Property cycles and the merits

I look at it this way, we have a long flat period ahead in Sydney and Melbourne at least...rents will now play catch up, rates will eventually rise, everyone will say its the end of the world and then sometime around 2022-20224 the market will start to recover. Feels like a lifetime away but it will be here before you know it.

 

Nice post @euro73 - I agree Sydney generally should now flatten off as there wont be average punters able to service debts of over 1m as the new norm. Foreign money is potentially a game changed as is SMSF funds if either come in sufficient volumes and neither rely solely on debt.

My clients buying smsf properties are asking for cash flow, not growth, and are prepared to be flexible about where to go to get it. They are also not maxing out debt but choosing either cash or 50% lends in many situations.

Markets outside of Sydney and Melbourne are (generally) not overpriced and have potential for growth within current income and debt levels. Down my way for example houses that were 300k for 10 yrs, have just started jumping as boomers are retiring down here having just sold up in Sydney. Those homes can easily double without any change in debt profile.

@Biz I agree people fail to think long term and realise that these things come around again more quickly than many believe given they have such a short term view of everything.

Rents will grow, loans will get tough, then easy, economy will worsen and improve, and around it goes again.

 

Just to add, Euro i am not making light of what you are saying, it is true obvioisly that peoples servicability has dropped but to me this was brought about because of strong markets in Sydney and Melbourme. The regulators are just being prudent.

When it gets to a stage where there is little housing investment and prices falling i have no doubt they will move to losen credit once more and around and around the merry go round we go again.

You can think of these Apra changes likes a proxy rate increase. They just make things that bit harder but remember apra are regulators, they follow action they don't lead it.

 

Its going to take years

 

APRA doesnt care about property prices. APRA cares about banking stability.

If everyone was paying P&I and borrowing only 80% LVR, APRA would likely have allowed "actuals" to go on and on and on and on... and ASIC would likely have left HEMs alone. The two pronged approach taken by APRA and ASIC would likely never have happened.... because there woiuld have been no systemic banking risk if everyone was at sub 80% P&I .

To cut right to the bone -This is more than a proxy rate rise. Multiple levers have been pulled simultaneously, by APRA and by ASIC . LVR. HEM. Assessment rates. I/O pricing. APRA thinks there is far far far too much I/O debt that will never be paid down... and ASIC thinks banks havent taken responsible lending legislations very seriously. So bank de-risking via re-capitalisation and the re-balancing of lender books towards P&I are APRA'S goals... and banks lending people less money full stop is ASICS goal.

The entire financial model and the associated mechanics that underpinned all previous cycles has been comprehensively altered and re-engineered. In less than 6 months it has stopped Sydney in its tracks. Todays auction clearance rate barely touched 60%. These changes aren't going anywhere. They aren't going to be reversed anytime soon. There is actually more to come. Australia forms part of the G20 and its banks will have to take further regulatory measures by 2018 RE BASEL IV.

I think you're probably about right that 2022-23 is about when we can start to see some capacity return, and maybe some growth will return then too...

That all being said... you still need to deleverage to take advantage of it

 

I agree.

 

I am not arguing about structural economics, my over arching view is cyclical, and I agree the specifics of every cycle is different. My issue is that very few people seem to remember (or articulate) just how much this year feels like 2003. The 2 rate rises at the end of that year also stopped Sydney cold. It happens.

 

Yep, feels like 2003 again without the regional spice this time. Last tine it was a couple of rate rises and vendor duty that killed the boom. Funny how vendor duty was removed years later when the market was tanking...

Mark my words, the people who ignore all the noise and keep building their poftfolio over the next decade will set themself up for life by the end of the 2020's.

 

That's right I completely forgot that duty, my parents got stung they were so cranky!

 

Agree, everything is possible. The main trend will be that the government will adjust the policies during the economy/property cycles to ensure a healthy economy. When the property cycle bottoms, the government will change the policy to encourage the investment.

 

But while Sydney has stopped , Brisbane doesn't appear to have , and that part of the normal property cycle ...

When Sydney stops , there is always a different trigger . It just happened to be APRA this time . Last time it was different and next time it will be something else and the cycle moves on .

Every cycle has logical reasons that can be used to explain why things happened . The only one thing that stays the same is how humans react .

Personally 2022 sounds about the right time for the start of the next upswing of the next normal cycle .

Euro , you seem to be saying that this time is different . The fine detail may be different , but the overall course of the cycle seems remarkably the same to me .

Cliff

 

60k is still below the average income. But you right, Joe Average won't be able to buy more than 2 houses. Is that really different to now? Most property investors stop at 1 or 2 investment properties anyway. What percentage ever get to 3 or more.

I will have a crack at this. I think what you are missing is that property cycles are not driven by a rational market. I mean who in their right mind would buy in Sydney right now? And yet, hundreds of homes are selling every week. Irrational. At the same time, the Perth market is nosediving. In less than a year the median house price has dropped from $551,500 to $520,000 and is continuing to fall. The houses are exactly the same as a year ago and yet prices are plummeting. Irrational. What this means is that people will find a way to buy if they really want to.

Some of the capacity will come from DINKS, who can be earning a lot more than your Joe Average couple. And what about Joe Average: joint ventures, shared equity schemes, parental guarantees. For my first IP, I went 50/50 with a mate because neither of us could afford to invest on our own. These days you could do the same thing with unit trusts so you could have 2, 3 or even 4 investors buying a single property. People will find a way to invest no matter what. Irrational I know, but this irrationality is what is going to drive the next boom. It always does.

You are quite right that the next cycle will be different. It has to be. But it will happen.

 

^^^ this. Property cycles are driven by greed and fear. Unless people stop being greedy and fearful, property cycles will continue as usual. How they fund their purchases will change. It has to.

In the 80s and 90s, they didn't have 105% LVR interest only loans. My last purchase was a 105% LVR interest only loan. Next time round it will be something different. But that doesn't mean it won't happen.

 

Maybe you're right Maybe I'm wrong. But I believe what you're missing is that property prices are driven by credit supply first and last. Imagine no one could get a loan? No amount of under supply or 5 star location will help drive a properties value up in a market like that.

This post asked whether cycles of old could be relied upon... implying they 'll just keep on keeping on immediately, and I said they cant. I am simply arguing that future cycles will not be repeats of previous cycles. They will take far longer and move slower, and fbe determined by credit. For those who want to get ahead of the cycle curve, creating capacity before the rest of the market creates it will be key. - and if most of them arent focused on debt reduction , that's where the edge will be.

Guys you are all missing one very fundamental point. For the majority all of the past 20+ years, ( where all "cycles" evolved) people have by and large been able to borrow more money today than they could borrow yesterday, and more money tomorrow than they could borrow today, and so on ..... Except for a few short periods where rates rose and capacity slowed for a time, Australian borrowers have enjoyed pretty much ever improving borrowing capacity for a very very long time. Whether early entrants with established portfolios, or newer entrants. Its pretty much been a case of come one, come all... as lower rates, higher LVR's, state and federal grants, more product innovations... more aggressive calculators etc- all created ways for banks to get more money to more borrowers.

But now Australians cant borrow more money tomorrow then they can borrow today. In fact, for investors in particular, who have made up well over 50% of all lending in the last few years, if they were to try, they may find that they can not only borrow far less money tomorrow , but many wouldn't even re qualify for their existing debt levels if they were re-assessed. And it would appear that it will be years before that position improves, because massive amounts of "useable" money has been removed from servicing calcs. All at a time when the economy is flat and showing little wage growth. And if 50% of borrowers cant borrow more money tomorrow than they can borrow today, prices "cycles" simply have to change .. significantly

There will be one last hurrah for some of the cheaper cities... I have already conceded that. Loan sizes to buy there are much smaller so some investors will be able to squeeze out 1 or 2 or 3 more purchases, but then they too will hit the wall.. and we will end up back here at the same question.. wheres the money going to come from to drive the growth????

My arguments simply centre around taking a 7-10 year view , beyond a few short term purchases in cheaper locations. Im interested in readers understanding how to keep buying for 10-15 years, not for 2-3 years and then getting stuck.

Its been easy to make massive profits for the past 20 years. Throw a dart , and if you held long enough- bulls-eye. But In every single example and counter argument presented to me on these posts, there appears a fundamental failure to appreciate the role credit played in every cycle that made you money .

20 - 30 years of expanding credit is now evolving into a more constrained credit environment. Whats different now is that there is a floor assessment rate and while ever its in place, no matter what the RBA does, your capacity cannot get any better without big pay rises or rent increases or a windfall... Its like a wage freeze on borrowing power. Apply that to every borrower in every city of the land and lets see whats what in 18-24 months. I guess we will see whether the same old cycles have kept rolling on, by then , or whether the concept of debt reduction /deleveraging that I embrace, might with the benefit of hindsight be proven to be a wise strategy Time will tell

 

Yes but when rates fell, capacity improved again and up started the merry go round. Australia was also enjoying a boom in wage and salary conditions, super easy credit and investors could borrow 95, 97, 100 or 105% LVR if they wished. .... ie - all very strong accelerants. Those are common themes to all the growth cycles across Australia since deregulation . Every. Single. One.

Now though;

1. wages are flat
2. Rates are at bottom, and even if they fall.. there's no improvement to capacity because of the floor rates.
3. HEM's are significantly higher
4. I/O renewals are going to get harder
5. Postcode restrictions and LVR restrictions are commencing
6. Cash Out is getting harder

These are all dampeners rather than accelerants. All the elasticity is gone. The accelerants just arent there. Again - this doesn't mean I'm doom and gloom. It just means I'm saying that cycles will start slower and take longer to gain momentum because the accelerants will be weaker. I intend to compensate by manufacturing accelerant via deleveraging / aggressive debt reduction.

My strategy has already delivered me a $6 million portfolio with a tax free income approaching 300K. From here its as simple as running it as a dividend reinvestment model, so that within a decade I'll have an unencumbered portfolio, generating well over 300K passive income for life. Even with zero growth. Even without purchasing another property. But importantly, as I deleverage, I'll be able to expand the portfolio footprint well beyond the current size and turn it into an even larger portfolio if I choose to.... The only other way I could get the outcome I have already built for myself , without deleveraging , would be to sell off assets - and that means relying on growth alone in the post APRA world , which I think is foolish, and it also means forfeiting passive income for the rest of my life - also foolish.

 

My post was saying the old cycles won't keep rolling on. I also wasn't criticising your concept of debt reduction /deleveraging. That's what I'm doing right now and I think other smart investors are too. But debt reduction /deleveraging won't be embraced by the general public.

My point is that people are stupid and they will do stupid things to get their next property fix. Greed, fear and stupidity will drive the next cycle, just like it has driven every cycle. Next time the funding model will be different. That is what will make the next cycle different from the last one.

 

One of the best argued posts I've read for a while. I totally agree with you. I find the current environment more similar to what was happening during the peak and bust cycle in the US property market - with many cities/regional areas still recovered from the peaks seen years prior.

Cycles are fueled by regulators swinging between the extremes of too loose lending practices or the heavy handed approach - are there are consequences to both.

However, investors still need to park their money somewhere. I would suggest looking elsewhere.

 

Sorry but maybe a silly question here, if people stop buying for years as you say because serviceability is affected then won't developers stop building which will lead to a reduction in rental stock which will push rents up and affectively increase yields and borrowing capacity again?

 

While euro makes a good argument and I can't say I disagree with the impacts the squeezing of credit will have..... not "every" property transaction relies on a high LVR new loan to be created.

There are those "average joes" who would be sitting on a bucket load of equity built up over the years untapped in thier own PPOR's.

Whether this is used for investing in an IP or used once sold to fund a new PPOR, it does make it possible to keep new purchasing of property possible.

If EVERYONE who owned property was sitting on a 95% LVR today right now....then the market probably couldn't go anywhere.....but that's not reality.

 

Also what is HEM?