Matusik Missive

I don’t know about you, but I am stuffed.

So much so that last week was the first one in over a decade that I didn’t do a weekly post.

Heaps of consultancy work, with hard timelines didn’t stop the Missive or Snapshot (for those with a long memory) in the past.

However, the last two years have taken their toll, despite the positives at my end far outweighing the negatives.

It seems that many things are in a snowballing flux, with more rules and regulations these days than you can poke a stick at.

And for the life of me I cannot see 2022 being much different to 2021.  We are putting a lot of pressure on 2022 – just like we did to 2021 late last year – if you ask me.

So goodbye 2021 and fingers crossed that I am wrong about next year.

I wish you a Happy Christmas, a fun filled New Year’s Eve and a relaxing break.

I leave you this year with some new music that I really enjoyed this year, some fiction worth reading (I do like crime novels) and some funnies.

We reopen in late January.  See you then.

So, will inflation raise its head and lead to higher-than-expected interest rates?

Five reasons for low inflation

Firstly, unionised labour is now a fraction of what it used to be.  Large collectively negotiated annual wage increases appear to be a thing of the past.  This is turn has led to lower inflation.

Second, the world has been investing heavily in technology and in particular, automation for the last decade.  The last two years has seen an acceleration of this trend.   Automation, robotics and ‘the algorithm’ displaces labour.  This in turn hammers another nail in the inflation growth coffin.

Thirdly, globalisation.  Low inflation of recent decades was influenced by global trade, with its emphasis on cheap production in low-cost locations, such as China, India and more recently Africa.  Open trade has also led to higher rates of immigration.

Four, immigration.  There is little doubt that a high level of immigration, especially when a large proportion of the migrant influx are looking for work, limits domestic wage growth.  Conversely, we witnessed recently that fewer overseas migrants to Australia resulted in higher wage growth.

Moreover, as we reach 90% vaccination coverage and our international borders reopen, the return of immigration will reduce labour competition and the current associated wage and salary pressures.

Five, Long Covid #1.  We see a repeat of 2021, being that we remain constrained due to new Covid mutations but this time there will be little government monies to bail us out.  Peeps will spend less.  Demand pull inflation will fade and maybe quickly.

So, we could surmise from my spiel so far that inflation is likely to remain mute.

And this is positive news because if inflation remains structurally lower, interest rates should also remain low.  Interest rates are set to rise but not as much as they would need to if inflation was operationally higher.

However, Australian CPI inflation rose 3% over the past twelve months and in the US, the corresponding measure has reached 6.2%, the highest in nearly 30 years and across the Eurozone prices are rising by is 4.9% per annum, the highest rate since the start of the Euro.

Is this just temporary, an anomaly or something more long term?  This is the $64 dollar question.

So, it would be remiss of me not to outline that there is also a case as to why higher inflation may return.

Five reasons for higher inflation

One, growing debt.  Much debt has been incurred to tackle the spread of Covid and help prevent economic collapse.  Government spending is also likely to keep running above tax revenues for the foreseeable future, resulting in even higher levels of debt.  Much of this debt will have to be repaid in raising taxes and this could flow through into prices.

In addition, restarting business operations as well as meeting post-Covid occupational health and safety requirements will require new expenditure.  Many businesses will try and rise prices to recover any pandemic losses and future higher operating costs.

Two, higher costs.  Australia faces higher transportation costs due to freight capacity constraints and a shortage of mariners from developing countries where vaccination rates lag.   At home, expansive government spending, record low rates and central bank largesse have driven up housing demand resulting in a shortage of building materials, trade labour and furniture etc.  Property prices have escalated as a result, feeding into an intensifying FOMO loop.

Three, rising geopolitical tensions.  Whilst globalisation helped reduce inflation, trade barriers and sanctions plus the ongoing Sino-American wrangling is retarding cross-border commerce, access to technologies and finance and is creating shortages of critical components, such as semiconductors and raw materials.

The rise of nationalism, enhanced by the Covid pandemic, could further exacerbate this trend.

Fourthly, the inflationary effects of climate change mania and especially the poorly thought-out energy transition – with underinvestment in traditional and economically sustainable new energy infrastructure – may result in persistent high energy prices. Carbon taxes, levies on carbon-intensive products and compliance with greenhouse gas reduction targets will also add to costs.

Fifthly, long Covid #2.  Covid-19, considered temporary at present, may become perpetual. The likelihood of substantial ongoing health costs and intermittent interruptions to activity have not yet disappeared.

Just how transient these factors are is not yet fully understood.  And that is why inflation is now a risk.

Inflation it is often said to be like a genie; once out of the bottle; it is difficult to put back in.

That is why I think central banks will act sooner than later and if they do so – and with everything crossed – they might just be able to get the genie back into the bottle.

Of course, interest rates are going to rise.

The banks are already lifting long term rates as the cost of money is rising and it is only a matter of time before one of the big four breaks ranks and lifts variable mortgage rates.

Of course, financial instructions like the cover offered by the RBA cash rate before they hike.

The RBA had been talking about no rate rises until 2024.  Now they are making noises about 2023 and expressing concerns about inflation.  We all know that APRA have just raised the home loan assessment buffer from 2.5% to 3.0%.

More APRA pain might be on the cards, but that depends on what the RBA does.

So, when will the RBA lift the cash rate and by how much this cycle?

The market is expecting the RBA to lift the official cash rate several times during the second half of calendar 2022.  Most economists say 2023.  I think these things are very political and the second half of 2022 – post the federal election – we will see the RBA tap the brakes, but most of the lifts will be during calendar 2023 and 2024.

And by how much?  Current model estimates of the neutral rate average around 3%.  That is a big lift from the current 0.10% RBA cash rate.  A lot depends on inflation and its longevity.

Covid has reset the baseline on spending and as we come out of Covid there should be a surge in inflation… the question is, will this be a sustained increase or is it a correction back to the norm?

Also, there is the question about wage growth.  Is the current lift sustainable?  Will a return of net overseas migration limit wage growth?  What about technology, robotics, digital stuff, and the internet of things?  Then there is geopolitics.

I will cover wages next week – but for now – there is a strong body of evidence that suggests that wage growth will remain weak over the medium to long term.  And as a result, a limited increase in official interest rates this cycle should be enough to adequately dampened inflation and lessen irrational exuberance.

For mine I don’t see the RBA overreacting and as a result I see the offical cash rate lifting between 1.75% and 2.0% by the end of 2024, with the first lift being just 0.15% – bringing the cash rate to 0.25% – sometime in late 2022.  After which I see 0.25% increases, and most likely on a quarterly basis, during calendar 2023 and 2024.

A few are now forecasting house price falls during 2023 as a result of rising interest rates, a lift in the number of dwellings for sale, affordability limits and even buyer fatigue.

The CBA is the most bearish (at this stage) with a forecast that dwelling values could fall by 10% in calendar 2023, after growing by 7% next year.  The CBA is keen to stress that this will simply see dwelling prices return to current levels.

The other three major Aussie banks (again at this stage) appear a bit more bullish, with average forecast dwelling value declines ranging between 4% and 8% during 2023 depending on who you ask.

I have included three charts this post that clearly show that rising interest rates do have a negative impact on values, sales, and housing construction.  And conversely falling interest rates have a positive impact.

So, what is my medium-term price forecast? 

Well, I don’t like to put a figure on it.  It is a bit like playing darts on a moving boat.  Ha, more like riding on a jet ski these days.

I do think we will see a plateau in home values over the next five plus years.  Some years values will fall, and during others they will rise, but overall, there won’t be much change until the next big thing drives values higher (or lower).

The trouble is that we have used up most of the ‘upside’ drivers such as falling interest rates, double income households, strong wage growth, low household debt, cheapish and more plentiful urban land, just to name a few.

Maybe generational wealth transfers, returning expats or more overseas buyers will have a positive impact in coming years?

To be honest looking forward the housing market looks like it will have to navigate headwinds rather than ride on the coattails of a tailwind, so maybe best not pay too much for your home, that investment property or development site.

But in the meantime, my short-term housing value model suggests there is some price growth left in the kitty.

I have covered this topic a few times already this year.

Our analysis is proving to be a reliable indicator of short-term house price growth.

In May I suggested that Australian house prices could rise by 14% for fiscal 2021 and by 25% for the year ending September 2021.

In August we found out that median house prices rose 19% for the twelve months ending June 2021.  That post we suggested that house prices could rise by 38% for calendar 2021.  Our anticipated 25% annual lift by September was still looking likely.

This post, we now know that Australian house prices rose 22% during the twelve months ending September (compared to our 25% forecast) and the revised official lending statistics suggest that house prices could now rise by 31% for calendar 2021 (down from our projected 38%) and median house values appear set to rise by 16% for the year ending March quarter 2022.

So, house price growth is expected to continue over the next six months with the pace of escalation slowing down early next year.

Last week’s property clock post, sparked quite a few questions.  

Three of them I thought were worth answering.

One.

Many asked if I had an apartment + townhouse property clock.  Yes I do and see below.

Two.

A few peeps also wanted to know how I assess where each location is positioned on the property clock.

On my socials I usually reply “darts” with a hyperlink back to my website and an invite to search away.

But to my tribe the answer is the “forward direction in the balance between supply and demand” and I do undertake a review of such fundamentals when updating my property clocks.

See table 1 below for the current state of play for apartments/townhouses across the Australian capitals.

I have updated last week’s post with a similar table for detached houses.  Revisit that Missive here.

PS. Regarding the * in table 1, I believe that once lockdowns cease in Sydney and Melbourne sales volumes will lift and most likely substantially for all housing types.

Three.

A few smart cookies also wanted to know when was the last time that most of the major detached housing markets across the country were similarly congested around the upswing and recovery phases on the property clock.

In short, for mine, that was between 1987 and 1989.

And whilst the economic conditions and policy responses were quite different in the late 1980s when compared to now; it is worth noting that there was very little price growth for a long period of time once the overheated housing market peaked in 1989.

It took almost a decade for half decent annual price growth to return.

See table 2 below.

As I noted a few weeks back – revisit here – next year looks much quieter on the Australian housing market front and I think calendar 2022 will be the start of long slowdown in price and rental growth, similar to what happened during much of the 1990s.

Words will fall short.

 

This week is a housing market update.

Four charts and two tables are included with a quick summary at the end of the visuals.

Comments

We all know that the current housing market is hot.  Crazy really.

For now, demand is outstripping supply.

National dwelling values are up 20% on the year before and median weekly rents have increased by some 15% over the same time frame.

These results are at odds with the past, where both nation-wide prices and rents showed little change on an annual basis in 2018, 2019 and even 2020.

Revisit charts 1 to 4.

Values and rents even fell in some locales over this period.

Table 1 suggests that we are facing a return to tranquillity over the next 12 to 24 months.

Given the attractive range of government incentives and record low interest rates it is little surprise that there has been an increase in first home buyer activity over the past two years.  See table 2.

Next year I expect to see a lot more expats and foreigners in our buying mix.  First timers’ activity is also set to decline, replaced by domestic second and subsequent owner residents.

Established home buyers have been facing a lack of stock, but once lockdowns are done and dusted, stock levels are likely to lift.  High prices are now also restricting buying activity and looking forward employment security plus rising interest rates/harder access to credit are starting to emerge as concerns.

The new housing market is suffering from a lack of economically priced development sites plus a lack of labour and certain construction materials.  In general construction costs are currently rising above the market’s willingness (ability?) to pay and tighter credit is already starting to bite into the first home buyer market.

As a result, 2022 looks much quieter on the Australian housing market.

I do think that the forecasts as outlined table 1 are too optimistic on the price growth front and somewhat undercooked when it comes to the rental market.

Returning expats and more overseas buying interest should see rental vacancy rates tighten especially in the middle ring suburbs in our capitals cities and in places like the Gold and Sunshine Coast.

I expect the BTR sector to start to expand into the townhouse and detached housing markets from next year.

In summary, 2022 is the start of a long rest on a high plateau after an unexpected and somewhat exhausting ramble up a very steep incline.

A few weeks back I posted a population update.

Revisit that missive here.

That post held this table.

Several people questioned if the Net Overseas Migration (NOM) result – being a loss of 95,000 residents due to more people leaving Australia than arriving over the last 12 months – was correct.

I think a lot of peeps think that NOM excludes movements by Australian citizens.

Confusing this issue further was a recent statement by Scott Morrison stating that some 380,000 Australian residents (as at late July this year) have boomeranged back to Australia since the start of Covid.

Before we unpack this stuff, lets review how NOM is defined.

For the purposes of estimating NOM – and thereby Australia’s official Estimated Resident Population (ERP) counts – a person is regarded as a usual resident if they have been (or expect to be) residing in Australia for a period of 12 months or more over a 16-month period.

 As such, NOM and ERP estimates include all people regardless of nationality, citizenship, or legal status, who usually live in Australia.

 Moreover, the term NOM is based on a traveller’s duration of stay being in or out of Australia for 12 months or more.  It is the difference between the number of incoming travellers who stay in Australia for 12 months or more and are added to the population (arrivals) and the number of outgoing travellers who leave Australia for 12 months or more and are subtracted from the population (departures).  

 Hence NOM is a net measurement.

Clear as mud?

I have included three charts that might better help explain things.

Chart 1 shows that there were 115,000 ‘long-term’ overseas arrivals to Australia for the year ending March 2021.  Some 210,300 people – who stayed for over 12 months – left Australia for overseas: resulting in a net overseas migration rate of minus 95,300 people.  Remember these figures are based on people staying 12 months (over a 16-month period) in Australia.  This chart shows NOM results.

Chart 2 outlines the net result (arrivals minus departures) of all people travelling to Australia or leaving the country regardless of time frame.  This includes visitors and Australian residents.  It shows that Australia lost 120,000 net visitors for the year ending September 2021.  This compares to a 410,000 gain in net visitors the year before.  Again, this chart captures all travellers regardless of time frame.

Chart 3 outlines the movement of all Australia residents, to and from Australia since the start of Covid-19 (in this case being from April 2020).  It shows that between the 1^{st of} April last year and the end of this August about 414,500 Australian residents have returned to Australia, whilst 423,500 Australia citizens left the country.  This has resulted in a loss of some 9,000 Australians going overseas.

Chart 3 also shows that such movements are starting to decline.

Some comments

The table in this post best outlines what is happening with our permanent population base and its annual growth.  Between census periods, these estimated resident population counts are the best indicator regarding our numbers.

Regardless of the Covid restrictions there has been some movements to and from Australia.  Such movements are down substantially when compared to the volumes typically experienced before Covid.

Statistical information on persons arriving in, or departing from, Australia is collected via various processing systems, passport documents, visa information, and incoming passenger cards.  Importantly they exclude multiple movements; travel related staff and undocumented arrivals.

Movements to and from Australia is likely to pick up, and maybe substantially, in coming months.

There is also evidence that expats have been buying Australia homes with the intention to return to Australia once travel restrictions are removed.

Our work suggests that one in seven (15%) homes sold across Australia since early last year have been purchased by an someone living overseas.

When thinking about a missive I often quiz myself about the topic.  ‘Questions to myself’ so to speak.

I also think that Q+A webinars and presentations work much better than the typical ‘I deliver, you listen’ approach.

Anyhow, here are five questions and my answers to the current APRA move in

attempt to slow the housing market.

Q1:  Will Australian Prudential Regulation Authority’s lift in the minimum buffer of 3% (instead of the previous 2.5%) above a mortgage loan rate ready slow to housing market?  It seems like a very small move.

My gut call is no, it won’t.  Well not much.

Official interest rates have not increased.  Just the buffer.  It also assumes – which is a big assumption – that loan applications are honest when it comes to such things as income and liabilities.

APRA’s new rule is also not active until November this year – and pre-­approved loans will not be reassessed at the higher buffer rate – so one can expect a rush in real estate activity and new home approvals this month.

This is already evident by the high auction clearance rates across the country last weekend.

APRA estimates that this new buffer would reduce the borrowing capacity of a typical ­applicant by 5%, dropping the average Australian household’s borrowing by $35,000.

Based on the big four banks, their variable mortgage rate currently averages 2.65%, so the minimum new ‘stress test’ rate would be 5.65% from November, up from the current 5.15%.

Yet Australian house prices, on average, have risen by $100,000 between December 2020 and June this year, and are set to potentially rise by more than double this amount between the 1^{st of} July and the end of calendar 2021.

 These rises are locked in.

Also, the new buffer rule also only applied to bank loans and not non-bank lenders.

Since the start of the pandemic the share of home loans to non-bank lenders has risen from 6% to 11%.

The irony is that APRA’s current move has probably added more heat to the housing market rather than actually cooling it.

Q2:  Surely most are honest these days when applying for a home loan?

Not really.  We too have embellished our earnings and lowballed our expenses in our early years, and I am sure that many others do to.

According to recent research by UBS some 41% of new home loan applications during fiscal 2021 were ‘not completely factually correct’.  This is up from 3% on last year and has risen from 27% in 2015.

In terms of the areas where people are misrepresenting their financial situation, the largest portion comes from under-estimating their living costs followed by under-representing their financial commitments (i.e., not declaring other debts and borrowings).

Perhaps the most shocking thing in the UBS survey is that an astounding 69% of people with ‘liar loans’ in the broker channel claimed that it was the broker that suggested that they over/underrepresent to be able to get approved.  This is up by over 20% when compared to 2020.

More worrying, if you ask me, is that 22% of people with liar loans said it was their banker that suggested that they should be less than fully truthful on their application.

Q3.  It this ‘loan lying’ a capital city thing or more widespread?

If you look at where the properties that are purchased with a liar loan are located, there has been a steep increase in regional and rural properties – some 57% during financial 2021 versus 41% in 2020 – which I guess can be explained by the number of people moving away from the capital cities because of the pandemic.

The UBS work also shows the propensity to be less than fully truthful on a loan application if you own one or more investment properties, indicating that most of those lies are connected to income and expenses connected to investment properties.

In conclusion, it seems like the recent strong house price growth is forcing people to be less truthful on their mortgage applications.

Q4.  Do you think the housing market needs slowing down?

An effective housing policy does not exist in Australia.  If we had one, then the answer would be no as the market would rise and slow accordingly.

But what we have is politics instead of policy.

The list of political (vote getting) interferences with the housing are a mile long. These are well known and have been written about endlessly in inquiries/reports and include:

• First-home buyer schemes since the mid-1960s
• Capital gains tax discount and negative gearing
• Punitive taxes on developers and builders
• Zoning restrictions
• Under-funding of transport infrastructure
• Higher immigration after 2005
• And, above all, the recent cut in the RBA cash rate to 0.1 per cent.

And we have now more emotion in the mix than usual.  This has been caused by the pandemic.

To most Aussies our homes are everything.  We now work there, as well as sleep, eat and watch TV there.  Many of us can’t (or won’t) travel or go out much – we’re stuck at home, at least for a while longer.

It’s no wonder the market has got emotional.

I wrote as part of a Covid caveat in my consultancy work in the early days of the pandemic….

…. residential property is unlikely to be affected anywhere near as much as other property classes.  People will always need somewhere to live, and homes are the true “safe haven” in the current environment. 

 This sentiment may also loiter after this emergency passes.  It may even strengthen the longer the virus remains unrestrained.

Positively clairvoyant!

But seriously folks the current housing boom is mostly due to the lowest interest rates in history, which of course is also due to the pandemic.   Despite the rise in house prices and household debt, overall repayments have fallen.

But I digress, back to the question.

Strong price growth and over the top price expectations can lead to over-exuberance in housing markets.

In practice, however, it is difficult to determine if housing prices are over-valued in real time.

On one hand owner resident models – which compare the relative costs of owning versus renting a property, and so consider a range of factors including the decline in interest rates – suggest housing prices remain broadly in line with fundamentals.

But on the other hand, investment metrics of over-valuation such as price-to-rent and price-to-income ratios have increased markedly, suggesting that in most Australian cities housing values are currently overpriced.  See chart 1.

But history suggests, unless we get a black swan event, then housing values are likely to plateau after this current surge.

Note that I didn’t say ‘another’ black swan event, as I believe that Covid-19 was a grey rhino not a black swan as many suggest.

Q5.  So, what’s next?  More APRA stuff or interest rate rises.

I think the solution – if we really do want to slow the housing market rather than give it just lip service – is to increase home loan rates.

This may happen to some extent without a move from the RBA as banks may need to lift them as a large part of their monies comes from overseas these days, but to really have some bite, and wide scale impact, the official cash rate needs to rise.

I think one of the more foolish things I have heard of late – well apart from “Queensland hospitals are for Queenslanders” – is the RBA ‘promising’ that “interest rates won’t change until 2024”.

I think they will rise, and the first increase will be in 2022, post a federal election.

It won’t take much to slow the housing market if actual home loan rates increase (rather than an increase in a loan buffer) as there is little wage growth and when you investigate our household savings rate – see chart 2 – we really don’t have much saved for a rainy day.

Any end comments?

The new 3% APRA buffer is useful in that is informs us – well me anyhow – where interest rates are likely to end of in the next couple of years.

At present the cheapest home loan you can get now is about 2%, that will be 5% in the next three to five years.

The best buffer is likely to be an honest one.

 

Twice a year – typically at Easter and Christmas – I share a list of books which I think are worth reading/listening to plus some music that I have recently enjoyed.

I have heard some great tunes – yes from the older cats – in recent months and have also read/listened to some impressive tomes too.

So I have shared these now rather than wait until closer to Santa time.