What Do You Do When You See Property Market Warnings?

I invest a significant proportion of my time on property market research. I really want to be informed and to understand what is happening and form a rational opinion on what could happen. But honestly, no one really knows what is going to happen in the months and years ahead. There are indicators (I named eight of them in last week’s article) certainly, and past real estate cycles can also give us clues. I always take note when I see a warning and I seek to dig deeper in to the thinking and research behind any warning before I give it any credence.

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The Reserve Bank of Australia (RBA) recently issued a “storm warning” to inner city apartment buyers, owners, developers and their lenders. The RBA also cites growing concerns with debt levels in China as a big threat to the global financial system, saying smaller & mid-sized Chinese banks could be at risk. They went on to pose the question as to what would happen – if prices dropped 50% – to the lenders who have loaned as much as $85BN to apartment purchasers? The RBA followed on to say that while they don’t believe that the booming Sydney, Melbourne & Brisbane markets could suffer the same type of catastrophe that afflicted Ireland and Spain after the GFC, officials believe the surge in new supply could lead to a price slide, leaving investors & banks exposed. The RBA noted that there are increasing signs of off-the-plan purchases taking longer to settle and valuations coming in below the contracted prices.

That’s pretty dramatic stuff coming from one of Australia’s most important financial bodies.

 

What really bothers me is that the RBA would issue statements that included sensational “questions” like – “what would happen if prices dropped 50%?” – but then go on to say they don’t believe it will happen. Readers are unlikely to get the 50% price drop scenario out of their minds.

Do you think the Australian property market is going to drop 50% in the next year or two? What could cause something like that?

I think it would need to be a very dramatic, probably external economic shock, like another even worse GFC to happen. While there are concerns about our major trading partner China, the RBA doesn’t seem to have outlined any rationale for posing such a question. And frankly, I can’t see any reason why it could happen in Australia’s capital cities.

I do however think there is some cause for concern for owners and off-the-plan purchasers of inner city apartments. Supply levels have been increasing for the last several years, with a lot of the interest and buying coming from overseas.

The key to this issue is how many of the off-the-plan buyers actually settle. In my estimation, most will, though there will be issues for a proportion of these buyers, due to some fairly precipitous actions taken here in Australia – actions aimed at both local and overseas buyers.

These actions, taken over the last few years and recently ramped up, could mean that the dire predictions do begin to come true – almost a self-fulfilling prophecy if you will.

So what has happened to endanger billions of dollars of development projects and housing supply and values in Australia?

  1. The Australian Prudential Regulatory Authority (APRA) has leant on the banks to slow down the level of lending to investors, which has cooled the market somewhat. Investors need larger deposits and are scrutinized far more heavily than they were before.
  2. In concert with the reduction in loans to investors, the banks have all but ceased lending to developers. Their demands for pre-sales equivalent to 120% of the peak debt of the project and higher levels of equity has meant many profitable projects have been shelved. This by itself will cut supply dramatically, and if maintained eventually will set up the next boom, led by pent-up demand for housing that was needed but not built.
  3. The Big Banks announced they would stop lending to foreign purchasers, who by Australian law have to buy new (or off-plan) property. That means much fewer new foreign purchasers being able to buy apartments that are to be constructed. And worse news for developers who have sold too much of their stock to foreign buyers who can no longer get a domestic bank home loan. These purchasers now need to provide cash or source funding from foreign banks.
  4. The Big Banks have also curtailed lending to apartment buyers – not just in the inner city either. They have produced a list of “black” postcodes in to which they will no longer lend or only lend at much lower loan to value ratios. This means that even Australian buyers of apartments can’t buy because of much larger deposit requirements. That means that stock that is coming on to the market as yet unsold, may remain unsold, which could lead to new developments not getting off the ground and even to a fall in values.
  5. State governments in Victoria, NSW & QLD all have announced stamp duty hikes to foreign buyers – anywhere from an additional 3-7% of the purchase price. This is likely to drive buyers either to other states or away from Australia to other countries with a more friendly foreign investment environment.

All of these factors, when combined mean that less housing apartment projects will be built over the coming 2-3 years – this is much of the housing that our country will need to grow. And we will miss out on the economic benefits and construction jobs that these projects could have provided – states like Victoria have boomed because of this over the last three years.

Less supply means less chance of price drops – certainly not 50%, such as posed by the RBA. The measures taken by the banks, RBA and various governments all ensure the end of the property cycle – at least for apartments. By default, you can’t leave out other types of property – though I do think that affordable houses & townhouses will continue to do just fine. The weekend auction sales clearance rates are still showing up near 80%, so there is little concern from buyers there. It is important to note though that this is on a lower volume of sales than at the same time last year.

I do very much feel, based on my research and the available statistics, and of course a good polish of my crystal ball, that there will be a pullback on apartment prices – both inner and near city in the coming year or two. It is hard to know how much – but anywhere from 5-15% could be possible, depending on which city and which project. The market simply can’t sustain the “pulling back on the reins” outlined for you in points 1-5 in this article without slowing to a halt. I would avoid buying inner city apartments for now and be prepared for a drop in values of ones you own. Though as with everything, that will pass, in time.

So is the sky going to fall on your property head? Unlikely.

Buy you might want to watch out for the lower ceilings in high rise apartments.

Please note: I reserve the right to delete comments that are offensive or off-topic.