What property investors need to know about macro prudential controls We all know it has to come to an end at some time. Something is going to stop this property boom, which has been particularly strong in Sydney and Melbourne. BY MICHAEL YARDNEY While most of us thought it would be the Reserve Bank of Australia (RBA) raising interest rates, things may in fact be slowed down by macro prudential controls on “high risk” lending. Since this latest buzzword isn’t in the vocabulary of many property investors, let’s look at it in more detail. What are macro prudential controls? These are financial regulations aimed at minimising the risk to the financial system as a whole, while traditional micro-prudential regulation limits stress to individual institutions. In essence we’re talking about measures that aren’t associated with monetary policy (raising interest rates) but are designed to slow lending, particularly to property investors. These could be policies such as capping loan-to-value ratios (LVR), capping debt-to-income ratios or stress-testing borrowers’ capacity to cope with rising interest rates. Why now? With property prices continuing to rise at a rapid rate, particularly in Sydney and Melbourne, the RBA and the Australian Prudential Regulation Authority (APRA) appear to be considering introducing macro prudential policies in order to ease mounting pressure in Australia’s property sector. What has happened is that over the past 20 years, home prices in Australia have almost trebled while average household income hasn’t kept up. The difference has been made up with debt. The ratio of household debt to household income is now 150 per cent – a historic high. In its September board meeting minutes the RBA notes that “additional speculative demand could amplify the property price cycle and increase the potential for property prices to fall later”. According to the RBA’s Financial Stability Review , “the Bank is discussing with APRA, and other members of the Council of Financial Regulators, additional steps that might be taken to reinforce sound lending practices, particularly for lending to investors”. Rather than raise interest rates, which would have a sledgehammer effect on our whole economy, it seems the RBA would like to specifically limit lending to “high-risk” property investment loans. Don’t get me wrong… The RBA is not saying we have a property bubble or that prices are going to crash. Instead it says: “The low interest rate environment and, more recently, strong price competition among lenders have translated into a strong pick-up in growth in lending for investor housing – noticeably more so than for owner-occupier housing or businesses. Recent housing price growth seems to have encouraged further investor activity. “As a result, the composition of housing and mortgage markets is becoming unbalanced, with new lending to investors being out of proportion to rental housing’s share of the housing stock. “The risks associated with this lending behaviour are likely to be macroeconomic in nature rather than direct risks to the stability of financial institutions… a broader risk remains that additional speculative demand can amplify the property price cycle and increase the potential for prices to fall later, with associated effects on household wealth and spending.” Yes… if property prices keep going up, they’ll have the potential to fall later. I guess that’s the property cycle isn’t it? Have macro prudential measures been tried elsewhere? While you may not have heard of this before, there’s nothing new in these policy instruments – their use mostly pre-dates the financial deregulation that occurred in the early 1980s. However, the term became fashionable again in the wake of the GFC, as it became clear systemic risks that had built up unchecked in the global financial system added greatly to the severity of the crisis. Macro prudential regulation is advocated by the International Monetary Fund (IMF), has been widely adopted around the world (including in Britain, New Zealand and a number of Asian countries, where housing markets were perceived to pose risks to financial stability) and has become the flavour of the month in Australia. However, assessing its effectiveness is complicated. Across the ditch, the Reserve Bank of New Zealand (RBNZ) last year decided to limit the proportion of bank loans with an LVR of more than 80 per cent to 10 per cent of new lending in response to a housing boom in Auckland and Christchurch. Property prices have nevertheless started surging again, causing the RBNZ to raise interest rates. And recently the Bank of England announced that it would restrict the proportion of loans that are 4.5 times the borrower’s income to 15 per cent of new lending. Lenders are also required to assess a borrower’s capacity to absorb a three per cent interest rate hike in the first three years of the loan. Can’t the RBA just raise interest rates? Yes it could, but increasing interest rates is a blunt instrument that will not only affect our property markets but our economy as a whole, and that’s not what the RBA wants. The fact is, our economy is just limping along – growing at a woeful two per cent (annualised) in the second half of 2014 and predicted to grow at a below-trend three per cent in 2015. This means raising interest rates could stop our economy dead in its tracks as consumer confidence (and therefore spending) dips. On the other hand, macro-prudential policies are seen as providing policymakers with a more targeted set of instruments that might complement or even be a substitute for changes in official interest rates. What does the government think about all this? Treasurer Joe Hockey recently endorsed macro-prudential controls, provided they are “targeted” and “time-limited”. His support seemingly came about after the IMF endorsed macro-prudential controls as “the first line of defense to address potential financial stability threats” at the G20 meeting recently held in Cairns. Will these measure slow our property markets? They may do so for a short time but they probably won’t have the desired effect in the long-term. While rising property prices tend to be blamed on ugly, greedy property investors, there’s much more to it than that. The combination of the Chinese economic revolution, which fed an Australian commodities boom and fuelled our economy; an immigration program that added a net one million people over three years at its peak; and a general shortage of housing at a time of historically low interest rates has produced a long-running property bull market driven by demand. Sure, investors contributed to property price growth, but in truth property investors only account for about 38 per cent of the value of total loans. In other words, even if the RBA targets “risky loans” from property investors, firsthome buyers, upgraders and downgraders will still remain out there pushing up property values. As will the hoards of overseas investors who’ve been fuelling our “off-the-plan” and new apartment markets. Are property investors really a threat to our financial system? Probably not! You see, the RBA analysed the types of households and the ages of Australia’s property investors in its biannual Financial Stability Review and found it was the highest-income households that owed most, 60 per cent, of the total investor housing debt. Compared to homebuyers, who often take out loans with very high LVRs, using lenders’ mortgage insurance, investors are “fairly well placed to service their debt” and “typically (used) less than 30 per cent of their income to service their total property debt”. Interestingly, more than half are ahead on their mortgage repayments and 70 per cent of property investors are 40 or over, which is important because the unemployment rate for this age group is very low. In fact, the RBA data shows that investors are typically cashed up, know what they’re doing and present little risk to the financial system or the economy generally. Now, I’m old enough to remember a regulated banking industry and credit squeezes that restricted funds for investors and businesses. Paul Keating introduced deregulation and a “free market” for many reasons: efficiency and productivity and equity because regulation simply wasn’t working. While some would argue, “let the markets run their own course”, history shows that it’s desirable to moderate our surging property markets in some way, otherwise we’re setting ourselves up for another property crash. But remember, it isn’t ugly, greedy investors that are causing our housing crisis. It’s mainly related to insufficient housing stock, other than in our CBDs, a lack of infrastructure and low interest rates. The fact that investors are taking advantage of the low interest rate environment to purchase the type of properties that are in tight supply isn’t surprising. It’s shrewd business and the way capitalism and our housing markets have always worked. So what’s the answer? Clearly, I’m not qualified to give one considering the experts, our authorities and economists, who are much smarter than me, have not been able to. However, maybe it’s a mixture of something like allowing the right type of properties – ones that are sought by a wide demographic of people – to be built in the right locations, enforcing prudent banking practices and keeping interest rates appropriately calibrated. We’re in for some interesting times ahead. Michael Yardney is a director of Metropole Property Strategists who create wealth for their clients through independent, unbiased property advice and advocacy. He is best-selling author, one of Australia’s leading experts in wealth creation through property and writes the Property Update blog. Subscribe today and you’ll receive a free video training – The Golden Rules of Property Investment.
Posted on: Thu, 02 Oct 2014 23:02:26 +0000
Trending Topics
Recently Viewed Topics
© 2015