Navigating investment property risks

How to take a leaf out of APRA's book when determining your asset's exposure to future credit changes

Navigating investment property risks



Over the course of 2015, property investors were finding it increasingly difficult to obtain finance as a result of constraints applied by APRA, notably a loan serviceability calculation against an annual interest rate of 7% or more.

At the time, Sydney was experiencing its most recent of many price booms. According to ABS figures, December 2014 reported an almost record-breaking number of house sales in Sydney this side of the new millennium. The median house price had also increased by 9.5% over the preceding 12 months. 

Sydney’s property market eventually peaked in 2017 when its median house price exceeded $1m. In large part, the city’s property price boom can be attributed to high levels of built-up demand combined with a series of RBA cash rate decreases.

Availability of credit

In late 2011, the cash rate target was 4.75%. Within two years it had plummeted to 2.5%. Passing on these rate cuts enables the annual interest bill on a $600,000 interest-only mortgage to fall by more than $13,000 each year. Alternatively, it leads to the same interest bill for an $870,000 interest-only mortgage.

Between 2012 and 2015, Sydney homebuyers appeared to have manifested the latter, with the mid-year median house price rising from $600,000 to $860,000 over that three-year period. A correlation begins to emerge between Sydney property performance and the availability of credit.

Sydney’s sensitivity to the availability of credit is also evidenced by the triple threat of 2019: a series of cash rate decreases, combined with a favourable federal election result and the loosening of APRA’s serviceability guidelines, precipitated a resurgence of the Sydney property market.

Even though the investor may be paying a mortgage at 4.5% per annum, they could calculate whether they could afford to pay it at 7.5% per annum

Auction clearance rates began looking more favourable, and month-on-month price growth records were being smashed towards the end of the year. Elsewhere in Australia, the story isn’t quite the same. This suggests that Sydney is more responsive to these changes than other markets. But why?

The prevailing sentiment over many years implies that Sydney is not only among the most unaffordable places to live in Australia but also in the world. The city’s sensitivity to changes in the availability of credit indicates that many Sydneysiders are teetering on the edge of externally imposed limits of affordability.

The positive for Sydney homeowners and property investors is that 2019’s bounce-back may have direct positive consequences for their sale prices. The negative is an awareness that any future lending restrictions could be proportionately damning.

Uncertain future

Such significant levels of sensitivity to market forces may cause homeowners and property investors to be apprehensive about the future of their assets, but respect for these market forces can also be an effective tool for long-term risk mitigation.

Median household incomes in Brisbane and Sydney were comparable, with a disparity of just 12% reported during the 2016 census. One year later, during the peak of Sydney’s boom, Brisbane’s median house price was less than half of Sydney’s. With equal access to finance, this grants Brisbane a much stronger level of housing affordability and therefore greater immunity to future changes to credit. The same applies to many other cities and regional centres throughout the country.

Evidence of Sydney’s unique sensitivity to credit changes can be demonstrated by the Harbour City’s recent price correction. While Sydney’s median house price was stalling and even plummeting, Hobart, Adelaide and Brisbane were all still reporting varying levels of house price growth or stagnation despite news headlines announcing a nationwide crash.

My solution

This analysis implies that a property investor could adopt the principle of APRA’s loan serviceability calculator to determine how exposed their own asset is to future credit changes. For instance, even though the investor may be paying a mortgage at 4.5% per annum, they could calculate whether they could afford to pay it at 7.5% per annum.

By extension, they could also calculate the level of mortgage stress a hypothetical future buyer would experience at certain purchase prices. This varies not just between cities but also between suburbs, property types and price points. It doesn’t guarantee future growth, but it certainly helps mitigate risk. 

While there are many other factors that influence property performance over the long term, property price growth nevertheless boils down to the amount a buyer is both willing and capable of paying. This simple loan serviceability calculation could help prevent a whole lot of heartache in a higher interest rate environment in the future.

Luke J. Graham
is founder and market analyst at Property Analysis Australia and is currently completing postgraduate studies at Oxford University

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