Saturday’s Sydney Morning Herald ran a story titled “'It's our version of the GFC': warning on looming interest-only crisis” speaking to the 1.5m Aussie households with interest only loans taken out for property. Just as the US subprime crisis caused the GFC, some experts warn we could have our own version as a swathe of interest only loans expire (triggering 30-40% higher P&I repayments) over the next few years, likely coinciding with higher interest rates as well. The other factor in play is that conditions have tightened considerably through both APRA’s actions and also the fallout of the Royal Commission. That means that many existing loans would never be approved in the current environment. From the SMH:
“Martin North, the principal at consultancy Digital Finance Analytics, said interest-only loans account for about $700 billion of the $1.7 trillion in Australian mortgage lending and it was “our version of the GFC”.
“My view is we’re in somewhat similar territory to where the US was in 2006 before the GFC,” Mr North said.
Craig Morgan, managing director of Independent Mortgage Planners, said one in five people who took a loan two or three years ago would not qualify for the same loan now, because of the crackdown on lending by the regulator and ongoing fallout from the Royal Commission into financial services.”
This is neither ‘just’ an investor issue nor one that won’t have broader impacts to those with traditional P&I loans. Firstly, from Mr North:
“We also know that some interest-only loans were not investors but they are actually first-home buyers encouraged to go in at the top of the market.”
And not only also a first home buyer issues but a broader market issue as forced sales exacerbate the current price weakening:
“His modelling suggested $120 billion of interest-only loans would fail tighter lending criteria over the next three years; about two in three of those loans would be able to accommodate a switch to paying the principal, while one in three would be forced to sell.”
Part of the issue faced by these mortgagees is that the increase servicing cost comes amongst near zero wage growth. In our property-centric economy, yesterday’s warning from BIS Oxford Economics of “Construction heading for 'worst crash since GFC'” won’t help. When the mining boom ended the government and RBA pulled the property lever to full tilt to keep the economy going. That saw the property market become the nation’s biggest economic generator. However BIS now warn that’s about to come crashing down. From Business News Australia:
“After years stimulating the economy, the construction industry could become a major drag on activity as it faces the worst downturn since the GFC, says BIS Oxford Economics.
The economic analyst and forecaster predicts the latest downturn is likely to be driven by a 50 per cent slump in the apartment market over the next two years.
According to BIS's Building in Australia 2018-2033 report, a sharply weaker residential market will lead to an overall fall in construction nationally of 10 per cent.
Residential construction starts are tipped to fall as much as 23 per cent, with high land prices, slowing migration and evaporation of investor demand potentially adding fuel to the fire.
The residential downturn will swamp forecast gains of 5 per cent in non-residential construction over the next two years.
"The building sector is switching from being a strong growth driver to a drag on the economy," says Adrian Hart, the associate director of construction, maintenance and mining at BIS Oxford Economics.
"The very mild drop in residential commencements in 2017-18 is just the beginning."”
Such a downturn will no doubt put further pressure on wage growth and in turn further pressure on mortgage stress, forcing more sales and hence potentially a spiral effect.
The AFR ran an article yesterday where Deloitte Access Economics chimed in:
“"Lending is down, it's amidst its longest dry spell since the global financial crisis, and investor loans have dropped to a six-year low," the report says. "That says housing price falls – now infecting Melbourne – will get worse before they get better.”
Property cycles are somewhat predictable in that we get a big oversupply as we are seeing in apartments now, everything stops except population growth, and then a ‘too late’ response which sees price growth on a resulting undersupply. To wit, BIS says:
"With stock deficiency to start rising nationally again from 2019-20, we anticipate a renewed upswing in residential building starts through the early to mid-2020s.
For the astute investor the picture before them is that the other hard asset, precious metals, is slowly coming off its December 2015 low and currently in an interim correction phase (i.e. it appears ‘cheap’ right now). Gold and silver ordinarily see higher price gains amid a crash or crisis in financial markets. There are endless calls for that happening within the next 2 years. In other words there is potential for a play of buy metals low, sell high, buy property low with proceeds.
Last August we wrote an article on the ramifications of a property crash in Australia, including a must read link to another. If you missed it click here as it’s a must read.