Australia’s most recent property boom, particularly in Sydney and Melbourne, really began in early 2012 following two consecutive rate cuts of 25 basis points in November and December of 2011. In May 2012, a 50-basis point cut was announced, immediately followed by another 25 basis-point reduction in June.
Between November 2011 and August 2016, the central bank announced 12 cash rate reductions, which helped drive property prices higher as credit became cheaper – more than 50 per cent cheaper in many cases.
This is an important point that often gets lost in much of today’s rhetoric around monetary policy as a lever to stimulate the housing sector; it wasn’t one cut, or even two, that led to the latest real estate boom – it was a dozen over a five-year period.
The Reserve Bank doesn’t have that much room to move anymore. A 1.50 per cent cash rate only has six 25-basis point reductions in it, exactly half the number of reductions that got us to this point.
Secondly, the Australian mortgage lending landscape looked very different in 2016 than it does today. Home loans were far more readily available, banks were open for business, the threat of a royal commission was virtually non-existent and LTI ratios were significantly higher than the six-times being used as a conservative benchmark by lenders today.
The volume of home loans being written hit a high-water mark of 58,552 in December 2015. There were 11 per cent fewer mortgages written in November last year.
The simple truth is that mortgages are not as readily available as they were when the Reserve Bank last cut its rates. The borrowing capacity of Australians has been reduced, despite their circumstances remaining the same. Property prices in cities like Sydney and Melbourne will need to fall to whatever amount buyers are able to borrow before they can start to recover. One or two cash rates from the RBA isn’t going to change that.
I’d argue that borrowing capacity is a far bigger driver of house prices than monetary policy, particularly in an environment where the cash rate is already at a record low.
About 12 months ago, APRA wrote to all Australian banks, driven by concerns over high debt-to-income levels, which in June 2012 was 130.8 per cent. Early last year it reached 200 per cent, which caught the eye of both the RBA and APRA. The prudential regulator’s 26 April 2018 letter to ADIs read:
APRA expects ADIs to commit to developing internal risk appetite limits on the proportion of new lending at very high debt to income levels (where debt is greater than six-times a borrower’s income), and policy limits on maximum debt to income levels for individual borrowers. This doesn’t suggest that there is any hard limit on loan to income (LTI) ratios above six-times but it does suggest that there will be less appetite for mortgages, which are in excess of six-times incomes.
Following APRA’s direction, which has since seen banks tighten up on lending, CoreLogic decided to run the numbers to see what an LTI ratio of six actually looks like.
“Six times the median gross household income in Sydney is calculated at $688,764,” CoreLogic’s head of research Cameron Kusher said in May last year.
“The median house value in Sydney is $1,058,306 and the median unit value is $774,124. What this means is that if a buyer wanted to purchase the median house under this scenario, they would need a deposit of $369,542 and for the median unit they’d need a deposit of $85,360.”
That was 12 months ago. Property prices have fallen since then, but Sydney’s gross household income is still $114,794. As at 30 April, Sydney houses have a median value of $880,369 and units $683,739.
By implementing macroprudential measures and pressuring banks to tighten up on credit, the regulators have effectively allowed the banks to control real estate prices: lifting the LTI ratio would have a significantly greater impact on home values than reducing the cash rate.
In a city like Sydney, the value of homes will need to meet whatever the market can borrow to pay for them – which currently stands at $688,764.