Could Sydney’s median house price really reach $1 million ?
There been a number of rebuttable presumptions concerning this property cycle, particularly through the course of 2014, including:
- Investor demand having been pulled forward, prospective buyers would fairly quickly “run out of money” and the real estate market would switch into reverse; and
- Yields would slide low enough that prices would inevitably soon follow suit and decline.
We have periodically highlighted a couple of possible counter-arguments here at various points through this calendar year.
Firstly, rising dwelling prices create equity for existing property owners, and as such although investor demand may have been pulled forward, investors can remain active, at least while banks continue to lend to them (we might also just briefly note here the potential role of foreign investment capital).
And secondly, the yield argument scores a miss, because, to our knowledge at least, nobody buys capital city property primarily for its yield – it wouldn’t make any sense to buy a heavily leveraged asset for the relative strength of its income component, particularly one for which the net yield is at best going to be close to nil.
Further the generic yields quoted by capital city do not always reflect the reality of the expected yield from an investment property. Let’s take in a stylised example.
What does an investment property cashflow profile look like?
An investor redraws existing equity and produces a 20 percent deposit to buy a $500,000 unit in Sydney, which she then rents for $420 a week.
Even without shopping around or undertaking a renovation, or indeed doing any research at all, a unit with such a yield of 4.3 percent is not hard to find.
Clearly the gross yield is ordinary compared to the ~5 percent that we would have seen when buying back in 2008.
Yet gross yields have not been eroded to the extent that might have been expected, since median weekly apartment rents have risen strongly in Sydney by up to 25 percent over that time.
What commentators sometimes overlook is that the lending environment has also changed dramatically since early 2008, with the the cash rate a thumping 475bps or 4.75 percent lower than it was at that time.
This makes a material difference to a property investment decision, despite superficially weaker gross yields.
In the example above, an investor can fix an 80 percent LVR mortgage for fully 5 years at an interest rate of around 5 percent, meaning that the annual rent of $21,840 more than covers the interest repayment of $20,000, with the inherent expectation being that rents will rise in the future.
Even where there are a range of other annual holdings costs (e.g. repairs, insurance, strata fees etc.) of, say, 1 percent or $5000, after all allowable deductions including “on paper” depreciation allowances are added back and the paper loss is offset against other income, the effective net loss after tax is likely to be as close to $nil as almost makes no difference to most investors.
In other words, lower yields have not deterred investors and nor will they do so now unless the cost of debt rises significantly.
Price growth expectations are what matter
As implied above, to my mind there is only one logical reason for which folk might invest in capital city residential property, that being that, as a traditionally effective long term inflation hedge, the asset is likely to be priced at a materially higher nominal dollar amount in a dozen years time than it is today.AKA: capital growth or pure price speculation.
Do punters believe that capital city prices will be more expensive in the future? Probably so. The experts certainly do, and by a huge margin at that, so it’s a fair bet that the answer is “yes”.
Residex, by way of an example, forecasts long run price growth for Sydney of 5-6 percent per annum.
We don’t necessarily agree with all of the Residex forecasts – in fact they appear to be remarkably bullish in some cases – but if sustained such a rate of growth implies that median prices would in fact be double what they are today in only a dozen years time, and certainly within well under 15 years.
Meanwhile, it would also be expected that gross rents from a well-located investment property would rise over such a time horizon too.
Part 1 – AFG mortgages boom to 21 year high
Can Sydney’s median house price really soar to above $1 million in this cycle? The data certainly suggests that this may eventuate.
In the month of October, Australia’s largest mortgage aggregator wrote well over 10,000 mortgages (totalling 10,463), a figure which the group has never previously come close to during its 21 year history.
Even allowing for likely shifts in market share, these are hugely strong numbers.
The trend data is not seasonally adjusted but, volumes written are up by 36 percent over the past two years.
Colossal figures which suggest that the housing market has more life left yet in this cycle.
Part 2 – State versus state – New South Wales roars higher
It is in the drilling down to the state level which reveals the most eye-popping figures. AFG wrote 2996 loans for New South Wales in October, a 19 percent increase on the prior year equivalent figure.
Meanwhile, the chart below is the most dramatic of the entire data series, with the value of New South Wales loans written soaring some 34 percent higher over the past year.
Thanks to record low borrowing rates, the value of loans written in Victoria have increased by 19 percent year-on-year and in Queensland mortgages sold have increased by 12 percent in value terms.
South Australia was flat, recording no increase over the past year.
The average mortgage size in NSW exploded higher in October to be up by more than 13 percent over the past year, although to date only 8 percent when calculated on a 3 month moving average basis.
There appear to be only three possible conclusions might be drawn from this data set:
(i) AFG has massively increased its market share at an astonishing rate; or
(ii) we have just witnessed an anomalous month of lending in October by AFG; or
Part 3 – Investor share of loans eases
And finally, an interesting point from this release was that following on from the warnings of macro-prudential interventionary measures relating to mortgage lending, the share of investor loans reported by AFG magically fell across every reported state in the month of October.
While the percentage of investors remains elevated in New South Wales at 49 percent, the share of loans for investment housing declined across all states with South Australia recording the sharpest drop down to 30 percent.
Again there are seemingly only three possible conclusions which one might draw from this: