Money & Markets | opinion

The days of property prices only going up are well and truly over

Quinn Rooney/ Getty Images

The days of property prices only going up are well and truly over.

The housing market landscape has changed and so too has the behaviour of borrowers, lenders, developers, valuators and buyers’ agents. There are now many high risks associated with residential property including oversupply, credit restrictions, the impact of the Banking Royal Commission and imbalances in the market.

Add to that the prospect of an ALP win at the next federal election, and with it reforms to negative gearing and capital gains tax, and there is much cause for concern, especially if a blanket approach is taken with their introduction across the country.

RiskWise Property Research and WargentAdvisory’s The Impact Analysis: Negative Gearing, CGT & Australia’s Residential Property Markets report assesses Labor’s proposed reforms to negative gearing and the capital gains tax (CGT) discount, and the implications if implemented.

How behaviour has changed:

Investors have a major impact on dwelling prices. According to the RBA they can amplify credit and dwelling price cycles.

One of the reasons for this is because investors purchase more off-the-plan dwellings than owner-occupiers, meaning they contribute to larger upswings in construction leading to the risk of future oversupply, particularly of units, in some locations. Conversely, elevated levels of investor activity may amplify any subsequent downswing, increasing risks to the broader housing market, particularly in areas that carry a higher level of risk for oversupply.

Also, rental properties are not always fully substitute products with owner-occupied dwellings (rental properties are typically smaller, carry a higher price per square metre and are closer to CBDs).

This means there is inherent risk associated with them as they do not appeal to families looking for three bedrooms plus outdoor space, close to schools, transport and employment hubs.

An example of a recent change in investor behaviour can be seen in Footscray, Victoria, where a RiskWise report analysis for one private investor considering buying an off-the-plan unit showed it was extremely high risk.

The development was a 40-unit high rise and the unit had only two bedrooms with no car parking. It had a rental return of $450 per week for a property value of $575,000 and strata payments $600, plus it was in a very oversupplied area.

Currently there are a large number of high-rise properties being offered to a smaller number of investors.

This has resulted in a reduction in activity and had a major impact on the market, including owner-occupiers. The investor market share in Sydney decreased between January 2017 to March 2018 from 50.4% to 43%.

A similar trend was witnessed in Melbourne, from 39.1% to 34.9%.

In addition, Foreign Investment Review Board figures show residential approvals to foreign persons fell sharply upon the introduction of application fees and duty surcharges from 40,149 in the financial year 2015-16 to 13,198 in the financial year 2016-17.

Chinese authorities have also made it more difficult for its residents to purchase overseas.

Borrowers are by far more aware of the risks regarding off-the-plan and are changing their investment strategies, purchasing existing dwellings, particularly houses, rather than units.

SuppliedRiskWise Property Research CEO Doron Peleg

A prime example of the impact of borrowers on dwelling oversupply and price reductions is units in inner-city Brisbane.

The area has experienced a high volume of apartment construction, stock listings and elevated vacancy rates, and there has been widespread evidence of price discounting and falling rents.

The volume of construction work has declined by 33 per cent from the December 2016 quarter peak, and further significant declines are expected.

Areas with a high level of stock and an elevated number of approvals and units in the pipeline have suffered from poor and often negative capital growth, and this significantly increases the settlement risk for units purchased off-the-plan, particularly in larger developments.

Buyers’ agents have also become more conservative and cautious regarding equity risk and, in particular, are very sensitive to any potential oversupply. For many, one of the key requirements is to only have a small number of dwellings in the pipeline and very limited supply.

Lenders have responded strongly to APRA’s requirement to reduce the proportion of interest-only loans. These declined sharply from 45.8 per cent of new residential housing loans by ADIs to 15.2 per cent by December 2017.

Also, lenders who previously only applied a very basic approach of flagging postcodes as high-risk areas, i.e. ‘blacklists’ (that require either lower Loan-To-Value ratio or not allowing the loans at all), are now reconsidering their entire approach towards risk management and applying more sophisticated risk practices and strenuous research to better assess potential over-supply and / or weak demand.

For example, RiskWise has received a number of requests from different lenders to assess the risk associated with Central Queensland. We have found there is little demand for dwellings there and plenty of stressed investors who want to get rid of their properties but can’t. This means you have a large proportion of investors with negative equity, low rental returns and poor demand.

We can also see major changes in the behaviour of developers. In the past they balanced between risk and return, and were keen to gamble on the profit side, developing in areas that suffered from over-supply and development approvals, but also in many cases developing small units unsuitable for families. They, therefore, gambled that their stock would be absorbed by local and foreign investors.

However, due to the reduction in foreign investor activity and increase in risk awareness by property investors these developments are significantly riskier.

Consequently, developers are now taking a thorough approach to manage their risks. Instead of focusing on high rises in central CBDs they are looking for medium-density development opportunities in the middle rings, or house and land packages. Again, inner-city Brisbane is a prime example of where this is the case and the lessons that have been learned.

Mitigating strategies

All parties should weigh up their ‘risk appetite’ before making decisions and consider any impacts from the potential introduction of Labor’s negative gearing reforms. They need to decide how much money they are prepared to risk losing. They need to plan ahead and invest in, develop and/or lend against properties that are within their risk appetite.

Firstly, the number one strategy for property investors is to have a low-risk, solid long-term projected return, and strong mitigating strategies regarding potential changes to negative gearing – and also to have long-term tenants where possible and this means attracting families.

Secondly, property developers should reassess their risk appetite and their business strategy, as demonstrated in the reduction of dwelling commencements in inner-city Brisbane, to fully avoid the risk.

Thirdly, lenders should take a more risk-based approach that includes voluntary stricter credit standards, a thorough review of loan applications and, more importantly, greater investment in risk models to ensure that the properties used as security for the loan carry the appropriate level of risk to minimise the likelihood of very low or negative equity.

Doron Peleg is the CEO and founder of RiskWise Property Research.

This is an opinion column. The views expressed are those of the author and do not necessarily reflect the views of Business Insider Australia.

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