Speaking at the Aus-China Property Developers, Investors & Financiers lunch on Monday (20 November), Mr Jonathan Kearns, the head of financial stability department at the RBA, outlined his thoughts on Australian property, looking at both financial stability and foreign involvement.
During his speech, Mr Kearns highlighted how the property market is important for financial stability, noting that banks have previously experienced “substantial losses on their commercial property lending because of its large cycles” while residential property is important due to the fact that resi mortgages “account for a very large share of banks’ lending in Australia”.
Mr Kearns said: “Because of the high value of households’ mortgage debt and housing assets, the property market also has implications for the resilience of households’ balance sheets.
“Historically, residential property lending has been less risky for banks than commercial property lending. Indeed, the stress test conducted by APRA indicated that Australian banks have sufficient capital to survive a deep recession and a collapse in the housing market.”
According to the head of financial stability, this conclusion was drawn following the findings of Wayne Byres’ 2014 lecture — Seeking Strength in Adversity: Lessons from APRA’s 2014 Stress Test on Australia’s Largest Banks — and a 2005 comment from the then-chairman of the Federal Reserve, Ben Bernanke, who stated that there had never been a nationwide decline in house prices (before house prices dropped by 30 per cent on a national basis).
Mr Kearns continued: “However, the sheer size of mortgage lending on Australian banks’ books means that residential loan performance is critical to banks’ health and so the stability of the broader financial system. Housing debt is also important for the resilience of the household sector in Australia. The ratio of household debt to income is high in Australia relative to other advanced economies, and has edged higher since the financial crisis.
“Despite the high level of mortgage borrowing, various factors mitigate the risks to the financial system. Housing debt is mostly well secured. Limits on the maximum loan-to-valuation for mortgage lending and house price appreciation over time mean that existing borrowers generally have a large amount of equity in their homes.
“In addition, the ability of Australian borrowers to make excess payments on their mortgage, and that this is a tax-effective way for owner-occupiers to save, means that borrowers tend to accumulate large pre-payments (‘mortgage buffers’). Close to two-thirds of loans have such pre-payments, which collectively amount to two and half years of scheduled mortgage repayments at current interest rates.”
Changing lending and property market
Touching on the regulatory measures to curb interest-only and investor lending, Mr Kearns outlined that these measures “have played a role in reducing the build-up in risks from household borrowing”.
He explained: “Lenders responded to the restrictions by increasing their interest rates for interest-only loans and investor lending. In response, the share of new loans that are interest-only has been falling, and overall investor credit growth has remained below the 10 per cent threshold. Many existing borrowers have also switched their interest-only loans to principal and interest loans and there has been a decline in the share of new loans at high loan-to-valuation ratios.
“While riskier types of lending have moderated, and investor credit growth has slowed, the pace of overall housing credit growth has been fairly stable this year as borrowing by owner-occupiers has picked up.”
Delegates later heard how the housing market has changed, with prices “particularly high” in Sydney while the Perth housing market “remains weak”.
Mr Kearns also outlined that dwelling construction has changed to have a “marked increase in the share of higher-density construction”, which he described as “a helpful response to the shortage of well-located land in Australia’s large cities”.
However, the department head said: “The longer time to build higher-density dwellings than detached houses increases the risk that a large number of new dwellings could be completed just as the housing market turns down, so amplifying the housing cycle.”
Mr Kearns went on to predict that “peak apartment completion in Brisbane is expected to occur this year, capping a three-year period in which the number of apartments has increased by over one-third from the stock in 2015”.
He added: “This change in the composition of the housing stock is resulting in a rebalancing of relative prices, with prices for detached dwellings growing faster than those for apartments in the major cities over the past five years. In the weaker housing markets of Brisbane and Perth, this has seen apartments experience small price falls in recent years. To date, despite valuations for some apartments at settlement being lower than the purchase price off the plan, there have not been widespread reports of higher rates of settlement failure or any notable increase in arrears or losses for banks.”
Foreign buyers ‘do not reduce supply’
The speech also outlined the impact of foreign buyers on the market, and while the RBA suggested that it “has been hard to get a firm estimate of how large these purchases are”, it estimated that purchases by foreign buyers are equivalent to around 10–15 per cent of new construction nationally (or about 5 per cent of total housing sales).
Mr Kearns elaborated: “Purchases by foreign buyers do not, on the whole, reduce the supply of dwellings available to local residents and, in fact, may actually contribute to expansion of the housing stock.
“Foreign buyers in Australia for work or study would have been renting if they did not purchase. Other foreign buyers rent the property as an investment and so contribute to the rental stock. Also, there are some new developments that only proceed because they get high pre-sales from foreign buyers.”
In conclusion, the RBA head of financial stability said: “Given their significance for financial stability, the Reserve Bank carefully monitors property markets. History has taught us that commercial property lending can result in substantial losses for banks. And the large stock of residential property debt means that it, too, is important for financial stability and household resilience.
“The high valuation of commercial property, which is common to many other assets, increases the potential for a sharp correction and so the risks from commercial property lending. The high level of household mortgage borrowing also brings risks, both for lenders and households.
“Purchases and financing by foreigner investors and banks have been prominent in the current commercial property cycle. We have seen this before and are well aware of the impact this can have on the cycle. The increased purchases of dwellings by foreign buyers, particularly for investment purposes, are a more recent phenomenon, and so their impact on the housing cycle is less clear.”
He added that the RBA will “continue to closely monitor risks from property markets and lending”.
Mr Kearns’ comments come just days after RBA assistant governor Luci Ellis said that Australia does not need to wait for an external trigger to kickstart the economy, nor is there a need for “an identifiable engine of growth” like mining or housing. Ms Ellis also slammed claims that a recession is the only way for the Australian economy to improve, saying that recessions engender “destructive destruction”.
Annie Kane is the editor of The Adviser and Mortgage Business.
As well as writing about the Australian broking industry, the mortgage market, financial regulation, fintechs and the wider lending landscape – Annie is also the host of the Elite Broker and In Focus podcasts and The Adviser Live webcasts.