Quarterly Market Review, Q3 2021 by Dr. Kevin Hoang, Senior Economist & Data Scientist at Milk Chocolate.
Domestic market
The national market has achieved the highest gain since 1989, recording 20.3% higher over the past 12 months. In the month of September 2021 the growth of housing value remains positive across all capital cities:
Sydney (1.9%)
Melbourne (0.8%)
Brisbane (1.8%)
Adelaide (1.9%)
Hobart (2.3%)
Canberra (2.0%)
Darwin (0.1%)
Perth (0.3%)
The annual change in housing values by 30th September 2021 remains extraordinary across all capital cities:
Sydney (23%)
Melbourne (15%)
Brisbane (20%)
Adelaide (19%)
Hobart (26%)
Canberra (24%)
Darwin (20%)
Perth (18%)
Notably, the rate of growth of detached houses is significantly outpacing that of units, except in Hobart and Darwin. This suggests the appetite toward detached houses remains strong despite numerous prolonged lockdowns in Sydney and Melbourne in the last 2 years.
However, the monthly gain has been easing in comparison to the peak in March 2021, partly due to the worsening affordability, the extended lockdown and the speculation about possible tightening policies by the regulators.
There is no doubt that the Australian property market, especially Sydney and Melbourne markets are volatile. Looking back over the last few decades, any fast-rising period will follow with a stabilising and then declining period. There is no exception for this time, we predict that the market will slowly converge to the long-term growth trends in the next 6-12 months. This does not mean that the price will decline instantly, rather that the price will grow at a slower pace than the last 12 months.
APRA’s intervention
APRA has decided to tighten the mortgage lending amid the rising market and there is a slight sign of increasing mortgage to income ratio. RBA data shows annual housing credit growth (5.6%) is outstripping income growth (1.6%), and APRA data shows a higher than usual concentration of new loans on high debt-to-income ratios.
APRA will require banks to test whether a borrower could repay a mortgage if the mortgage rate is 3% higher than the product rate on offer. Therefore, the testing rate will be 5% for 2% owner occupied home loans. The new buffer rate will be effective by the end of October, 2021.
It is important to note that major banks already have used a buffer of 2.5% in the serviceability assessment since 2019.
Using the average owner occupier rate as an example, APRA’s announcement would mean owner occupier borrowers would need to demonstrate the ability to repay a mortgage with an interest rate of 5.36%, and investors would need to demonstrate the ability to repay at 5.72%.
Therefore, investors will be likely more impacted than owner-occupiers following the implementation of the tightening policies. However, since the percentage of investors remains low in comparison to the long-term trend, as well as they are usually more flexible with their budget, therefore, the real impact of the policy on the market demand is expected to be minimal.
It is important to emphasize that the latest APRA intervention has purposefully served as a “testing the water tool” to signal to the market that further interventions will be in place if the market continues to overrun. Overall, the overheating market usually comes with risks, including vulnerability to shocks for households who have a high mortgage to income ratio, as well as social inequality between those who have and have not.
The Evergrande Crisis
Evergrande is the second largest property developer in China with a revenue of RMB 600 billion=AU$120 billion in 2020. Despite the company's large revenue, it accounts for only 3% of Chinese market share of the Chinese property market worth AU$4000 billion per year.
It is known to the world that Evergrande is now struggling to service a debt of over US$300 billion. It has missed a few scheduled repayments, which has been red-flagged by Fifth as “C” credit rating-or “exceptionally high risk”.
The causes of the trouble can be broadly divided into two categories:
Excessive and risky expansion to other non-core sectors, including electrical car company and theme parks where the company has no expertise
The (excessive and usually high cost) borrow to build model is vulnerable to the external shocks
The “borrow to build'' model has been working very well for Evergrande (and other Chinese developers) thanks to the obsession of property ownership in Chinese culture and in the context of the rising property market in the last decades.
In the political and economic landscape of China, the government has a strong desire to intervene in the economy when deemed necessary. The reason is that any significant economic adversity could lead to social unrest, which in turn could lead to the shaking of the communist party’s power in China.
Therefore, in the context of (economic and political) costs and benefits, I predict that Evergrande will be orderly restructured, both its debt and the business structure, rather than a free fall.
The pandemic has worsened the appetite for real estate in China. The number of unsold apartments were at record high, accounting for 60% of the company's assets. This has created a catastrophic liquidity problem for the mounting debt of US$300 billion.
Chinese developers have been a major player in the property development landscape in Australia. On average, Chinese developers and investors purchased $2 billion/year worth of Australian residential sites; equivalent to 31% of total sites sold in the last few years. In many cases, Chinese developers outbidded local developers thanks to their large business scale and deep pocket, as well as access to large customer databases that likely drive down the marketing costs, as well as overall costs.
Despite acquiring 31% of total sites, the number of completed apartments by Chinese developers accounted for around 20% of total sales in the last few years, which reflects the fact that Chinese developers prefer large sites that may take a relatively longer time to complete.
Most of the sites are located in the east coast cities, for reasons not only of strong economic significance, but also where the chinese investors want to invest.
In the worst case scenario, Evergrande’s fall could trigger a domino effect that is strong enough to cause the property market in China to collapse, and to a larger extent, to the Chinese economy. The immediate effects on the Australian economy would be:
The price of commodities will collapse
The demand for Australian goods and services, such as tourism and education, will be greatly reduced
The development sites that were acquired by Chinese developers could be sell off
The demand for Australian properties could be diminishing
Big three cities including Sydney, Melbourne and Brisbane would have a strongest hit
Overall, the Australian economy would be significantly impacted
Iron Ore Price, US$ per ton
China has a population of 1.4 billion people, where the growth of the middle class has been unprecedented. Officially about 400 million Chinese are categorised as middle income, which is defined by the National Bureau of Statistics as a family of three earning between 100,000 yuan (US$15,200) to 500,000 yuan (US$76,000) annually. By 2027, it is estimated that 1.2 billion Chinese will be in the middle class, making up one quarter of the world total.
According to Credit Suisse estimates, the number of dollar-millionaires residing in China totaled 5.3 million individuals, ranking second after the United States in the world. Although China's economic growth slowed down considerably over recent years, the number of millionaires still increased constantly.
There is no denying that some Chinese investors would be impacted by the Evergrande event, however, the number of investors impacted is small relative to the rising number of the middle class and the dollar millionaires in China. Therefore, the underlying demand for premium properties around the world, including Australia, remains sound.
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