Westpac has released its monthly housing market report which sees investors driving the property market forward in 2022:
Generally speaking, where investors go, housing markets usually follow. The recent revival – led by owner occupiers – is a rare counter-example with owner-occupiers leading the way. However, as already noted, affordability pressures are starting to weigh on owner occupier demand. Meanwhile, investor activity is now clearly lifting, albeit off a low base. Chart 14 shows investor finance approvals have been rising strongly since the turn of the year. They now account for over 30% of new housing loans by value, compared to just 23% late last year. That is still well below the 40% peak share seen during the previous price cycle in 2016-18.
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The question is whether the current resurgence will carry to those previous peaks.
Our sentiment-based measures point to a further rise in investor activity near term and a clear outperformance compared to the wider market. Our ‘experimental’ Westpac Consumer Investor Housing Sentiment Index is a reconfigured version of the Westpac Consumer Housing Sentiment Index used in this report with a heavier weight placed on price expectations, excludes the ‘time to buy a dwelling’ index and uses ‘real estate’ responses to the ‘wisest place for savings’ question rather than risk aversion.
The index foreshadowed the latest lift in investor activity. It also shows a much milder slowing in recent months with current reads still consistent with solid rises in investor housing finance approvals heading into late 2021/early 2022.
There are a few other factors that will also be supportive for investor activity over the medium term.
The first is the relative pricing of units. Investors tend to favour units over houses for a variety of reasons including the favourable tax treatment of depreciation allowances. Unit prices have lagged the gains seen in houses over the last few years. This has been for a variety of reasons including most recently shifts in population flows and demand relating to the pandemic. With some of these factors easing or reversing and affordability pressures returning to the fore, units are likely to become more appealing for many buyers, a shift that will encourage investors in this space as well.
A second, and partly related issue, is around building quality concerns. Flammable cladding and defects have been significant issues in the Sydney and Melbourne apartment markets. A ‘flight to quality’ is evident in the relative prices of units vs houses in Sydney’s outer areas and in Melbourne’s inner city. We are now seeing much clearer and tighter regulation of build quality with processes in place for redressing defects over time. While that still has a long way to run, the improved transparency should ease investor concerns about these specific risks going forward.
The third factor is rental yields. While these vary widely across and within markets, they still compare relatively well overall. Average yields nationally remain above ‘fixed rate’ funding costs, offer comparable incomes to shares without the volatility and much better returns than deposits, particularly given the differences in tax treatment.
Investors look set to be a key ‘swing factor’ for housing from 2022 on, presenting upside potential near term if they return en masse but also the potential for a more volatile cycle if this draws a more stringent response from policymakers.
Thus, it appears that we are seeing a repeat of the post-GFC housing boom, whereby First Home Buyers (FHB) initially drove the price growth, only to hand the baton to investors, which kept the boom going.
This situation is illustrated clearly in the next chart which shows FHB mortgage demand briefly overtaking investor demand in early 2009 and again in late 2020 and early 2021, only for investors to then crowd-out FHBs once again:
Investor mortgage commitments surged 62% over the first nine months of 2021 and are now clearly crowding-out FHBs.
Investor mortgage growth is also now far outpacing owner-occupier mortgage growth:
The big question mark is whether the regulators will step in to crimp investor lending via macro-prudential tools? Westpac answers that question as follows:
Macro-prudential policy is now ‘live’, regulators instructing lenders in early Oct to increase the buffer used in loan serviceability assessments from 2.5 to 3ppts and setting out a clear operational framework for policy going forward. More recently, the RBA Governor has indicated that ‘more may need to be done’ on the buffer front. A further rise looks likely at the next quarterly meeting of the Council of Financial Regulators – the coordinating body for Australia’s regulators – scheduled for Dec 1.
There are two technical points on the way buffer rates are applied worth noting here.
Firstly, the rate used in serviceability assessments depends on the variable rate on the loan (for fixed rate loans, the variable rate the loan reverts to after the fixed period). The guidance is to use the higher of some ‘floor rate’ and the variable rate loan plus a buffer. This has meant that many low variable interest rate loans were being assessed on the ‘floor rate’ rather than the ‘buffer-adjusted’ rate and would have seen a smaller step up in the actual rate used in assessments.
Secondly, the serviceability assessment is applied to all outstanding debt, not just the loan currently under consideration.
The bottom line is that while owner occupiers are often more marginal borrowers in terms of their serviceability assessments, the announced increase in buffer rates may actually weigh more heavily on investor segments that face higher variable rate mortgages to begin with (i.e. where the full impact of the buffer rate increase is flowing through) and where some borrowers are carrying higher levels of existing debt. Looking ahead, these nuances will be less relevant for further increases in the buffer rate…
The RBA and APRA have also signalled other areas of focus for prudential policy: the share of high loan-to-value ratio (LVR) and high debt-to-income (DTI) borrowers. Latest APRA figures show just under 40% of new loans are on LVRs over 80% (up only slightly on 37% two years ago) and 21.5% to borrowers with a DTI>6x…
That said, more recent RBA and APRA commentary suggests these ‘high risk’ lending categories are not yet a ‘burning issue’. Commentary from both suggests that – aside from the buffer rate issue already mentioned – they are in monitoring mode rather than actively considering other actions. The tempo for policy seems to be one of move, wait and assess, then move again with a slow operating rhythm dictated by quarterly timing of CFR meetings and updates on the detailed lending data.
What might draw a more urgent response is a significant kick up in credit growth that questioned the sustainability of borrowing and lending decisions. Drawn on this in the Q&A following his November inflation speech, the RBA Governor commented: “I would be worried if household debt continues to grow at say double digit rates and income’s growing at four or five.” With household credit growth lifting towards 8% next year, that threshold will be tested.
Personally, I can’t see regulators taking any further macro-prudential action before next year’s federal election.