Best of 2023 - #2: Rent crisis, property prices, borrowing capacity and fundamentals – how will it affect you

Ready to conquer the Australian rental crisis and spot the next big investment opportunity? Our latest Investopoly podcast is your treasure map through the tumultuous terrain of the property market. As the rental squeeze tightens its grip, we dissect the factors at play, from vanishing vacancies to skyrocketing rents. This isn't just a breakdown of the problem—it's a rallying cry for private investors and landlords to re-enter the game. We confront the so-called mortgage fixed rate cliff and dismantle the myths that have been circulating, showcasing why Australians are more resilient in the face of rate hikes than you might think.

Beneath the surface of the rental crisis lurks a complex web of cause and effect. Over six years, a dwindling supply of rental properties has collided with steady demand to create a perfect storm. We peel back the legislative layers to reveal how recent property market shifts have starved the rental pool, and why proposals like increased social housing or build-to-rent schemes might not be the silver bullets they're made out to be. Instead, I champion a more immediate solution: empowering the private investor. With a candid look at borrowing constraints and rising interest rates, I navigate the currents of change and pinpoint how to harness these challenges for investment success.

As we usher in an era of variable mortgage rates, the whispers of market sentiment change grow louder. I share decades of industry wisdom to explain why the transition might not spell the forewarned financial fallout and how Australia's robust economic backbone supports homeowners. And finally, as property prices teeter on the edge, I revisit my prediction of an imminent market floor. This episode isn't just about weathering the storm; it's about setting sail at the first sign of clear skies. For veterans and first-time property investors alike, now could be the moment to anchor your portfolio in tomorrow's victories.

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Transcript

Speaker 1: 0:00

Hi, this is Stuart Weems and welcome to the Investopoly podcast. My goal is to give you simple, easy to understand strategies, insights and tips to help you master the game of building wealth. If you listened to last week's episode, you know that I'm reviewing the most popular three podcast episodes for 2023. And this one this week is the second most popular podcast that I published in early March and I entitled it Rental Crisis, property Prices, boring Capacity and Fundamentals how will it affect you? And in this podcast, I talked about the rental crisis, how boring capacity is incredibly tight, how fundamentals around property, which is really supply and demand, which is population growth, mainly driven by population growth are very robust. And I made a comment that the mortgage fixed rate cliff which is all these people, all these Australians, coming off very low fixed rates rolling over onto very high variable rates or much higher variable rates, wasn't going to be an issue this year, and it certainly hasn't. You see, we haven't seen, obviously, mortgage arrears rates rise a little bit, but nowhere near what some people were talking about at the beginning of the year.

Speaker 1: 1:17

And actually not much has changed since I wrote this blog in early March. We still have this rental crisis. I've written more recently about how they might be able to solve that rental crisis, and it really is about changing borrowing capacity, capping the benchmark interest rate, giving borrowers some certainty around interest only terms and really encouraging landlords to come back into the market, because a lot of landlords have exited over the last couple of years, cashing out why prices are high and demand was strong during the COVID years, as well as a reaction to increase scrutiny from tenancy laws and so forth and the cost and risk that goes along with that. And so if we want to solve the rental crisis, we need to increase the supply of existing properties rented out, because we've had these existing dwellings that have been sold and now they're no longer available for rent. Of course, we've got to build a whole host of new properties as well, but that's only geographically sent it in certain locations. It's not going to serve everyone. So not much has changed since this podcast.

Speaker 1: 2:24

All the commentary is still very relevant and it really is a bit of a moving feast, but where there's uncertainty in markets and certainly there is some uncertainty around the property market and the rental crisis solution and all those sorts of things where there's uncertainty, typically it creates investment opportunities because, as a general rule, people don't like uncertainty, and so if there's fewer investors to compete with, it's a really good time to invest. You don't want to wait until the government solves the rental crisis, because the solution to the rental crisis is increased demand from investors, and then you're going to have to compete with a lot more people in that market in order to make a good quality property investment. That doesn't make a lot of sense. Anyway, I will throw over to the episode and hope you enjoy it. Cheers.

Speaker 1: 3:17

Firstly, let me apologise for a little bit of a longer episode this week, but what I wanted to talk about was the property market, specifically the impending or growing rental crisis, what property prices might do, how borrowing capacity links into that, and also to remind ourselves that long-term fundamentals look very, very strong. But really, over the last six years, it's been a pretty wild ride for property investors. I mean, if we cast our mind back in 2017 and 18, the banking regulator started to demand that the banks reduce the volume of interest-only loans that they provided, particularly to investors. The media jumped on the bandwagon and labelled this the interest-only cliff, and the idea was that, as borrowers are forced to repay principal interest, that's going to squeeze their cash flow, significantly cause a lot of financial distress, and large or increased in defaults was expected. Of course, that didn't happen.

Speaker 1: 4:21

Then in 2018 and 19,. You may recall, bill Shorten, the leader of the Labor Party at the time, during the 2019 federal election campaign, promised to ban negative gearing and increase capital gains tax, which certainly unsettled property investors and the property market, created a bit of volatility. Now, of course, bill was a short-priced favorite to win, but of course he didn't end up winning that election and the ALP has now abandoned that policy. I'd imagine most political parties probably won't go near that policy anymore. And then, of course, the COVID years 2020 and 2021 were very kind to property investors, with prices booming.

Speaker 1: 5:03

Unfortunately, really, since the RBA started hiking rates in May last year, prices have come back and in fact, I was reading an article in the paper last week that suggested in some locations prices are actually now lower than what they were at pre-COVID levels. So we've benefited from a little bit of growth and in some situations they've lost that growth. So certainly last year-ish or so hasn't been overly optimistic for property investors. So if we think about last six years, it's been a pretty tumultuous time for the property market and, as a result, we should probably expect, or shouldn't be surprised when we see that reflected in prices and price growth. However, the commentary by the media typically is very short term and they might look at maybe last year or year and a bit and start drawing conclusions. We always need to sort of look wider than that, of course, as anyone that's listening to this podcast would certainly know by now.

Speaker 1: 6:02

Okay, so let's talk about the rental crisis then, which is really. There's a massive shortage of rental properties in Australia at the moment, and domain recorded or reported, I should say that the national vacancy rate was a mere 0.8 of 1% Perth, adelaide and Hobart essentially reporting zero vacancy, or ostensibly zero vacancy and vacancy rates in Melbourne and Sydney have fallen from 2.7 and 1.9% respectively a year ago to only 1% today, so, really, vacancy rates are very, very low. Over calendar year 2022, nationally, rents have risen about 20%. Now, of course, that was coming off a lower base due to the reductions rental reductions and so forth that occurred during the COVID years, we'll call them, but the trend is that rents are rising and it doesn't look like that trend is going to abate anytime soon, just because there's a big shortage of rental properties, and I think we'll see the media reporting more and more on this so-called rental crisis.

Speaker 1: 7:10

What is causing the rental crisis? Well, some commentators have suggested that tightening rental laws have dissuaded investors from the property market, and one of the most attractive elements of investing in property is the fact that you have control over the asset. You have control on who you rent it, to, what improvements or repairs that you make, you know the best use of the asset. Those sorts of things. Now, tighter rental laws, as like the ones that were rolled out in Victoria in early 2021, reduce an investors control and that tends to have negative impact on at least demand for property investments. Now, whilst that's probably of likely to occur, that is, it's reduced the attractiveness for some people, I think it's at the margin. You know, I think the tightening rental regulations around the country that have occurred over the last couple of years, yeah, I think they will dampen demand from property investors, but only at the margin. So I don't think it's the major cause of the current rental crisis.

Speaker 1: 8:13

I think the rental crisis is really driven by supply demand, but mostly supply, that is, the supply of rental properties has reduced over the last six years rather than increased. Firstly, research firm PropTrack estimates that 15% of vendors are typically investors. So 15% of the people that are currently selling properties on the market, or that tend to sell properties on the market, tend to be investors. That proportion, however, increased over the last couple of years, during 2020 and 2021, when properties were booming and investors represented 20 to 25% of total vendors out there at the time. So, clearly, over the last couple of years, investors have taken the opportunity to cash out. Whilst prices were high, whilst there's a lot of FOMO, all those sorts of things, obviously a whole bunch of investors thought great, it's a great time to sell which it was and, as a result, if they went and sold those properties to own occupiers, then of course, that pool of rental properties reduces.

Speaker 1: 9:19

Also, when we have a look at lending statistics for the six years between 2017 and 2022, remember, at the beginning of the podcast, I talked about all the things like banning negative gearing and tightening up lending restrictions, all that sort of stuff that happened during that period Well, between 2017 and 2022, 31% of all new loans were made for investment purposes. If you compare that to the previous 14 years, when the data set began in 2002, it was used to be 38%. So there's been about 20% fewer investors over the last six years, which is quite a long period of time on average, of course, that have entered into the market. So, putting those two things together, you've got more people selling investment properties than usual during the COVID boom, and over the last six years, probably because of all the government intervention and regulator intervention, you've had fewer investors being attracted to the market and, as a result, we've got a smaller pool of rental properties and also, therefore, increased demand because of population growth. That is translated into a rental crisis. So of course, we've got to think about then how do we solve, or how does the government solve, the rental crisis.

Speaker 1: 10:38

And of course, there's been a lot of commentary and proposals made by special interest groups and so forth, so I thought it was worth at least sort of summarizing them. So one suggestion is to increase social housing. Now, of course, that's a politically attractive proposal, but the truth is that most renters won't qualify for social housing. So whilst it's a nice feel-good thing, I'm sure we need more social housing. In Australia. If we're just talking about the average renter pricing, social housing isn't gonna do anything to deal with the current rental crisis. There's been a proposal, I think by the Greens, to talk about introducing greater regulation to prevent landlords from increasing rents, so rental caps or those sorts of things. And now, if they do that, that will just cause a mass exodus of investors from the market.

Speaker 1: 11:29

Build exactly what happened in Ireland, and then what happens is it makes the rental crisis much, much worse rather than better. You want to do the reverse. We wanna be encouraging more investors into the market rather than fewer, and it has been also suggested that built rent could be a way to increase rental supply. So built to rent properties typically sort of high density buildings that are owned by institutions for the sole purpose of renting them out longer term, not for developing in sale, as a lot of developers might do today. Firstly, there's not enough build to rent construction currently going on in Australia to make any meaningful impact to the rental crisis, which is not to suggest we shouldn't encourage more, but there's not. Secondly, a valuation firm called Charterquette Cramer puts some research together that highlighted that the rents were 19 to 27% higher in build to rent properties compared to privately owned properties. That makes sense, because you need to develop the property and then you've got to generate some income off it. So of course, there's going to be greater pressure on increasing rents. So the build to rent sector certainly could help us longer term, but isn't really an obvious fix at this stage.

Speaker 1: 12:48

Unfortunately, the only way to fix the rental crisis is to increase the number of rental properties. Now you can go and build a whole bunch of rental properties, but that's only going to be centered in some geographical locations, so that's not really going to work. What you need is more established properties becoming rental properties, and to achieve that, what you need is more property investors private property investors to participate in the market. Now the problem at the moment is borrowing capacity and interest rates. You know, obviously interest rates have increased significantly. Look as investors long term investors we know if we're going to own a property for 30 years, interest rates are going to change over time. That's no big deal. That's not going to really worry people or stop people from entering into the market, but borrowing capacity will, and there's a chart that I shared, course links in the show notes that CBA put together in their recent profit announcement that shows that borrowing capacity has significantly reduced. And the reason it's significantly reduced is the regulator is adding, or asking the banks to add a 3% interest rate buffer.

Speaker 1: 13:54

That means that if you go on apply for an investment loan, your repayments are getting tested at an interest rate of 8.7% over a 25 year period on a principal interest basis. That means that if you want to go and borrow a million dollars, you've got to prove to the bank that you can afford to repay $94,000 a year. Now it only gets worse because obviously the RBA hasn't stopped hiking at least that's what the market consensus is. The consensus is maybe there's two, possibly three more rate hikes. So in a relatively short period of time banks will be testing investment loans at 9.5%, which I think anyone today would agree. That is ridiculous, particularly if you're going to do it on a principal and interest basis. So at the moment the way they're testing repayments as I said, 94,000 for a million dollar loan the actual repayments based on sort of current variable rates, is about 56. So they're doubling the actual repayments to make sure that borrowers can afford it at what looks to be close to the top of the interest rate cycle. So it doesn't really make a whole lot of sense.

Speaker 1: 15:04

The biggest thing that's going to attract more property investors into the market is by giving them access to credit and eventually dealing with that 3% buffer. Now we can debate whether the regulators should do that, whether they should loosen credit policy, how we could talk about how households already have high indebtness, particularly with respect to property investing, and so forth. We could have those conversations, but the reality is that the government will need to solve this rental crisis. It will get a lot worse before they actually do solve it, and the government will need to recognise that the only way to solve it is by letting more investors into the market. So if we're sitting here today thinking about property as an investment, we have to realise that there's a high likelihood that there's a potential tsunami of property investors that are going to want to enter the market or going to be encouraged to enter the market sometime in the next six to 18 months. Let's just sort of. You know I know that's a large sort of range, but it's going to happen. It's got to happen really, because otherwise, you know, the Labor Party is going to have really blood on their hands by not acting to resolve the rental crisis sooner than they could. And remember most renters you know weaker from an economic perspective, so they at least can afford both the rental crisis and also the cost of living crisis all at the same time so many crisis is to keep tab of, so they do need to solve it. So if we're sitting here today thinking about property investment, we know that there's a big force of demand that's most likely going to enter into the market at some point and that's always going to push prices higher. So it really is a kind of a good opportunity today.

Speaker 1: 16:54

But I'm not interested really in highlighting short term, short term changes or opportunities. I'm not here to sort of say now's the great time to buy property. I don't think there's ever really a bad time or a or a good time if you're a long term investor. But if we do look at the long term fundamentals, you know that they are very, very strong. We've got higher rental yields and higher rental yields will attract more investors into the market. Sure, borrowing capacity is a challenge, but for those where borrowing capacity isn't a challenge, higher rents will attract more renters into the market.

Speaker 1: 17:28

If we look at sort of the supply of housing at a macroeconomic level, I was interested to read the HIA predicts that new home starts will fall below 100,000 for the first time in a decade. So we're not building enough new homes and really high interest rates are a big negative for the construction industry. It really does slow down construction. So it's not surprising We've got population growth going nuts, mainly driven by obviously increased immigration. Westpac estimates the immigration net immigration last year for 2022 reached a record 400,000 people and expects another 350,000 this calendar year. In addition to the, you know, around about 50,000 Chinese international students that are expected to land on our shores over the next couple of months.

Speaker 1: 18:19

And then, if you look at Australia, economically we're in pretty good shape. You know the federal budget is expected to be in surplus this year. You know, really, thanks to strong iron ore, gas and coal exports, the nothing of their own doing, but really again, just the commodities boom again. Unemployment is at historic lows, although the labor market does appear to be cooling a little bit. But should we face any economic headwinds because of the higher interest rates, both the RBA and the federal government have plenty of options with respect to fiscal and monetary policy stimulus. So you know we're in a good position to sort of help our way through whatever economic pain the RBA is hell bent on causing in the pursuit of lower inflation. So, really, despite the volatility that we've experienced over the last six years, though mentioned at the beginning of the episode. Actually, property investment fundamentals are very, very strong Now, finally, I wanted to finish by talking about the fixed rate mortgage cliff that the media talks about regularly now.

Speaker 1: 19:28

So I mean, there's been a lot of talk about how many mortgages are going to switch from a fixed to a variable rate and, as a result, the rates that people are going to pay might go from 2 to 6% or 2 to 5%. Whatever it is, it'll be a significant change. I don't think defaults rates will change much default and arrears rates, which I think we'll see a small uptick, but I don't think we'll see a big change. Interestingly enough, last week in the RBA minutes they cited that Australia's excess pool of savings so how much cash Aussies have saved over the COVID period is higher than almost anywhere else in the world, and fixed rate borrowers have been well and truly warned Like. If you're sitting here today and you've got a fixed rate expiring this year, you've definitely thought already about how am I going to afford and what changes do I need to make in order to afford it. Interestingly enough, last week, westpac reported that around about 45% of its mortgage portfolio was tested at a benchmark interest rate equal to or lower than the current interest rate, and so what the media said then, or what the media read into that, was well, hang on, if interest rates are higher than what these borrowers have been tested at, then maybe they're going to run into trouble. However, what they didn't put together is, or didn't understand, is, that more than 75% of customers borrow less than what the banks will lend them. They don't borrow up to their maximum borrowing capacity, so they've still got some surplus cash flow to weather another two or three interest rate hikes.

Speaker 1: 21:04

Look, I've been in this business for 20 years. During that time, I've seen lots of commentary and rationale predicting that ARIA's rates and mortgage default rates are going to go through the roof and it's going to be a big problem. During that time, we've had the cash rate getting as high as 7.25% in 2008. We had to navigate through a global financial crisis, a massive credit crunch, we've had to deal with the supposed interest-only cliff, where now the volume of interest-only loans is essentially halved over a very short period of time.

Speaker 1: 21:41

And despite all these events over the last 20 years, australian mortgage rates have remained persistently low, and a big reason for that is that, firstly, we've got a well-regulated banking industry. You know, we don't have the same sort of cowboys that created the GFC in the US. And then also, australia is very much the lucky country when it comes to economic stability, and it won't be any different this time round. You know, we've got plenty of cash savings. We've got good prudential regulation. The banks are going to work with people that are experiencing a cash flow crunch. Of course, there's going to be a small cohort of people going to get themselves into trouble, but those people are always going to be there and it's always going to happen. And in the main, this mortgage interest rate cliff, I think, is well and truly overcourt.

Speaker 1: 22:36

And finally, to finish off, actually, one last thing to finish off is just to, I guess, share an observation over the last couple of weeks. So feedback from clients and total evidence that I've witnessed in the market. It seems like sentiment may have changed over the last couple of weeks with respect to property. Interestingly enough, corelogix daily home price index, so they release an index that is based on real life data. It showed that prices stopped falling in the mid to end of January, which is interesting. I mean, it's only a small amount of data, so we can't read too much into it.

Speaker 1: 23:14

Also, february tends to be a pretty buoyant month Because, as you think about it, if you're a potential property buyer and you weren't successful last year, you really had to wait through most of December and all of January to get your eyes on any new listings, because most people don't start listing property until after Australia Day, so into February.

Speaker 1: 23:36

So it's true statistically that February is a little bit of a stronger month, so we can't read into it too much. But I did do a episode in late November last year that stated all the reasons why I think we're close to the bottom in terms of property prices, and my view certainly hasn't changed from then. So it'd be interesting to see what property does this year. But on the whole, I think the long term fundamentals look very attractive and it's also important to remind ourselves that it's far easier to buy property in a market like it is today, where either prices are falling or stable, than it is when prices are rising strongly. It's very difficult to operate in that market. Okay, again apologies for a longer episode today, but until next week. Bye for now.