If it ain't broke, don't fix it

The Reserve Bank of Australia believes that some sectors within the Australian residential property market may be headed towards a bubble.

Over the past few weeks, the RBA and APRA have been considering regulatory controls in an effort to curb investor interest in the Australian residential housing market, citing “unbalanced” levels of investor purchasing of residential property, with some sources quoting 40 per cent of new purchases being acquired by investors.

The regulatory controls that the RBA and APRA could put into place are known as macroprudential policy tools – a term that has crept from academic obscurity to common vernacular since the Global Financial Crisis. Such tools are designed to strengthen or dampen confidence and are generally considered less blunt compared to the alternative of decreasing or increasing interest rates.

But the considered moves by these government agencies are both unwelcome and dangerous – especially because the rationale is built on wrong market conclusions. On many counts.

Firstly, there is no property bubble. At least, not yet. Rising property prices do not suggest a bubble. A bubble only presents when artificial demand is created, or when supply is artificially limited. No contributing factors on either side of the supply and demand ledger have changed over the past few years. Properties are selling under the usual supply-and-demand conditions, with one exception. With the downturn in the world economy generally, we are seeing more offshore investment into Australian real estate.

Melbourne and Sydney – the two markets often quoted as being in a bubble – are global cities. They should not be thought of as Australian cities any longer. The world is smaller, and Australian real estate is rightly considered by many international investors to be amongst the most stable in the world. Melbourne and Sydney real estate should be compared to real estate in London, New York, Paris, Munich, Rome and other global gateway cities. Compared to these cities, Melbourne and Sydney real estate is not overpriced.

Secondly, where in the RBA mandate is it their role to manage investor interest in a specific asset class?

The answer is, it isn’t, other than operating under the broad brush duty of maintaining economic stability. If the RBA implemented actions designed to cool investor interest in equities, the outcry from the major banks and financial planning networks would be deafening.
The fact remains that residential security has always been a more stable asset class than any other. Australian residential real estate is one of the most stable in the world. And it is especially attractive with interest rates at historic lows.

Thirdly, who determines what a “balanced” level of interest between owner-occupiers and investors is?

To say that a market is out of balance implies that there is a belief that aspiring owner-occupiers have an entitlement to own their own house. This is a dangerous belief to have, and fundamentally wrong. There is no such entitlement.

But many first home buyers not only believe they are entitled to own a home, but to own a home in the more desirable locations. Desirability leads to increased demand, which leads to rising prices. Instead of buying one’s first home in a central or desirable location, a first home buyer has the option of living on the urban fringe. They, however, choose not to do that. This being the case, they are their own problem.

In times past, the RBA may have considered increasing interest rates to dampen investor enthusiasm. Rate rises will not be considered at this time? The damage to unemployment levels will be too shocking.

Other than an increase in interest rates, what might these other regulatory tools look like?

Both New Zealand and Canada have implemented LVR caps, limiting the maximum LVR for a new mortgage to 80 per cent. Whilst at cursory glance it might appear worthwhile, this policy will hurt first home buyers more than it will investors. Investors often have equity in their own homes that can be accessed for additional investment. But with deposits the main obstacle to owner-occupiers entering the market, this policy will only result in placing first home buyer entry to the market more out of reach. In the countries that implemented such a policy, it simply served to push up housing prices in the lower end of the market.

Placing restrictions on lending in specific geographic markets is also being considered. It is questionable whether this practice of red-lining is even legal in Australia, with precedence in many other countries of it being illegal to practice such discretional lending policy.

Another option is a requirement for credit providers to change their serviceability calculations so as to ensure they do not place borrowers in stressful circumstances when rates on borrowings become more normal. This is already practiced, with most lenders checking servicing against a stressed interest rate up to two percentage points higher than the rate the borrower is paying on their mortgage in any case.

There is only one pragmatic solution available to the regulators, which is to enforce an increase in the amount of capital required to be held by banks when certain classes of loans are written, such as investor loans for example. Such a policy would, by extension, result in banks being somewhat less interested in writing such loans, and if so, possibly under higher interest rate conditions. This is only a lukewarm solution, however, and will have little impact.

If there is one facet to the market that requires regulation, it is reducing buyer competition through the implementation of a government policy that would limit property ownership to Australian residents only. This would remove the unprecedented demand in Australian real estate by offshore investors, and thus cool the market accordingly. Unfortunately, these actions are beyond the powers of APRA or the RBA.

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