What’s really happening with mortgage stress?

There’s no doubt that the economic fallout of coronavirus has left many people feeling uncertain about their future when it comes to finances.

You’ve probably seen the term ‘mortgage stress’ being bandied about in the media.

Some of the usual suspects are touting headlines that suggest up to one in five Australian households, a massive 20 percent, are in some sort of mortgage stress.

But is this actually the case?

Mortgage stress occurs when a household finds it difficult to cover their home loan repayments and to pay their bills, based on their usual income.

Interest RateI read with interest the most recent monthly mortgage and rental stress data from Digital Finance Analytics, as I believe there are some interesting patterns emerging, and therefore lessons for property investors.

DFA defines mortgage stress purely in cashflow terms.

It assesses money coming into a household, which is typically made up of salary, pensions, interest, dividends and other sources such as rental income from investment properties.

It also assesses money flowing out of a household, which is comprised of tax, mortgage repayments (across owner occupied homes and investment properties), other housing costs (property-related insurance, council rates and water rates), food, childcare, school fees, other non-discretionary spending and discretionary spending.

Interestingly, and correctly, assets are not taken into account.

Therefore, households that have a strong asset position but whose cashflow is close to or at zero are, by the DFA’s definition, in mortgage stress.

Households with a net cashflow position of 10% or more are classified as under “severe stress.” 

But are they genuinely suffering from mortgage stress?

What these calculations fail to take into consideration, which is often the case with data, is individual circumstances.

I would like to note that within their definition, DFA ignores the widely accepted benchmark that states households who spend more than 30 percent of their after-tax income on mortgage repayments are in mortgage stress.

I believe that the DFA definition is actually a more accurate reflection of mortgage stress, because an arbitrary 30 percent figure doesn’t take into account individual income positions or budgets.

If you own a $3,000,000 house, earn $700,000 a year and pay 35 percent of your income into your mortgage, you still have hundreds of thousands of dollars in income each year – hardly placing you under mortgage stress!

Similarly, a household that spends 40 percent of its net income on mortgage repayments is not necessarily in higher mortgage stress than its counterpart who spends 30% of its net income on mortgage repayments, if the former manages to reduce its spending across other categories to make up for the higher repayments.

In any event, what impact does mortgage stress have on property values?

The repercussions on the real estate market are generally only observable over the path of the subsequent two to three years.

This is because within this time period, households tend to naturally undertake drastic mitigations, which include actions such as cutting back on non-discretionary spending, drawing down on deposits, shifting more spending towards credit cards or even resorting to other credit sources such as payday loans.

House Money ValueHowever, this “bandaid solution” does not tend to last long, as the majority of cases will eventually lead to forced sales or defaults over the subsequent years.

Now, I said earlier that there are interesting patterns and lessons for investors to be mined from within DFA’s data, so let’s get back to this.

Because DFA maps out down to postcode levels where the occurrence of mortgage stress are, we’re able to identify micro-markets.

As Michael Yardney often points out himself, there is not one Australian property market – or one Sydney or Melbourne property market, for that matter.

The Australian property market is made up of thousands of small geographical submarkets, which are each influenced by their own supply and demand factors.

This is where the DFA findings get really interesting…

A1

Source: DFA Analytics

A2

Source: DFA Analytics

A3

Source: DFA Analytics

Before we get down to the postcode level, let’s look at the numbers on a state level

National mortgage stress sits at 37.5 percent, which was down from over 38 percent last month.

This is due to the JobKeeper and JobSeeker initiatives and the repayment holidays being offered by the banks, among other measures.

TasmaniaWhen they look at the numbers nationally, Tasmania has the highest occurrence of mortgage stress at 45 to 46 percent.

Tasmania (just like any other state) is made up of hundreds of smaller submarkets, and as an investor, you cannot help but think about the influence of the biggest and most lasting trends: population growth, infrastructure, employment and economics.

These are typically present in the three major capital cities on the eastern seaboard.

Interesting patterns begin to emerge when you observe the illustrations below.

You can see that higher occurrence of mortgage stress regularly happens in the outer suburban fringe areas.

In NSW, it is predominantly in suburbs in the Campbelltown, Blacktown, Blue Mountains and Wollongong regions.

In Queensland, it is predominantly in south-east corner including Ipswich, Logan, and some pockets on the Gold Coast region and in Moreton Bay.

In Victoria, a higher occurrence of mortgage stress occurs in regions such as Ballarat, Point Cook, Hoppers Crossing, Packenham, Dandenong and Craigieburn.

In each of the states, the lighter color (green and blue) which is associated with lower mortgage stress, tends to congregate the inner to middle ring.

Many of these suburbs are new suburbs comprised of new housing estates where thousands of lots (in increasingly smaller lot sizes) make up the suburb.

Aerials Of NeighborhoodThese suburbs tend to have an inadequate level of infrastructure, which lowers their appeal to renters and buyers alike.

While many of these regions and suburbs have been aggressively marketed as growth corridors in the past few years, they severely lack many other crucial criteria that need to exist to make them “investment-grade”.

These are factors such as diversity of the demographic profile (ie. a balanced mix between established households that have been entrenched there for the past 20 or more years vs new residents who move into the area), diversity of household income profiles and scarcity of land and properties supply.

Presence of these crucial factors will ensure that your property assets are in-demand in the short-term due to the foundation under demand, which translates to lower vacancy rates and they will remain strong performers in the long-term – as there will be less volatility in prices during uncertain times, and a faster bounce-back or recovery, and most importantly, more sustainable long-term growth.

All of the above reasons combined demonstrate how important it is to have a very clear understanding of the micro and macro factors that drive property markets.

They also comprise one of the major reasons why we at Metropole have always recommended that our clients invest in inner to middle ring suburbs, generally located within 15km from CBD.

MortgageWithout making myself sound overly repetitive, I would like to emphasiae again that inner to middle ring by themselves are made up of hundreds of smaller geographical submarkets.

You need to drill deeper with your research to determine what suburbs, what pockets within those suburbs, what streets within those pockets and lastly what suitable property types within those streets are the most in-demand and the highest quality, to eventually determine precisely what an investment-grade property needs to look like.

This is because no suburbs are immune from mortgage stress: there are obviously suburbs within inner to middle ring that have occurrences of mortgage stress, however the right research and strategy can lead you towards the highest quality assets.

A proven ‘Top Down’ approach is generally the best place to to start: consider the bigger picture so you can narrow it down to the granular level (ending with asset selection).

Starting with the bigger picture in mind is absolutely critical – because you in the end, you cannot fight the big trends…

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Robert Chandra

About

Robert Chandra is a Property Strategist at Metropole and has an intrinsic understanding of property markets backed by many years of real estate experience. This coupled with several degrees gives him a holistic perspective with which he can diagnose clients’ circumstances and goals and formulate strategies to bridge the gap.


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