If the residential property market was a person, it would be an Instagram influencer selling you slimming tea right now.
Any article about house prices is clickbait gold for publishers.
If you have a property, you want to know what it’s doing.
If you don’t, you want to know if you’ll ever afford one.
(If you’re a communist hoping for the proletariat to expropriate the bourgeoisie from private property, it’s less relevant).
So it’s in the media’s interests to run story after story predicting housing Armageddon.
The other night, a story on 60 Minutes proclaimed the end of days for property. It was alarmist claptrap. Some of the points were accurate, but the tone and conclusion was an irresponsible media beat-up.
Making sense of the drama
I work in an investment firm specialising in real estate, and I spent last year working in the mortgage broking industry. So I’ve seen it from a few angles.
Nobody has all the answers (and don’t trust anyone who says they do). But this post will hopefully give you a bit of insight into the headlines.
Are we heading for a property market crash?
Nobody knows for sure. But it’s important to remember that property follows a cycle. Just like sharemarkets, property prices rise for a while, get so high they are unsustainable and then come back down.
This is as normal as your menstrual cycle. Home prices will moderate eventually, just as sure as I will turn into a bloated eating machine a week out from my period. (Hey, I did the sums in MyFitnessPal today and was totally allowed to eat that TimTam).
But the crazy thing about cycles is that when they’re peaking, people forget they end.
You know how when you’re drunk at 2am and having the best time of your life, you assume you’re gonna feel like this forever. Life is ah-mazing.
Well, house prices in Sydney, Melbourne and Brisbane have had a long, intense party. Many tequilas were slammed. Many tables were danced on. But in the end, the ugly lights have come on and the bouncers are shooing us out.
What we do know about these cycles is that the pain will be unevenly shared. Some areas will fall faster and further. Outer suburbs and regional towns are often in the firing line.
Inner city areas and premium areas will fall a bit, but it’s very unlikely we will see the 40% price falls one analyst mentioned (although he only said there was a 1 in 5 chance of that).
For one thing, our population is growing at 2.6% a year (ABS stats), which creates ongoing demand for housing. There is also pent-up demand from buyers who have been priced out of the market until now. When prices cool, first-home-buyers and upsizers pounce on the discounted properties.
Long story short, most industry people see this as a market cooling – not crashing.
Is there a massive debt bubble that will burst and cause havoc?
Probably not. But there may be some pain ahead for people who are stretched to the limit. One of the big issues is interest-only loans. Strap yourself in for a quick primer on this – it’s kind of important.
A normal principal-and-interest (P&I) mortgage sets the minimum repayments based on the interest, plus the amount you borrowed – remembering that in a 25-year mortgage you can end up paying almost as much in interest as you borrowed originally.
So if you think of it like eating a cheesecake – in a P&I loan, you eat some of the cheesy goodness (interest) and the crumbly base (the principal) all on one delicious spoonful, a mouthful at a time.
But in an interest-only loan, you just eat the filling and leave the crust till later. Sure you’ve spent less calories but now you’re stuck with a dry old base.
This is where the analogy probably falls apart, but the outcome of interest-only (IO) is it’s cheaper at first, but somewhere down the line you probably have to stump up for the principal repayments.
Traditionally these IO loans were given to investors for tax reasons. They can also be good if you have temporary cashflow issues like two small kids in daycare.
But they became much more popular when property prices went through the roof. Why? Because it’s hard to afford the repayments on million-dollar mortgage.
So some greedy/stupid/careless lenders and brokers have shoveled a bunch of people into these loans. And the regulator, APRA, took a look at it and was like:
So they told the banks to dial it down as part of several ‘macroprudential reforms’.
And the best way to reduce demand for a product? Make it more expensive. IO rates went up, the loans were harder to get and APRA was happy with the reduction in new loans.
However, there are literally millions of old IO loans kicking around. Two-thirds of these are going to hit the end of their five-year IO period by 2020 (source).
Some borrowers will be able to roll those into another interest-only period, but others won’t. And some will be shocked and/or disappointed about this, as it can be a big jump in costs. Some people may be forced to sell if they can’t afford it.
Either way, it’s going to be a period of transition in coming years.
If you’re interested, I recommend this speech by the RBA’s Christopher Kent. But the TL;DR is that it’s not going to be a total disaster. He is pretty chill: “For the household sector as a whole, however, the cash flow effect of the transition is likely to be moderate.”
There are other commentators out there saying otherwise, because they like drama and headlines. But if our nation’s central bank is chill, then I’m chill.
If you personally have an IO loan and you haven’t thought about how you’ll afford it when it rolls onto P&I, then you’d better start. Because there’s no guarantee you’ll get another crack at IO.
What’s the verdict then?
Is the housing market about to do a Britney: mess up at the VMA’s and shave its head in public?
I don’t think so. It will go through some tough times. Gain a few kilos. Have a few drunk nights. Marry a random in Vegas maybe. But it always does that when it’s stressed.
Overall, it will be ok.
You know, I really could go on and on about this stuff because I find it super interesting. But I’ll stop here, and encourage you to get in contact with me if you have questions or ideas for related posts.