David Llewellyn-Smith | Sydney Morning Herald | March 8, 2013
This morning, Residex’s John Edwards sees the same momentum building in the property market that we are all seeing in the past few weeks of auction clearance rates:
He argues that property prices are likely to accelerate from here. And in the short term he may be right. Although we haven’t yet seen much growth in mortgage issuance outside of fiscally stimulated bounces, the kind of clearance rates we are seeing are consistent with higher credit growth to come.
But I wish to make two simple observations.
Those looking to the RBA for succour that property price rises are inevitable are only seeing half the picture. In the post-GFC environment, APRA is just as important to credit availability. It is APRA that has to date forced banks to lend dollar for dollar on deposit growth. This means that there is an implicit macroprudential constraint on the distribution of credit, even if the price is cheap. By that I mean considerably tighter credit standards than pre-GFC.
I do not see this changing unless APRA itself changes, or is changed. And if it does not change then property price growth is inherently limited. Right now deposits are growing at 7 per cent per annum and falling. Given they make up 60 per cent of funding, that means aggregate credit can only grow at 4.5 per cent, more or less. That’s where it is now.
There are swings and roundabouts here. People are paying down debt faster so there is more credit availability despite capped aggregates. The stock market rally may draw out deposits but it also boosts equity. But as long as APRA maintains this discipline, property prices cannot rise like they used to, nor far above inflation, for any period of time.
In an era of volatile financial assets and low returns that looks pretty good, especially when you tack on some rental yield. Certainly it appears early-moving property investors think so. But the analysis is not yet complete. We have not yet considered risk.
I have never been a part of the “don’t buy now” narrative and have seen the slow melt in Australian house prices largely as a function of two forces. One is credit conservatism in the populace limiting demand. The other is regulatory intervention backing that up. Both the RBA and APRA have prevented credit expansion so that offshore borrowing by the banks and external risk for the country remains contained. Crucially, this endeavour was made possible by the mining boom, which enabled property-suppressing interest rates and economic strength to co-exist.
But that has begun to change. The 15 per cent or so correction in the terms of trade means that the mining boom is ending. So far it has done so reasonably gently. And it may continue to do so if China keeps on spending on the fixed assets that require iron ore.
But that is not my base case. Rather, I am of the view that China is serious about rebalancing because the costs of inaction are now higher than the costs of action. I therefore expect the trend in Australia’s terms of trade to continue to be down for the next few years. Which means at some point both national income and mining investment are going to drop more precipitously.
That will mean rising unemployment and falling standards of living will pressure rents because more people live together. The corollary of falling property prices, despite falling interest rates, is easy enough to draw. Really, this is a terrible irony. Folks have avoided property for a couple of years for fear of an interest rate-triggered shakeout. Now that rates are falling because real risk is growing, the market is warming up.
Of course, if your long-term goal in buying a property is to live in it then who cares, right? As long as your equity is good and you intend to live in it for a goodly period.
But if you’re investing for capital growth and yield over the medium term then I’d be asking myself if you’re being appropriately compensated for risk, especially when you can get the same exposure in bank shares, with better yield and the same capital growth prospects. And most importantly, in a liquid form.
David Llewellyn-Smith is the editor of MacroBusiness. The site offers free 2013 forecasts for the Australian economy, the Australian dollar, Australian property and the top ten stock picks for the year.