NSW Crystal ball model - Sydney property price

Hi guys,

So I've being playing around with building a crystal ball model for Sydney property price using macro assumptions based on a dual income professional family:

• Inflation (CPI)
• Wage increase
• DTI (APRA rule)
• Interest Rate
• House hold spending assumptions

The result is a model which predict Sydney property price to be the following by 2025.

• Dove scenario +14.75% (2% CPI, +3.50% wage increase p.a., DTI X8.5)
• Base scenario -20.50% (3% CPI, +3.00% wage increase p.a., DTI X7.5)
• Hawkish scenario -27.53% (4% CPI, +2.50% wage increase p.a., DTI X7.0)

Tried to make the model as easy as possible to follow. Would love to hear your thoughts, poke holes at the model and make fun of my assumptions.

 

I don’t think you will find many retail financiers that do DTI over x7.5. Most ACL holders are restricting it to 6 with a very particular amount between 6-6.5.

Private finders market is definitely different but that’s another story.

 

DTIs close to 8 are not that hard to get, pretty much across the spectrum of lenders. If your sub 70 or 80 its not too tricky. They say it is, but any mortgage broker will get you what you want using a wide panel and having a wide range of options within that panel.

BUT

Once rates rise the serviceability calculators feedback to no longer get surpluses for DTI's above 7. With assessment rates at 6.5-7 instead of 5, then DTI's will cap out at 6-7 again.

 

So my hawkish scenario for 2025 I believe is reflective of the environment we are in.

The interest rate I assumed is 4.80% variable. It significantly increased interest expense. Particularly, if some one looked at the trade off between renting and buying then you just wouldn't be borrowing like you would today.

All to say, price should fall around 30% as borrowing capacity will fall by 50%.

 

Haha this is a thing of beauty. Thanks for sharing. My team and I do this type of stuff a lot, generally a bit more back of the envelope and a bit more feel in it (we have a closer handle to BC's though).

How did you calculate the DTI? Why'd you use net income for this? Is this trying to replicate high level bank serviceability? If so, these numbers are a fair bit of actuals.

As an actual guide to live serviceability calculators:
- First example, dovish, the borrowing cap of this couple is $2m+ NOT 1.45m.
- Second example is around $1.9million.
- Third example is around $1.55-1.6m

Nonetheless the way your calculator works changing the amount borrowable doesn't actually change the results(?). It just changes the rent to buy factoring you have which yields the same results.

 

@Redom thanks. Be great to get feedback and for people to poke holes.

DTI assumption is a variable number. I have used X7, X7.5 X8 on the basis that these are the maximum that APRA would allow Financial Institutions to have (should they impose a limit by 2025).

Net income is used because I wanted to use this model to reflect as much as a real life example as possible. Imagine a young professional couple looking to by an owner occupied home. How much money do I have to service a loan (however big) after I budget for non-discretionary and discretionary spending.

In the dovish scenario, the couple can borrow $1.65m, assuming they have equity laying around of $330K and have saved another $332K in cash for a deposit. Therefore, the max budget they would have is a $2.31m (vs $2.01m in Dec 2021)

I was playing around the rent to buy factor to adjust for the loan size in row 39. The idea is, when your rent budget is bigger than interest on the DTI calculated loan. There is incentive for you to borrow even more. Hence dovish scenario debt isn't $1.45m for this household, its $1.65m after adjustment

 

Yes that's great way to start something like this.

Personally I don't think this type of household will want the 2m BC thats on the table. DTI's on net incomes are approx 12 in reality, not 6-8 thats assumed. Generally for an OO purchase with this type of couple they set their own budget around 1.6-1.8, around 80% of their actual BC.

 

I just adjusted the DTI to 12, 11 and 10 for the 3 scenarios (columns F, G and H).

Funny enough, the the Rent to interest factor adjustment kicked in. The debt becomes $1.65m for dovish scenario. So that is in line with what you see @Redom?

All things being equal, the reduction in borrowing capacity still carries through on the Hawkish scenario. Which is where I'm trying to glance into the crystal ball.

 

Yes I think so.

Overall I think if people can borrow more, then they will purchase higher though.

Also unsure how static rents are across the models. I suspect if interest rates are 4.8%, rents are up 20%+.

I love how your analysis uses renting as a benchmark though, as it IMO is a big factor in equilibrium values along with rates.

We talk about rates rising and prices falling hand in hand, I agree here. One important factor is rental inflation here. If rental inflation takes off shortly (1% vacancy rates, 10% increase in detached housing already, and rising quickly), then rate rises are partly absorbed by the live or rent equation adjusting to higher rents.

 

Interesting to know. Is this across tier 1 &2 lenders or limited to Tier 3 and credit union type providers? I knew 7 was possible with NGB added in at some lenders.
Do these lenders have lower assessment floors also? It would make sense....

 

Rental increases will be largely offset by rate increases. Repayments @ 2.5% on $800k are currently $3161. With an increase to 2.75% the repayment becomes $3266. Assuming rental yield of $700pw you would need close to 5% increase to offset the first rate rise, then the second, then the third.....

Adding onto that only a third of properties are investment (off memory).

Yield will not be mining boom/COVID stimulus/emergency cash rate of 2022

 

Yes all true.
Reason why renting figures are important is for owner occ decisions, not investors cash flow.
One sense test we use is ‘buy or rent’. Ie the cost of buying (interest + a bit for rates/strata) vs renting. If there’s an imbalance there it tips demand. E.g. in mid 2020 OO blended rates were 1.7-2.1, and prices 30-40% lower. This meant a lot of people were paying a fortune to rent as an opportunity cost. Drove OO demand levels higher and led to rebalance.
If rents go up 30% in a short time period and rates go up similarly, the balance remains without a big price adjustment.
I don’t know how much rents will go up, but we’ve got vacancy at all time lows along with big increase in temporary migration at the same time, this could lead to a big increases in rental demand and prices.
If rents stay at 2020 levels and rates go up 30-100%, an imbalance occurs the other way and prices will fall as it doesn’t make sense owning.
@Tofubiscuit model has this dynamic captured in the sense test of equilibrium values.

 

Rental yield in Sydney, especially for house, is still so low though. I am not sure how much they can increase by but will take a massive rise to keep up with rate rises. I don’t see how people can increase 30% rent across the board - perhaps some can when they are so under market value, but most can’t and they are too afraid to lose tenants when you increase by $100 or $200 a week.

 

Agree it seems too much at the moment.

Not sure how much it’ll rise. We have the conditions for some of the strongest rental growth in years though (near zero vacancy, and incoming demand following years of fairly low investor demand reducing supply of rentals). The results are to be seen…

Really rough and dirty, if rentals do go up around 30% from 2021 levels, then that absorbs about 3 rate rises.

 

https://www.domain.com.au/research/vacancy-rates-march-2022-1128965/

 

I reckon it will be a combination- rent rises for 10-15%, which is about $70-$100 per week on average, which is still a lot. Then prices also drop a bit. If rent rises a lot, it will push people to go to units and townhouses, which will close the price gaps between houses and units.

 

So in the model, the rent budgeted is assumed to be 20% of take home pay for the household. I used this so that when household income increase, it means they have more options, be it pay higher rent some where or buy a home.

The model on average has factored in $75-$100 increase of rent (now to 2025) already.

I then came up with a "rent to interest expense" factor to adjust for willingness of a household to increase or decrease debt depending on rental market environment.

What I found, is that if interest rate increase say 2.00% from today (Which is expected by 2024). Even with rental increases, the borrowing willingness could decrease as much as 50%

 

There is no way that rents can flow through to houses in Sydney. Maybe $10-$30 increases. 30% is pure madness...it ain't going to happen.

However, the rents for units is super cheap...for example in places like Campsie (other side of Burwood) you can get 2 brm units for less $350pw....same in Parramatta....less than $400 in Eastwood/North Ryde/Marsfield and surrounds.

 

WFH is driving people to move to the regions to places like Brisbane/Perth/Adelaide where housing costs are lower. It looks like Sydney and Melbourne have 15-18% actually in the office...interesting....based on what I am seeing rents are actually stabilizing or only moving to inflation in Sydney and Melbourne whilst they are exploding in regions...Brisbane/Darwin/Perth.

Two years on from COVID-19 lockdown one, some workers will never go back to the office

 

RBA updated their messaging today. As a result I've made some updates to the "crystal ball" model.

Base scenario for end of 2023 (1.5 years discount factor used)

• -22.59% decrease in Sydney Property value.
• RBA rate increase by 1.00% (avg OO variable rate 3.30%)
• 3.50% CPI
• 3.00% wage growth
• $36 rent increase per week

In row 67-70, I tried to take a look at different segmentation of the property market.
- An average 2 bedroom unit in Sydney (C grade) will decrease from $670K to $518K
- An average 4+ bed room house (A Grade) will decrease from $2.4M to $1.86M

Will up date again if rate environment change.