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Risks to housing and the banks

31 August 2014  |  Investing

banksAustralia's housing boom continues apace. It is an extraordinary era of price appreciation, dating back well over a decade. Most independent observers (as opposed to spruikers) believe the market is severely distorted. Negative gearing has encouraged investors in. Investors now are reponsible for about two fifths of applications, and first home buyers are very much sidelined. Chinese investment is reported to be growing fast, especially at the higher end of the market. And low interest rates are not only encouraging more borrowing, they are encouraging investors to look for alternatives to term deposits, whose interest rates are now barely keeping pace with inflation.
One wonders when the reckoning will hit (or if). There is certainly the possibility of a sharp downturn. If investors decide that negative gearing is not a great play (after all, it only happens when you lose money) they will dump massive amounts of property stock on the market. That, in turn, would trigger a crisis in Australia's banks, which heavily depend on  mortgage lending for their profits. But there are no signs of that occurring.
The question facing SMSFs is how to treat property? Normally, an overheated market should be considered dangerous. The trouble is that other options, especially cash, are not good.
It is a conundrum. But there is little doubt that the market is hot, as the AFR reports:
"New data shows Australia’s immense investment-backed speculative housing boom, which is now as big as the last investment “bubble” in 2003, has continued at a ferocious pace over the past 3 months even in “seasonally-adjusted” terms."

The market is growing at 15% annualised. Sydney and Melbourne have been hottest:




The Reserve Bank is concerned that it could be a speculative phase similar to what happened in 2002-2003. According the the AFR, investors made up nearly 39 per cent of new housing finance commitments, which is an almost identical level of participation to that recorded at the peak of the early 2000s boom.




Foreign interest and SMSFs are further inflating the market:


"Foreign buyers make up about 40 per cent of all newly developed homes in Sydney and Melbourneand the $560 billion self-managed super fund sector, which can now leverage its cash five times when purchasing properties ... home values across the 8 capital cities are 26 per cent above their peak prior to the global financial crisis and 10.2 above the levels touched in the last cyclical boom in 2010."




Meanwhile, Business Spectator is questioning the commentary on housing from the big banks, which of course are deeply conflicted. It is also a danger signal for SMSFs that are heavily invested in bank shares:


"Australian banks have binged on mortgage lending over the past couple of decades, reaping record profits year-after-year, which has resulted in Australia possessing one of the highest levels of private debt in the developed world.

In recent years, they have taken it to a whole new level. Slowly but surely, they have undermined the very business sector that allows Australia to pay such high prices.

Mortgages to owner-occupiers and investors have accounted for more than 100 per cent of outstanding credit growth since the end of 2008. That means that credit to businesses actually declined. Mortgages now account for more than 60 per cent of total credit outstanding and is rising rapidly, up from just 43 per cent at the turn of the century."


Credit growth for housing greatly exceeds business investment, which, considering that it is essentially a non-productive asset, suggests that the capital markets are not working well:


Graph for What the banks aren't telling you about the housing market

Here are the new lending statistics, which again suggest overheating:

Graph for What the banks aren't telling you about the housing market


The big threat is not just to property prices, it is also to the banks:
"Our major banks seem rather complacent about the challenges facing the housing market, which will threaten their entire business model. The reality is that the housing market has become increasingly cyclical. Following two decades of unprecedented growth, house prices have suffered three downturns over the past decade, with mounting evidence that another could be on its way (Watching the housing market for vital signs, August 21).

These downturns occurred despite solid income growth, low unemployment and the mining boom. What would happen if the economy suffers a genuine setback such as rising unemployment, a sharp fall in mining investment or China slowing significantly? How does a combination of the three sound?

Add in a variety of other issues such as negative real wages, university students potentially beginning their careers with six figures of debt and an ageing population, and it becomes clear how vulnerable the Australian housing market might be.

Not that you’d know this by listening to these chief economists. Don’t expect much discussion on the housing implications of a shift towards lower income growth. Certainly don’t expect them to offer a critical view of the systemic risk posed by the four ‘too big to fail’ banks and their exposure to an increasingly volatile asset class worth more than $5 trillion.

The unfortunate reality is that with hundreds of billions on the line we shouldn’t expect our major banks or their chief economists to talk sense about Australian property. If there really is a bubble or a housing downturn, you can be sure that our banks will be the last people to let you know. They can’t afford it to be any other way."




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