If you wanted a deeper understanding of one of the key aspects that drives property values, read the article Christopher Joye wrote for the Weekend AFR which I have attempted to summarise below for you. In my view he is one of the top thinkers in Australia on the subject.
His motivation to have this deep knowledge is partly because he runs a fixed income securities (EG Bonds and the like) business. This means understanding the interplay between debt, consumer behavior and property values is vital.
He and his cohorts analyse the quality of the money that is lent to the banks and lending institutions. This is money that is invested for an interest rate return from lenders that is then packaged up as a mortgage product and on-sold to you as a borrower so that you can purchase a property.
This means that to successfully advise his clients, it is incumbent upon him to understand the Australian property market. His expertise led him to assist Core Logic with designing the Hedonic Index used to determine property values (this explanation vastly over simplifies what the Hedonic Index is and does!)
His main thesis in his weekend opinion piece for the AFR is that we are a long way from a property Armageddon which would require a significant de-leveraging by borrowers across Australia, largely through lending arrears and defaults.
Instead, he states, we are having an orderly and needed unwinding of property values. In fact, he demolished (his words) a journalist on a televised debate last week who propositioned that we are looking at forty per cent drops in values by asking him to explain what factors would cause the deleveraging that would precipitate a massive correction?
Apparently, the journalist was unable to answer, despite his fervent views that property values were about to plummet.
Q – So what would precipitate this event?
A – Unsustainable debt serviceability levels for a large percentage of borrowers across the country.
In other words, lots of people would not be able to make their loan repayments!
This would be caused through the interplay between these three factors:
- Debt levels
- Income
- Interest rate
Pretty logical right!
(This serves as a good reminder that if you invest the time to figure out the complexity in a situation, the fundamental principles are logical and simple to understand.)
Most people would be able to put into words if asked, what would cause a borrower not to be able to make their repayments?
The Australian property market would be impacted if this happened on a macro level with enough people. There are a lot of statistics that show our arrears rates are historically low, most people are a long way ahead on repayments and the gross loan to value ratio’s (LVR) across the country could sustain quite significant property value reductions.
Yet an experienced journalist was flummoxed when asked this question in relation to the Australian property market, despite holding a very strong and extreme view.
An overview of the outtakes that Mr. Joye eloquently made are:
- The average mortgage interest cost is 9.1% of our income, the 40 year average is 8.2 per cent so the current macro average is in line with the long term average.
- Property values are unlikely to fall significantly further (EG more than ten percent) because our average interest rate is so low. Further, I and most economists expect rates to reduce in the coming months although Mr. Joye may not agree or appreciate this sentiment. The RBA has a lot of ammunition to underpin property values through rates cuts, despite the cash rate being historically low. By its estimate it could drop the cash rate to zero which would increase property values by more than 30 per cent.
- The Morrison government (largely by virtue of our mining exports and reduced spending) has Australia in its strongest financial position for years. This is supported by a very low net government debt to GDP. These factors provide extra protection and room for the government to provide stimulus should we incur any unexpected or significant financial shocks. Politically he also makes the point that the government need to get this message across to have any chance of winning the election.
- IFM Investors Chief Economist shows that if you index the median house price in 1980 and household incomes and borrowing costs between 1980 and 2018 (the three areas of interplay pointed out above) you can find a direct correlation between income growth and property value growth relative to borrowing costs. In other words, property values are right where they should be based on a 38 year history.
On a somber note, Christopher Joye does point out some areas of concern regarding the number of high-risk loans increasing, the reduction in prepayments of these loans, and the increase in the volume of Residential Backed Mortgage Securities (RBMS) being issued, which does suggest not everything is rosy.
For further insights on what drives property values, below are links to his article and two others on the topic.
Is this the final straw for the property market?
