Cheap money has fuelled huge prices increase for residential property and that is not going to stop just yet. In this fortnights update we talk about why rates are low, why they are going to stay low and what that means for property prices.
Low rates are not going anywhere, for now
Since the virus crisis started about a year ago we have had historically low interest rates across the board.
Low rates for homeowners, property investors, commercial property, cars, machinery, equipment, and almost anything else you might finance.
There is a lot of talk about rates moving up, and they will, but not anytime soon and not by much.
The most notable upwards move in rates is residential mortgages. This is mainly for fixed term rates over 3 or 4 years. You can’t get a 4-year rate under 2% anymore.
There are a few drivers of this but one of the most fundamental is the expiry of the innovative and causally essential financial support mechanism for banks and the economy, the RBA’s ‘Term Funding Facility’ (TFF).
The TFF gave Australian banks access to low capital to on lend to customers, such as people wanting to buy a house.
The access to the 0.10% guaranteed low rate for banks for the next few years under the TFF enabled the banks to offer home loan interest rates under 2% for the first time in history.
We have already seen a couple of the major and non-major banks increase their 3- and 4-year fixed rates by around 0.20% as they predict their own funding costs to rise by that time.
This means the banks expect rates to be higher in as soon as three years, but are they right?
Well, rates will go up from here as banks funding costs rise, but rates will probably stay below long-term averages for the medium term. That means we can expect rates under three or four percent for the next three to five years.
Globally the macroeconomic environment is not conducive to any significant rate increases, it is fragile, but that does not mean they will not rise as we have seen central banks like the one in Canada start the next cycle of monetary policy increases, with mixed results such as their currency appreciation.
The global economy has been plunged in record levels because of the virus crisis which saw balance sheets at centrals banks globally blow out to trillions of dollars in new debt as they struggled to support their government and citizens by issuing cheques, job keeping payments and more.
All that debt makes means if rates go up to quickly we will have recessions.
Further, central banks have flooded the bank accounts of citizens and retails banks themselves with money and that has inflated and seen asset prices rise globally.
There are two main asset classes where prices have inflated are residential real estate and stock markets.
This is a global trend across almost all first world economies even though we can forget that and myopically see Australia as being unique in this respect.
Down under we are consistently seeing residential property prices and previous suburb record highs being obliterated as people buy property as fiercely as ever before.
We have talked before about how I predicted record high property prices in 2021 driven by 5 forces of high demand, low supply, record low interest rates, government financial support and FOMO, and I would like to elaborate on this a bit further based on our current context.
High demand, higher than almost ever.
This is obvious from the real prices being paid for property diverging from the ‘under quoted’ advertised prices and reserve bets from the owners to guarantee a minimum price. There appears to be massive pent-up demand as most people came out of lockdown (excusing those in Victoria whose state government apparently has no options but to lockdown millions of people entirely rather than isolated places) with more cash and need for more space seeking to buy into a rising tide of a market.
The demand is also skewed to the high end and houses in general as people want more space to work and play at home.
Low supply has been a persistent issue, not just for listings of people selling, but there is a broader structural issue here.
For decades, federal and state governments have inadequately executed on property development to cater to economic needs of their civilians and provide (relatively) ‘affordable’ housing. Australia is the largest island country in the world with more liveable landmass than we use so it is arguably crazy that we have concentrated into a handful of cities with explosive property prices, compared to regional and coastal areas. The virus crisis is somewhat changing this as people flee cities for sea changes.
Vision is not commonly associated with government and housing planning is no exception.
One can imagine that if it were a mandated task of the government to provide housing (amongst other things like education and healthcare) to its people that the average house price in metro cities in Australia would not be some of the comparatively highest in the world and would mean we would not have some of the highest debt to income positions of any western democratic country.
It is hard to understand why housing is left so much to the private sector when the economic security of the country depends upon individual having their own economic security, and at the most basic level that security comes from having a place to live.
Low interest rates cannot be sustained forever but they can stay around for a while longer.
It is easy to forget that the current low rates are a response to an emergency, that they are at emergency levels to support the economy, and they can’t stay this low forever.
The emergency was a once in a century life-threatening global pandemic and disease that has killed millions. The more we get over that locally, the faster low rates should and will rise.
We are rather insulated from the worth of it so it is easy to forget the world is largely suffering and sick right now.
The main, if not only, lever the RBA and other centrals banks had to combat the virus crisis was to lower the rate.
Five years ago, the average owner-occupied P&I fixed 2-year home loan rate was about 4.3%. Today it is about 2.3%. Soon it will be somewhere in the middle.
Funnily, in one of these updates from March 2019 we talked about how low rates and the growth in credit were causing property prices to increase, and now rates are even lower and credit growth is historically high. A known trend that has been recurring. Historical data points to higher property prices from here.
Be careful of inflation when rates start to rise, often inflation is already here when they go up.
Government financial support has seen government debt hit record highs.
JobKeeper was an entirely necessary payment from the government as they ordered millions of businesses to shut their doors and people stay inside their homes, but it will bring issues in the future. Billions of dollars in debt must be repaid in the future by future generations.
But the tapering of government support has not led to any ‘cliff’ in property price drops like so many expected which I adamantly refuted previously.
For now, many people have had their jobs saved and a lot of people, believe it or not, are actually financially better off now than pre virus crisis because of the ‘free’ money from the government. Many peoples savings bank balances are higher now than before.
This also means people feel richer and might have more money to spend on a property, further adding to rising prices.
But the free money train has stopped. No more JobKeeper and less money being thrown at people. This is mostly a good thing but neglects sectors like the arts, entertainment and travel which were disproportionately affected by under financially supported in specific ways.
Conversely to government support is government intervention, and as we talked about in an earlier update we could see the government intervene with restrictions on Debt to Incomes to cool the market but as the banks raise their rates it takes the pressure off APRA to step in.
While there is high debt from this, Australia has recovered GDP faster than after any previous recession and has led the world in recovery. A truly stellar result. One that I predicted at the end of last year in last years wrap up update which you can read here.
FOMO is a real psychological phenomenon.
In fact, people are often more fearful of missing out on something than doing the thing itself.
This is a key driver, often overlooked or inadequately quoted in media, about how key it is. Housing and shelter are a basic human necessity, both physically and mentally. We will always be driven to acquire safety through the bio-organic algorithms that dictate our survival instincts.
Once we pass the necessity phase and get used to being safe and having somewhere to live, we want more of it. A bigger one, a bigger house, with an extra feature and in a location we like and that suits our perceived status in the social hierarchy.
All of the ‘crazy’ buying activity is not viewed as crazy by the people paying those prices. They think it is worth it. And it most cases they are right because they are the market for that house and product, so they and the people they compete with (i.e. the market) are the ones who set the price, driven by their mentality and hopes and fears.
Where to for property prices
So, what does all this mean for interest rates and property prices from here?
My expectation is no significant rate increases for the short term. Yes there will be increase in home loan rates by around 0.20 – 0.50% give or take, but by historical comparisons that is still a bargain.
Persistent low rates will be due to liquidity, inflation, and competition.
On liquidity. There are billions or more of dollars hunting for a return and some of that giant pool of capital will continue to flow into low return generating, but perceived to be, safe residential properties. Home loans is where banks make most of their money and it is what they borrow the most money for. So as the large pools of capital and global investors seek safe bets, Aussie banks and houses will continue to get cheap money. That cheap money will put downward pressure on funding costs for banks which will allow them to continue to keep rates lower for longer. But, as soon as rates start to rise, whether to combat inflation or not, that could change and change very quickly.
On inflation. Yes this is a serious concern and a very real probable outcome we will see, but no one knows when, and if you look at inflation targets set by the RBA they have been falling short of them for years. This means they need to keep rates low to try and get unemployment lower, wages higher and inflation higher. Remember a key part of their job is balancing between inflating prices and cauterising prices, but they rarely achieve either, or when they do achieve it they over or under shoot it and respond with drastic rate rises or increases. Often that knee jerk reactionary rate movement is the reason for recessions. Watch out for the RBA reactions.
On competition. In the UK about 4 in 10 home loans is done by a ‘non-bank’ lender. In Australia, it is less than 1 in 10, but that is changing. We have seen the non-banks move into “prime” territory and recent stock market listings of major non-bank lenders. This is all indicative of overly aggressive competition across the residential finance market and there are not signs that will abate. This increase in competitive forces will both keep rates low and money flowing into borrowers hands to spend more on property.
So, what does that mean for property prices from here?
Upward.