Property market risks you need to be aware of

5th Nov 2014By: Tim Lawless

Investment in Australia’s housing market moved to new record highs recently with the Australian Bureau of Statistics (ABS) showing investor related mortgage commitments (excluding refinanced loans) comprised 49.7% of the new mortgage market. In dollar value terms, over the past year, investor mortgage commitments totalled almost $128 billion, which is also a record high, and 29% higher than what was recorded over the previous twelve-month period.

Looking at data across the states, it is clear that the largest proportion of investment demand is flowing into the New South Wales market. Investors accounted for 59.2% of all new mortgage commitments in New South Wales during August, which is, once again, a record high. The Northern Territory has recorded the second highest proportion of investor loans at 53.9% of the market, followed by Victoria at 49.7%, and 44.4% in the ACT. Investors comprised 41.6% of all new mortgages in Western Australia and 40.4% in Queensland. The lowest proportions were recorded in Tasmania (30.0%) and South Australia (39.5%).

Investment demand highest in Sydney

Anecdotally, the concentration of investment demand within the New South Wales market is focussed mostly within Sydney. Such interest from investors comes as no surprise, considering the spectacular capital gains recorded across this market post GFC. Since the beginning of 2009, through to the end of October 2012, Sydney dwelling values have risen by more than 50%. In fact, Sydney dwelling values are up by almost 30% over the current growth cycle, which commenced in June 2012.

Investors are clearly very much focussed on the prospects for capital gain, however this segment of the market may be overlooking some of the more important fundamentals that are signalling a heightened level of risk. Firstly, the growth curve in Sydney is very mature – values have already risen substantially, and affordability constraints will, at some point, naturally start to slow market demand. Secondly, the yield profile of Sydney is looking increasingly unhealthy. Sydney houses are returning a gross rental yield of just 3.6%, while units show a slightly better average gross yield of 4.5%.

The risk for investors is that they are purchasing an expensive asset in a market place where the prospects for capital gains are looking less certain at a time when the cash flow from the asset is well below the ongoing costs. The current low interest rate environment lessens the cash flow burden, but of course interest rates won’t stay this low forever. When mortgage repayments eventually start to rise in line with the cash rate, there is some risk of an interest rate shock, which ultimately could result in higher arrears for those home owners on a tight budget.

Regulation uncertainity

Investors may already be feeling uncomfortable with the heat in the market and the RBA warnings. While investment in the housing market continues to grow, the rate of increase in the value of investor mortgage commitments has slowed from a recent peak of 40% annually in December last year, to approximately 28% in August this year.

If the Australian Prudential Regulation Authority (APRA) introduces macro-prudential measures to cool investor demand, as is widely expected before the end of the year, we are likely to see investor demand slow further, as the cost of debt rises in response to the regulatory changes implemented by APRA. In the meantime, we may actually see a lift in investor mortgage demand, as some investors look to beat the potential introduction of these macro-prudential tools.

While we can only speculate on what these macro-prudential measures may be, they are likely to take the form of higher risk weightings associated with investment loans. This may mean that lenders will need to place more capital aside for these loans. In turn, we can expect lenders to pass these higher costs onto investors in the form of a higher interest rate margin.

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