The real deal behind the rate hikes

This is a Momentum Media production. Nerd alert! Property nerds. The home for data-driven property investors, where we uncover Australia's hot and cold markets, latest headlines and trends. Welcome to the Property Nerds podcast.

It's another episode and we don't start this episode with the greatest of news because New South Wales unfortunately went down to Queensland in the state of origin. So it's that one time a year for any rugby league fans. I'll be honest too, it's that one time a year where Leah and I sit down and we actually watch rugby league. We sit down and we jump onto that bandwagon. Yeah, absolute bandwagon.

So anything basketball, you can talk to me all day about it. Rugby league, this is my one time of the year where I actually watch it. But unfortunate for us, I'm here joined by the fantastic, the magnificent, the beautiful Leigh Paliwal. How are you? Thank you.

Hello. And I'm joined by the wonderful Arjun Paliwal himself. I thought I'd spice it up in this introduction. But Leah and I, to give you some background for those who are tuning in for the first time, I run a data-driven buyers agency called InvestorKit and we help property investors start and scale their portfolios with the majority of InvestorKit clients owning three or more properties in their portfolio, which puts them in the top 10% of property investors. So many of them working with us did not start their portfolio that way.

They had no assets or just the one and we're glad to be a part of that scaling journey. And Leah, how about you? Yeah, so I'm the director and principal for Hills Finance. We're located in the Hills District in Bella Vista of Sydney, hence the Hills Finance name. And yeah, we look after local professionals, business owners, investors, obviously needing assistance with all things finance.

We do investment loans, residential lending, SMSF lending. We also have access to commercial lending and also we needed asset finance and also personal loans. So predominantly a lot of our clients, similar to what you mentioned, Arjun, is they either have two or more properties, generally the one owner, the one investment and looking to continue to grow. So yeah. That's a bit about us, but hey, enough about us.

More about what some exciting stuff we've got to go through. So each month for those who tune into the show, you'll be familiar with us putting together research white papers as part of InvestorKit and some of the free research we want to make available for many of our listeners and readers. So thank you for all of you downloading them. We have, you know, coming close to 10,000 downloads across our research white papers and we cannot have that level of support without all of you. So massive thank you.

If it's the first time that you're hearing about these papers, well, you can jump on, download them for free. It's investikit. com. au slash white papers. And if I got that slash completely wrong, just jump on investikit.

com. au and it'll be up in the property market research tab where we've got an array of white papers focused on, you know, the topic of the now and what we're thinking is the most important things that are out there that we can touch on and share some research and insights on. Well, I know we will definitely be touching on the most recent one in this episode. Yeah. So before we jump into that, as we do, we're going to dive straight into our finance updates.

So for anyone that's new to listening to this podcast, every month I will cover off the ABS lending data and go through what does that actually mean? So ABS every month will release, you know, housing finance data. And this was just recently released for April 2020. And so I'll go through that. So housing finance, total housing has fell by 6.

4% to $31 billion in total. And that's following a rise of 2. 1% in March. So that's a little bit of a drop there, 6. 4 down.

And that was what rise in March, but then a little bit down in April. Yes. So it will make more sense when I go through what that split up is between owner-occupier and investor. So owner-occupier housing fell by 7. 3% to $19.

9 billion. And that's the largest fall actually since May 2020. And then investor housing has fell 4. 8% to $11. 1 billion.

And that's after nine consecutive months of growth since June 2021. Well, so both investors and owner-occupiers taking a bit of chill on, you know, their debt levels or finance commitments over the month of April. Lee, when it comes to these numbers, what does that mean in terms of your observation on the overall finance numbers? So what does this mean? It pretty much appears growth across owner-occupier lending has hit its peak because we have seen loan commitments go through the zigzag of up and down from Jan this year.

It's definitely showing, you know, it's hit its peak levels. Yeah. And so the investor curve, however, is much smoother upwards trend. And essentially, there is this little dip that's just happened this month of April, but it's yet to be a clear sign of a downwards trend overall. And I guess it's also important to note that finance take up is still operating at levels that are over 50% more from pre-pandemic levels.

And pre-pandemic, for those thinking how long ago that is, that's not 10 years ago. It's not five years ago. I know it sure feels like a long time ago that COVID was on our shores, but it's only two years ago. Hence the largest fall being May 2020 for owner-occupier housing. Obviously, the pandemic all started around March.

And so now, yeah. So anyway, so that's what that all means there. And so the other most important thing, I guess, that just got announced this week from a finance point of view is, again, another cash rate hike following the first hike after 10, 11 years the month prior. So essentially, that was just announced earlier in June. And so May was, if you haven't heard, which I'm sure you have, but May was 0.

25% increase and June was announced for a 0. 5% increase. So we're currently sitting at 0. 85% cash rate. Well, 0.

85% seems a lot more than the 0. 1%. So let's not pretend that it's not a lot more. But then it also doesn't feel like long ago we were kind of already at these levels. I mean, Lee, when it comes to cash rates, when we look back to 2019, I believe the cash rate was sitting at, what, 1.

5%. So if we think of it that way, it's still half what it was only two years ago. So should households really be surprised or should they feel uneasy about it considering this isn't some 7% or 8% cash rate? It's half of what it was in 2019. No, I don't think people should be extremely worried because it's not all doom and gloom.

Like you said, this should be viewed as a normalization of the cash rate. Essentially, as we know, a whole lot of money has been thrown at the economy to keep things alive following the pandemic and lockdowns. And this is from both the RBA and the government point of view. So obviously, RBA keep decreasing the cash rate at that point and RBA with all their grants and all that kind of stuff that they had on offer. So like all the government, I guess, support and RBA support and turning down that cash rate was, at the end of the day, just flooding the systems to give it as much support as it could whilst we're in the midst of this once-in-a-lifetime event for many of us.

And it did its job. Here we are. Here we are. Here many are today. So I think it took so long.

Unemployment rate, the lowest it's ever been for a long time. And job advertisements are just going crazy. So I guess in a way, it's like, hey, something crazy went on. Lots of support got thrown at it. That support gets winded back.

And it's now time to see if that support was a structural part of our system or if it was just a temporary support and the economy still does its thing. And from what the signals suggest, with job ads surging and infrastructure projects galore and the borders on their way as well in terms of having more people and so forth, things are still quite positive when it comes to that overall economic state. But on that note of interest rates, if you haven't caught the previous white paper, we talked about in the last white paper, it was actually about the five reasons, sorry, five trends that we saw emerging from the borders reopening. And these five trends are emerging from the borders reopening. One of the things that we talked about was changing economic winds.

Trend number five, if you haven't caught that white paper. And on that trend number five, I make a note saying we will obviously see the interest rate rise cycle to do with many supply-related conditions and a strengthening economy. However, as borders get into full swing and people come into the shores of Australia seeking work, seeking opportunity, seeking leisure, enjoyment, whatever it may be, as the years progress, we're going to move into a level where we start to have the interest rate cycle not continue its upwards trajectory for a key reason that the job market will have some pressure ease as more people hit our shores to have those jobs that are all over the place right now. So as a result of that, they will likely stop their rate rise cycle and eventually move into a static point and find that sweet spot. And also, having that interest rate go back up is a key part of the economy to show I guess other people during a pandemic, if they want to stay safe, that's what the thought would have been at the time.

And then obviously, you know, people were probably staying put a bit longer than they usually would with all that happening. What are your thoughts? Yeah, definitely. So health and lifestyle, really. Don't want to be in a house jam-packed full of people.

Don't want to be in an apartment that doesn't give me enough fresh air. Want to have a bit more space to breathe, chill, work from home. Balance from home in terms of, you know, work from home, go outside, do something in the backyard. For sure, for sure. So speaking of backyard, we don't use ours enough.

No, we hardly ever use it. It's because the dogs go poo and pee there. So it's probably not the best. Yeah. Actually, you know, on that note, remember how I think we were talking about our dogs being like our masters and us not being their masters?

Because if you think about it, like we pick up, we clean their pee, we wash them. They walk us because they're like ahead of us. They're ahead of us. So for all you dog owners out there, you are not the master. The dog is the master.

But increasing housing demand, especially for detached houses. That was the first one. Lee, did you want to run through the second one? So the second one was increased housing prices are making people stay in the rental market longer. Yeah.

So Australia's high housing price in the recent property boom is forcing people to wait longer to get into the housing market. So, yeah. I guess when you look at that, you know, ING reviewed the national average age of first home buyers back in early 90s. How much was that, Lee, in the early 90s? 27.

27, right. And then so three decades later, this number went on to become 36. Right. So when you look at that, it's clear that people are staying longer in the rental market. And so there's greater demand there rather than that rental market, you know, leaving or becoming weaker in its pool or less people being active renters.

So that's definitely one part there. So I think when you look at that part, it's quite important because, you know, at the end of 2021, people aged over 40 made up a quarter of all first home lenders, which was up from 9% 10 years ago, which means the age is being pushed back. So housing prices and that gap is definitely increasing. So that's another core part. This next part comes from our research that, you know, the likes of the demographic group, McCrindle, these sorts of demographers have really inspired us to see what's happening in this particular space.

Lee, did you want to touch on generations and what's happening in terms of the Gen Y age group? Yeah. So increased demand for Generation Y as they enter the family formation stage is the next point. So family formation is short for making babies. Baby making.

Yeah. So this is actually the largest demographic group in Australia. So now at 27 to 42, they are well in obviously the family formation stage, baby making stage. They're looking to obviously move out of home, shared housing or upsizing. And so compared to the older generations who have mostly sought out their family home, you know, where they live, all that stuff, the younger generations who are staying with family, Gen Y's housing demand influences the property market the most.

So the more and more of them, you know, that are getting priced out of home ownership, their demand for rental properties goes up and is increasing. Yeah. So I guess the first three points we feel have to do with just detached housing demand, Gen Y and the gap in house prices and rent prices, which cause, you know, just the longer time periods for people to be in the rental market. So the next part is I'll jump on that in terms of the demand and supply imbalance. There's a clear imbalance when it comes to the regional markets of Australia.

Population in regional areas has just been growing significantly. And when you look at, especially during the pandemic, which has been a big part, regional New South Wales and Vic, their local rental supply just could not meet. And they're just two examples, could not meet the massive increased demand. So when you look at it from that perspective, there has been a huge amount of owner occupiers also entering the regional market. So when you think of those people taking up more stock in comparison to the investors, which is clear by the ABS finance data, which shows some of the biggest surges in owner occupier lending during the pandemic, that's a big part of replacing investor stock, but also creating a huge amount of demand shift into the regional areas, which has absolutely pummeled their vacancy rates that were already tight into huge crisis territory.

So that's been a big one. Other things that have been helping out, and it's not massive just yet, but it's one of the factors is reopening of the state and international borders. So I guess many short term rental properties converted back to long term rentals. I guess as the borders open back up, they're going to come back into that short term rental space as well and also start to see the flow of students, other temporary visa holders, start to give that inner city love back. So that's kind of where they reach their peak and they should start to come around, especially around those university suburbs too.

Obviously we haven't had overseas students and things like that. So, you know. Yeah. With international borders. Big part, right?

So that opening back up will be key. With regards to house prices, though, from a cycle perspective, that's another key part. They've outperformed rents and house prices and rents tend to have that lagging relationship where rents tend to catch up. The house price performance, if you look at it from the 2006 to 2021, so a good 15 years of data, there's 116% of increase in prices. Wow.

Right, which is massive. And for most of the time they were, you know, that little bit of a lead ahead of the rent prices. They were quite closely aligned and up until 2014. Then if you recall the Sydney, Melbourne and the big investor boom kicked off and that really created some separation, more rental supply across the two big cities and the rental trend and the house price trend didn't quite keep up. But weekly rental price trends have been up 65% over that same time period.

So it's almost half the amount of growth as house prices have had. So there's that lag and the underperformance is acting as a drag while the surging house prices push people away. So I feel that that catch up needs to occur. Lee, in terms of another one, you and I talk about this all the time, but, you know, there's been a big fall in property investor activity. That was another reason we noted down.

Did you want to share your thoughts on that? So definitely a big fall in investment lending over the years and that would most definitely be due to the APRA limitations on investment lending, which has been obviously in full effect over the last few years and affecting those investors. What were some of the APRA changes that came in during that time? I recall one around the, I think it was the investment loan, the annual growth benchmark that was there. There was like to stop the investment loans coming in because that was big.

And there's also some things to do with interest only. Is that the case? Well, yeah. I mean, even when I started back in lending myself back in 2014, 2015, we were doing interest only servicing. That has been long gone for some time.

APRA has limited interest only lending to 30% of new loans. These restrictions obviously have caused suppression and invested activities over the years. And so it is indicated by the decrease in investment loan value and investors share in total property buyers. So interest only was one of them. And also that was definitely a big one that impacted, I guess, serviceability and people wanting to get into the investor market.

Yeah. The other one that APRA placed on was that 10% annual growth benchmark on investment loan growth. So that was the first of the two. And then later on was that interest only lending that you spoke about, Lee. So those things made a huge, huge impact because obviously investor lending just clearly fell off.

And when you look at that ABS data on investor lending, it's only taken until like what now. So that's a good four or five years of falling off the cliff for it to come back on. I think the other thing is on top of the APRA restrictions on investment loans, higher council rates, higher lending rates, land tax and other increasing holding costs of investment properties are also a bit discouraging to property investment activities. And that could obviously potentially reduce rental supply further. So that was another point regarding investor activities over the years.

So those are our thoughts. They're the big why. So if you're thinking, why is the rental market going crazy? Just to bullet point that investor activity falling off through self-sabotage by regulatory bodies and the banks that naturally have to follow. And so that was big house price outperformance from the rents and the lag reopening of the state and international borders now coming back in to fuel rental growth, demand supply imbalance in the regional areas that has just had a catapulted demand into their increased demand from Gen Y as they enter family formation stage, increased housing prices, making people stay in that rental market pool longer and increased housing demand for detached houses as people spread from share houses and those types of living conditions.

So a lot of reasons there. It is not the one silver bullet that just made this all happen. It was many things in our opinion that came together. So Lee, that's some Huge corporate level of ownership allowed there to be a flood of rental stock to the market to allow that ease of pressure, allow lifestyle and quality of these lifestyles to be enhanced. And that's where build to rent is actually starting, but it definitely still has a long way to go.

So we can see that coming into it, but it definitely has a long way to go. And coming back to that social housing piece, Australia's population has grown by more than 30% in the past 20 years, but the social housing stock has barely changed. Grattan Institute's research was great on this. Brendan Coates, Director of Economic Policy, he mentioned that in 1991, 6% of housing in Australia was social housing. But now that number is less than 4%.

So we need more social housing investment from the government. It's another key part. Would build to rent models support the social housing or is that two separate? Two separate things. So the social housing is for the government to play that key part in.

But what build to rent is, is the government playing another part where from a taxation perspective has largely been the main reason for unpopularity in Australia. But if we can pair up with some of the biggest bodies to create an environment where they feel more capable, more willing, and more supported in building these large build to rent models for property unit blocks, then they're just able to collaborate and bring forth that stock in large volumes purely for rental and all of it in one go. So that's what it is. It's happening, but it's still got a long way to go. Lee, did you want to go into this last piece?

Because I know this last piece is something we talk about when we travel across Australia. Quite a lot of land around. A lot of land around. That brings to the next point is a structural change to our cities. So Australia's population is extremely concentrated.

So 72% of Australia's population is concentrated to a few major cities. And so only five cities have a population over 1 million. And that's in contrast to UK, for example, where the population is merely distributed across all their cities, right? So 21 cities in the UK have a population over a million. And so I believe the population of Australia is what, 25 million now?

And so we've only literally got five of those cities with over 1 million. Yeah, so you can see what that does from a planning pressure, right? And also from the constant solutions that are there are just putting out small fires rather than big structural change. And I think this is probably something that we're talking about. I can say that the...

Literally the other week, like you will be driving, you know, as you do along the motorway and you can see mass amounts of vacant land. I mean, more so just like as you go through various cities connecting to Sydney and the likes of Melbourne, the population drop off is just so huge. And the population drop off is just huge as you translate outside of our sort of five big cities. The gap between them is just massive. You know, so what does that mean?

It's easy to say, yep, spread it, but how? So we just need to look at how can we enhance the livability and connectivity of regional cities, right? Make them places where people want to even more than today. It's already very popular, but even more than today want to live there, want to, you know, feel like it's great from multi aspects of life, lifestyle, social, transport, work, affordability, whatever it may be. And that means we need to think big.

We need to think massive projects across connecting cities, but also within our cities, not connecting them, just making them more comfortable and better places to live. Question on that. When you go to Bendigo, is that a direct flight? It is. So yeah, air travel is one of those ones that can play a big part because that connectivity piece.

But again, air travel is just one of the solutions, right? We've got some of the busiest routes in the world when we talk of Sydney and Melbourne. Imagine how much pressure there is in our domestic airports, just people flying between the two cities. One of those reasons is obviously connecting to those two cities, but second of those reasons is also using them as connection points to other cities. This is where things like rail, high speed rail becomes important and you can just take a look at the impact they make across other parts of the world.

So we're very much behind on our connectivity of cities and massive infrastructure planning when it comes to big city changing and country changing stuff. Fantastic. So the next one, the next point is improvements to our planning system. So I guess various studies have really highlighted the importance of planning and land use regulations. And when we looked at the impact of it from housing affordability in the economy, RBA in 2018 released a research discussion paper, which estimates that in 2016 zoning restrictions raised detached housing prices 73% above marginal cost of supply in Sydney, 69% in Melbourne and 54% in Perth.

On the other hand, if we look at the conflicts that exist between state and local level strategies, overly prescriptive zoning systems, complex development assessment approval processes, all of these things create barriers. Now barriers need to exist to ensure we maintain the integrity of certain cities and the character, the appeal, the safety more importantly as well. But these barriers need to find that balance. And in some way, some may argue we're perfect and we don't have enough regulation, we want more. Some may argue we want less.

But the main thing is zoning restrictions do play a part and the RBA's research paper back in 2018 highlighted this as a core component of housing price changes and how it's increased a lot more because of what's happening. And look, some reforms, I don't want to take the credit away, some reforms are in place and people are undertaking them. New South Wales had one recently, but long story short, as we're saying, more needs to be done. Okay. And so the last one is reducing the taxation charges on new home building.

This is huge. So you go and get a new build, it looks fancy, it looks great, but what you're paying for- Bumped their costs up recently since all the supply chain issues and everything. What you're paying for is a bucket load of tax. Right. Right.

And that's what many people don't realize is that in, you know, AFR and Urban Development Institute of Australia put some numbers and research together. And this is where things get pretty crazy. This is a 2017 AFR report and it was the government's take on a block of land, you know, can be as much as 40% of the total costs. That is huge. 40%.

Just think about that for a moment. Imagine you give someone $10 to buy this new shiny thing, but $4 is straight into the government's pocket. So that is definitely playing a key part because it makes housing more expensive. Right. So the greater the gap is, which we touched on one of the reasons, the new building housing as well, this reduces and lowers the rate of supply that can hit the market as pricing is one component of demand and ability to get in.

So reducing taxation charges on new home building is one key part. But Lee, that is our solutions and our opinions of solutions for what we feel will help put this rental crisis at ease over time. It is not a silver bullet, but a combination of all these three things or four things coming together will definitely make a big difference. Amazing. A lot of good information there.

Now, obviously, we've gone through the why, the solutions. This report actually has 20 key regions where rentals will continue to surge. So tell me, Arjun, what are the standout cities that InvestorKit found in this research? Yeah. So firstly, when it came to selecting 20, this was probably one of the hardest things to do because all these issues that are causing this rental surge coming together, they are just so prominent across many parts of the country.

It's not just a couple of key standouts that we could say, hey, here's 20. These are going to be strong. There was a lot of cities. And so culling it down to a list of 20 was extremely difficult. When we were doing this research, we relied on a few indicators, Lee.

So we were looking at statistical area three. So SA3s, if anyone wants to do some more research on them, they're just in simple terms. They're a cluster of many, many suburbs coming together to create a bigger region, but not quite as big as, say, a council or a city. So they're in between. But what we were doing is we were looking at things like rental price trends, rental supply and demand indicators, long-term pressure versus short-term pressure changes, vacancy rates, rental percentages of ownership, and also building approvals in the pipeline that would go on to at least be some level of rental components, rental properties.

And we also look at things like unemployment, job ads, things that bring more people to that workforce and rental capability or rent paying capability. So when we looked at all these factors, our forecasts were firstly that these 20 regions are going to see rental increases by between $2,600 and $5,200 per region in the coming 12 to 24 months. So that is no small amount. On a per annum sense, you expect these areas to go up by that much? Yeah, so $2,600 to $5,200.

So if you're thinking of interest rate increases, this is going to play a lot of counter reaction to them, meaning it will definitely solve some of them. Not all of it, because interest rates are changes to a much bigger dollar figure.