratios (LVRs) above 80 per cent
  • require justification for interest-only loans with LVRs above 90 per cent
  • ensure better management so that previously instated 10 per cent investor lending growth caps are not breached
  • ensure serviceability measures are met and set at appropriate levels for current conditions through a review process
  • continue to restrain from lending in high risk areas, for example, high loan-to-income and high LVR loans.

These are all sensible measures, and none are overly restrictive. Indeed, it has been argued that these new rules may even improve bank profitability as the banks will simply raise rates on interest-only loans to ‘comply’.

Intervention by the regulator has been prompted by challenges of the two-speed economy

This is largely due to the problem that the RBA has in attempting to control a multi-speed economy with a single interest rate. For example, while Western Australia and the Northern Territory may benefit from lower interest rates, Sydney and Melbourne may require higher rates to brake the strength in their economies.

In the current environment, raising rates clearly worries the RBA as much as lowering them, and to counter the effect of a loose monetary policy on the hotter markets, the RBA and Australian Prudential Regulation Authority (APRA) have turned to regulation.

Increased lending rules do not remove the liquidity effect of the RBA’s monetary policy

Their policy is highly accommodative and as such, the new rules provide us with some cause for concern. As demonstrated in the run into the financial crisis, lenders (in the broadest sense, not just banks) are under pressure from shareholders to make returns. Where there is demand, the weight of liquidity provided by central banks will encourage innovation.

Perversely, the increased rules on banks could drive borrowers into the arms of less or ‘un’-regulated lenders, ceding control of property lending at the margin. And in our view, this is not particularly sensible in the current situation.

So, where does that leave us in the debate about residential property prices?

We find it hard to ignore the fact housing prices in terms of multiple of earnings are high, wages growth is low, and household indebtedness is high. As such, we remain cautious, recognising that investors are in general very exposed to the residential property market through home ownership, the high weighting of banks (in the Australian Stock Exchange indices) and the relative dependence of the Australian economy on the housing sector.

This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.

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Patrick has 32 years of investment banking experience spanning over a broad range of financial markets, including equities, fixed income, hybrids and convertibles and foreign exchange.

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