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Property market fundamentals look strong

Four key developments over the past few months have created a significant turnaround in the prospects for the Australian property market:

1. The Coalition election victory, and with it, the removal of capital gains tax, negative gearing and other Labor policies that were adverse for the property sector.

2. APRA's change to the serviceability criteria that banks must apply when assessing a home loan. This was formally implemented last week and in simple terms means a typical borrower is eligible for approximately 10-20% more in capacity compared to the old rules, and this loan size will grow as interest rates continue to fall. It also means a large portion of borrowers who were recently denied credit approval may be eligible for a home loan.

Of all the changes, this is likely to have the largest impact with a material increase in the amount borrowers can spend when buying a house or bidding at auction.

Assuming a mortgage rate of 3% in the coming months if interest rates continue to fall, serviceability calculations will be conducted at 5.50-5.75% versus 7.00-7.25% under the old rules. Here's an excerpt from APRA release dated 5 July 2019: 'APRA finalises amendments to guidance on residential mortgage lending'

“In a letter to ADIs issued today, APRA confirmed its updated guidance on residential mortgage lending will no longer expect them to assess home loan applications using a minimum interest rate of at least 7 per cent. Common industry practice has been to use a rate of 7.25 per cent. Instead, ADIs will be able to review and set their own minimum interest rate floor for use in serviceability assessments and utilise a revised interest rate buffer of at least 2.5 per cent over the loan’s interest rate.”

3. RBA rate cuts of 0.25% in May and June and further expected. With the official cash rate at 1.00% there are now home loans available with interest rates less than 3.00%.

4. Tax cuts and fiscal stimulus.

Other developments will add to the positive property conditions

1. Co-ordinated action between the Federal Government, ASIC, APRA and the banks to increase lending.

The Australian recently reported: “Post-election positives for the property market are huge, says Stockland’s Steinert“ which included the following statement:

“Last week new federal Housing Minister Michael Sukkar signaled that he would bring together ASIC, APRA and the banks to help streamline mortgage approvals and cruck up credit flow.”

This can, and in my opinion will, have the biggest positive impact on the property market in coming years. With the Royal Commission seemingly behind them, and with APRA's blessing, the banks have recently started loosening lending standards and increasing access to credit. In my experience, access to credit (and in particular cheap credit) is the key driver to asset performance. Combined with the serviceability changes and low mortgage rates, an increase in lending by the banks could see another property boom.

2. It is becoming increasingly likely that the Federal and State Governments will heed the call of RBA Governor Philip Lowe and spend up on infrastructure. The RBA Governor has been urging governments to take advantage of the lowest interest rates in Australian history (10-year government bond rate is below 1.5%) to fund long-term infrastructure projects. This would see a lift in GDP and employment. Further, infrastructure spend has a positive impact on surrounding property.

3. Unrest in Hong Kong has the possibility of reinvigorating the flow of both money and people from China/Hong Kong into the Australian property market

Sentiment has 'turned on a dime' since the week before the election

Following the Federal election, we immediately saw a jump in appetite for property deals, from both investors and funders. Many property deals have been presented to us and around half have been lost quickly to competition from other funders. Speaking to market participants, there has been a flood of new funders enter the market such as family offices, hedge funds, foreign funds and other non-bank providers in recent months.

There is an increase in appetite from regular sources and a potentially significant boost from the banks. This bodes well for an exit from the shorter-dated land deals we have been involved in over the past 14 months. Already, several funding transactions have redeemed early as testament to this trend.

With strong tailwinds for the property sector, we believe the low LVR land deals are a good place for fixed income investors. With expected internal rates of return in the high single digits or low double digits, the returns outweigh the risk on senior secured positions with LVRs in the 45-60% range and maximum time horizon of 12-24 months.

 

Justin McCarthy is Head of Research at BGC Fixed Income Solutions, a division of BGC Brokers, and a sponsor of Cuffelinks. The views expressed herein are the personal views of the author and not the views of the BGC Group. This article does not consider the circumstances of any individual investor.

For more articles from Mint Partners and BGC, click here.

 

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