Zeroing in on interest rates, financing and price growth

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.

My name's Arjun Paliwal, co-host here, and I'm joined by Leigh. Hello, how are we? Good, Leigh. Well, it's been a very interesting week in property. I think the last few days have been a lot to do with interest rates, haven't they?

And you've been getting bombarded in the emails with all the banks and what's been happening. A lot of increases coming in in terms of increased rates being announced. So, yes, a lot to cover off there. Definitely. So we've got an exciting episode today and we'll be chatting about what's the latest on finance data, joined by superstar mortgage broker and principal of Hills Finance, Leigh, as I mentioned earlier, which I'm also quite lucky where, you know, Leigh and I, husband and wife combo.

So the benefit is that I get to learn all about finance data from start to end of day. Now, some may say that's a pro, some may say that's a con, probably annoying, but for me, I find it boring. Yeah, for me, it's a definite pro because it helps me with what I do. In terms of what I do, I'm the head of research and director at InvestorKit, and we're a data-led buyers agency. So Hills Finance and InvestorKit, we've come together to talk all about property data, finance data, and hence why we call ourselves the property nerds.

But with today's episode, Leigh, we've got finance data to go through, what's happening on the interest rates and the impact it makes. And I've got some very, very exciting new data that I'd love to share, which is all about purchasing power index. So let me go more into that because this might really help with what's happening out there with regards to what we think is undervalued or overvalued, as well as how that ties into the finance trends and what could be happening. So Leigh, I might start with what's happening on the finance front. Could you maybe share more about the trends of finance and what we're seeing at a broader scale?

So we've had the September 2021 ABS finance update released. So I like to obviously always dive straight into that as soon as it's come out. So overall, there has been a fall of 1. 4% overall for all finance in general for that month. Okay, so when I break that down and look into it further, so owner-occupied lending was down on the month of September by 2.

7%. However, it was actually up for the year to date by 20. 8%. Now that putting into context, Leigh, that's big. 20% jump in finance trends are no small number.

So when you think about that, I guess, how does investor lending stack up against the owner-occupiers? So investor lending is up and that's up by 1. 4%. And then that was also up for an overall for year to date by 83. 2%.

So it's definitely clear the investors are back in action with an 83% jump in finance from last year. In saying that though, the volumes of investor finance and owner-occupier finance are quite different in the total volume. So whilst you see the 83% jump up in investor finance, it's not as big volume-wise or nowhere near as much as that volume jump of 20% up on owner-occupier finance. What else has been happening on that investor lending front? So investor lending is almost at its peak and which that's basically reached its peak, the highest peak it's been since April 2015.

That's pretty big numbers. So I think when I think back to 2015, I think of finance numbers of the huge booms that were happening across Sydney and Melbourne, right? And those times, the finance data and the impact it had on those two cities were just huge and the growth that was happening. So we are at some pretty high numbers when it comes to investor lending. What's the trend been like for investors versus owner-occupiers, not just over the recent month, but I guess going back over the last few months, how's that been looking?

So investor lending has continued to rise since October 2020. And then basically owner-occupied housing has been trending downwards for the last four months. So that's what's been happening. So we're seeing a bit of a change, hey? Investors definitely coming back into action and owner-occupiers, I guess, slowing the role a little bit, but coming off huge numbers.

So when you think of these trends, Leigh, what are your thoughts on what's happening out there on the finance front? So overall, the finance trends do suggest that we are coming off peak levels of finance take-up. However, numbers are still extraordinarily in terms of large levels of take-up. So with the correlation of finance and property prices, it is expected that we will still see a very strong finish for the year and the first half of next year that is likely to still be strong, although the month-on-month price rises are likely to taper off in many areas. So in my opinion, combining slowing finance, increasing listings, and increased mobility, that will reduce the very high household saving ratios and growth rates.

So these are all core reasons for the slight taper off that we will see. So slight taper off on the finance, definitely a kind of clearer signal on what's happening over the next six to 12 months based on finance trends. I know when you and I have looked into the correlation data, that does tend to move pretty strong. But like you said, it's important for people to look at that data from now versus 12 months ago, not just the month-on-month. I always think of it from, okay, on a month-by-month for a few months in a row, investors have been trending up and now going back to October 2020, investors have been trending up whilst owner-occupiers have been trending down the last four months.

It's still 20% above this time last year for owner-occupied finance. So even a slowdown in finance, which tends to mean a slowdown in growth rates, does not mean though that a slowdown is necessarily a huge decline or a slowdown is a worse growth rate that we should feel unhappy with. I think as investors who are listening to this, it's important to realize that those levels of growth are not forever sustainable. So if we're coming down from a 20, 30% growth in some area in a year down to 10 or 15%, these still sit massively above long-term averages of 5% to 7% per annum. So it's all about that context to go.

A slowing doesn't mean everything's ending and it's not happening. Even one more year of half the growth rates on a portfolio could make hundreds of thousands of dollars in differences considering a 20, 30% growth rate is never going to keep happening. So great point on the finance trends, Leigh, of everything slowly. And I get what you mean as well with listings increasing too. We're seeing that and some increasing in mobility.

Mobility is an interesting one. Think about all these lockdowns and restrictions and all that sort of stuff opening. Where's all that cash going to go? Before, I think we were thinking of it just goes into housing because we're sitting there at home thinking of what the next move is. But now the cafes are definitely stealing a lot of our money, aren't they?

Oh, definitely. And look, typically in the finance space, November and December are actually busy months anywho. So I think it's only going to be busier again now that everything has come off in terms of lockdowns. And obviously everyone's now back out in the market in terms of just a normal sense, shopping, whatever. They're also going to be out viewing properties more, probably see maybe a bit of a potential uptick of people looking for their own property by the end of the year, potentially, because they haven't- So the big dash is coming, the big rush.

Yeah. And I've noticed that in terms of clients coming through for pre-approvals and things like that, there's a lot more interest with the year finishing up to go out and be looking for those own occupied properties than before, because obviously we were locked down in Victoria and New South Wales. You'd just be, more people were inclined to look at investment properties in that period in the state or whichever. Yeah. So I think with overseas travel, we think of the local spending, interstate travel, just more shops and things and choices being open, that pent up release of demand definitely should chip away at that household savings ratio.

And some of the interest rate moves as well should chip away at the household savings ratios, but we'll give some more context to what's happening on the interest rate front. Now, I know last episode or maybe the episode prior, I think we're talking about the 3% buffer. This was a change that APRA brought in, Leigh, from a finance perspective. Could you kind of talk through, just for those that didn't maybe catch what that 3% buffer was about, what's happening on that front and what you're seeing in the current environments when it does come to interest rates? Yeah.

So we covered that off last episode. APRA came out with the announcement of increasing the buffer that banks or deposit-taking institutions put on top of new and existing mortgages when they're looking at borrowing capacities or servicing calculators for applicants. So that buffer was 2. 5% previously and increased up to 3% last month for, well, actually most of it has just been implemented since beginning of this month, November, for the deposit-taking institutes. So now that's been applied across most of them.

We went through that scenario, an actual live scenario for like as a loan applicant, what that might look like and how that impacts borrowing capacity. You can, as a customer, lock that rate in at a fee, depending on the lender, they vary. And that means if you've gone unconditional on that loan, even if there are further increases on that fixed rate, you would still be honored that if you locked it in for up to, generally it's valid for 90 days. So it's a lot of discussions that have been happening. Obviously, you know, been discussing, we want a great rate for a client that's fixed, giving them the option to lock that in even with these changes happening.

You don't have to lock it in, but you know, this is an option to be wary of. But then I've noticed on the other side actually is a couple of second and third tier lenders are coming in with changing rates in the opposite direction, obviously coming in with that business potentially as well. So slight decreases for their fixed rates. I haven't seen any major announcements from a variable rate standpoint. It's really fixed rates that we're seeing coming in with changes at the moment.

So I guess, yeah, that's what's happening. They've been happening for the last couple of weeks, I would say. It's a mixed bag, isn't it? Like there's some changes where they're actually making their fixed rates better. Like you said, with some of the second and third tiers who are trying to capture some market share.

So it's almost like one part of it is your lending book and repricing it and moving with the direction of areas. But another part of it is just competition where you can see the second and third tiers trying to go, hey, we're not targeted as heavy with APRA because we're non-deposit taking institutions. And then at the same time, we're not going to make these fixed rate moves just yet. But eventually, I guess they'd follow too, right? Because everyone gets their funding lines from somewhere that will naturally be thinking that will come from an increase.

So can we talk through why this is happening in your opinion from some of these fixed rates and the changes that are going on? Yeah, so obviously it's a big question that we get asked regularly by clients with these fixed rates happening. What does that actually mean for them and why does this happen? So first of all, let's talk about why this is happening, I guess. So a big reason is pressures from inflation is building is a big reason.

Yeah, I mean, that inflation pressure building, Leigh, there's a few things to talk on that one. I think when we think of inflation pressures building, one of it is to do with a lot of the supply angles. Because when I hear so many things as part of that inflation index rising, it's to do with supply issues, largely. It's one, when we think of fuel and all of these different areas of the world, the trading and how difficult that's become during COVID and the environment we're in, the stop start, the working together with different countries. These things don't make things easier.

And then from the property investing front, the lack of investor activity that's come on and increased the rent impact as well, the low building that we've come off the peaks and the building that's been declining, all of this comes together as a supply problem. But there is another part of why rates go up that can actually be a good thing that many people forget. And that is a stronger economy. Because you see, our unemployment rates, whilst there are some funky parts to how that's calculated, considering so many people not looking for work or considering the certain labor shortages that we're having and how that's not really forever, again, due to supply constraints with how we're operating as a world and different countries, I do, though, feel that our economy, nonetheless, is still trending in the right direction. So that having rates increase off the back of a stronger economy is welcome.

It's not a bad thing to have. It's all relative. Other places will shift as well when you have a stronger economy, whether it be on properties that you receive or whether it be the wages that come into your back pocket. But all in all, Leigh, what you're really saying is that the banks are going to have an increased cost of funding or they're anticipating it. And as a result, that's where rates are going up at the end of the day, right?

Correct. Now, when it comes to this rate movement, Leigh, I was crunching some numbers. And this is where it will really start to help investors that are considering what's happening in the market. Now, when I was looking at some of these numbers here, I was leaning on some of the things that I'm seeing on the core logic rents change. Now, if we think of, say, just for the purpose of this example, we think of a 500K loan, a 500K loan, and we take it to the 0.

45, which was some of the larger changes made by Bankwest, that at a 500K loan equals, you know, put it at $2,200 per year in extra interest. Now, it feels like a big number, and for some it may be, but dividing that by 52 equals a $43 increase per week, right? And this is whenever I think of big changes, just like on the positive of what's happening in the market, on the negative as well, we love to nerd out and figure out what the true numbers are, what the actual impact is. So on a 500K number, you're getting charged an interest that's increasing by $43. Now, this isn't considering principal and interest, which is another element which will increase because the loan is now more costly.

But let's also have a look at the other side, because we are talking to an audience of investors or those wanting to become investors. What's happening across the country? Now, looking at the last 12 months rents index, just from a national perspective, rents grew by 8. 9% over the last 12 months. This is huge.

If we take into account a regional movement, that's moved 12. 5% based on core logic data, with our capitals moving 7. 5. If we take an example of, say, Adelaide, just to use one, or Brisbane, Adelaide moved up 8. 3% in rents over the last 12 months, and Brisbane moved up 9.

7%. Melbourne struggled a little bit, only moving up 1. 8%, but this is an all dwellings chart, and we know in all dwellings, the units can make up a bit of bias in the Sydney and Melbourne markets. Taking a look at that Adelaide example, just to use that, 8. 3%, if we had a $500,000 property, and that $500,000 property was yielding 4%, that's $20,000 of rent per annum.

Now, if we times that by an 8% increase, then that 8% increase, or 8. 3% in Adelaide that's happened, is $1,660. So that's $1,660 in rent increase, dividing that by 52, equals 31. 9. Now that 31.

9 versus that $43 means that, yes, you've had still a net increase in costs, but that's about $10 in a week now, and it doesn't feel so bad if you're operating off considering all factors. So you see, this is where we need to look at interest rates as a whole. Rents are rising, so are prices, which doesn't help for those entering in, but for those who are in the market, your holdings from an interest rate picking up to rents picking up don't have large margins in between them. So if you've picked the right asset in areas that are increasing in rents, which most of the country is, pass some unit markets, parts of Sydney and Melbourne, most of the country is, but even in Sydney, the rents have risen pretty strong. Like if you look at that last 12 months on the index, it's 7.

2%. So that's healthy. So the key here to consider when looking at interest rates is looking at it as a whole. How much are rents changing? How much are costs to hold the property changing?

And also when you think of an investor making a move in today's market, going back to the many decades, even as interest rates did rise, not all markets operated the same, similar to our last episode when Leigh, you and I touched on the APRA impacts and markets like Ballarat, Hobart, Sydney, and the varying impacts that the last round of APRA changes had. So that's pretty much what's happening on that front where interest rates are rising in the banks and how their fixed rates are being calculated. But there are some interesting data sets to come out over the next few months. So yes, we've got the economy opening up and everything that's happening. We've got some shakiness in how the RBA is responding.

But remember, we are yet to see the full data, which is on its way any minute from all the lockdowns that we've just come out of, right? So that sort of data will play on to how we're starting to see the impacts of Sydney and Melbourne or Greater Victoria's lockdowns. And as a result, that may kind of, again, bring some of these numbers back into check. But then we should see those numbers pick up back again come November, December. I was of the belief, and I still am, that interest rates are here to stay low.

Now, increasing interest rates from a low twos to a high twos is still low in my opinion. We've got to look at it with that greater context to see what rental yields we can also still achieve, just like that exciting signal of the rents rising versus the interest rates. You can see the variances in huge, but it just shows what I think is happening, that interest rates are still likely to stay low, even if banks are increasing it, they're still at fairly low numbers. If we see these increases continue on, I do feel that these supply issues as the The finance numbers are still massively ahead of last year, so a slowdown is not the end of the world for property price growth or the boom that we're in. We're expecting it still to carry on, and fixed rates are rising.

Now, expecting it to carry on does not mean we're saying 2022 is another 20% plus year of growth. What we are saying is that it's going to be stronger 2022 than the long-term averages for most markets. And lastly, on that finance piece, fixed rates. Lots of it rising, but when you take it into a whole holistic view of rents rising and interest rates rising, that's where on that 500k example of Adelaide with 4% rental yields and its rise in rents, you're essentially $10 per week in difference on a 0. 45 interest rate rise, which isn't a big thing when you're looking at a long-term investment journey.

On the property front, I've got some exciting news. We have been working behind the scenes at InvestorKit. So a bit about us, a data-led buyers agency really helping investors look nationally to make the best investing decisions as a buyers agency to help our clients grow their portfolios. Now, crossing the 50% mark and about to hit 60% from what I just looked at, three or more properties are owned by our clients, which means that our specialization is all about helping investors scale and achieve scale through growth, cash flow, diversity, and take their portfolio to new heights. But what we've been working on behind the scenes on our research division is something that was inspired by the University of South Australia.

So the University of South Australia created this index or whether they created or shared it, I'll leave that to debate. But this index that they created really inspired us to look at housing data from an overvalue, undervalue perspective. Now, to give you the basic version of what overvalue and undervalue can look like, imagine we're sitting in a part of Sydney and you're going out 40 or 50 kilometers to buy a fibro home out near St. Mary's and it's crossing the one mil mark for a decent backyard. And you go, this is just not making sense to me.

Then all of a sudden, you know, Leigh and I are going for a drive down the coast and we see the same sort of price point and we look at it, it's by the beach, it's up near Central Coast, and we're looking at it and going, wow, this is pretty cool. It feels cheap. Now, this is where the concept of undervalue or overvalue can be raised, but it's driven by a few factors. It's driven by income. It's driven by affordability of using that income to mortgage repayments.

And lastly, the mortgage repayments are driven by interest rates and house prices that, you know, the variable of those two components. So what we've done off the back of this is created what we call now the InvestorKit Purchasing Power Index or Home Buying Index that we can look at it. And what we've taken is used personal income or, you know, median incomes going back from the latest available data in 2018. And this is a perfect moment where if you've got a pen and paper handy to take this methodology in, please do, because we're going to really go deep into explaining what we're seeing here. And this will help explain what we mean by the concept of overvalue or undervalue.

So firstly, data has its pros and cons, but in this current data set, we took the income levels of 2018, which is available from ABS. We then used the state by state growth rates, which are more available to 2021. So we, you know, fast forwarded the 2018 data, but at a state level of its growth rate. So in New South Wales, the growth rate between 2018 to 2021 was 8%. So we took that 8% growth and applied it to the income data for the more smaller sub regions at an SA3 or sub region level, just to simplify it, which is clusters of suburbs.

And that's how we caught up the income from that lagging 2018 data to the 2021 data, which has been released at a state level. So that's how we're trying to bring up that income. The next thing is we're calling this income from a personal to a dual income household. So we're assuming it's a couple or mom, dad, or, you know, partners. And we're just basically taking two of those incomes to now make it the median of a dual income household and assuming that growth rate to 2021 dual income households.

The next variable is we're assuming the 30% global benchmark of affordability. So we're saying, hey, after tax income, 30% of it is to be used for mortgage payments. And so when we look at that, we now say that when it's 30%, that's fair value. Anything above 30% is overvalued. And then when it's below 30%, it's undervalued.

The last variable here is we take into account a median house price. And then we from there use an 80% loan of that median house price on a 30 year term. And we utilize 3% interest rates because we are seeing fixed rates in the twos. We are seeing variables in the low threes for investors. So we're taking that sweet spot of 3% in the middle.

And this gives us a current environment of whether we feel a location. Again, it's raw. It's using medians and that's common in the industry. So whilst there's love hate with that, it's the common indicator. And we're really taking income of a dual income household, the affordability benchmark of 30%, the household 30% number being used to an 80% loan on 3% and considering that market's median price.

And now we're saying, hey, if you spend, say, I've got the data in front of me for the market of Quenbeyan, right? So Quenbeyan touches the market there of Canberra and has some ripple effect there. But based on Quenbeyan's income levels and current 30% of those net income levels, we feel that mortgage repayments of $33,000 can be afforded when it comes to annual mortgage payments on that 3% of interest on an 80% loan. Now that 3% of interest on an 80% loan, if you look at it at current median price and using that figure, there is an undervalue of 11. 6% that's apparent in the Quenbeyan market.

So this would suggest that in current interest rates, median incomes, median house prices, 80% loans at 3% for a dual income household, there is an 11% undervalue of Quenbeyan house prices for it to reach that fair value component. And so this is just that undervalue of not necessarily house prices in isolation, but more so that undervalue of how much room there is in loan repayments because that's where it would take fair value, the actual repayment that comes out. So when running this index, we've got some more refining to do and I can't wait to share another white paper on this. But if you'd like to just take a moment to say, hey, Arjun, what have you currently shared today? We've released a couple of white papers.

Gold Coast Market Pressure Review is our most recent one that's gone through, just analyzing what's happening in the Gold Coast market. And the prior one was the New South Wales North Coast. Every single month, our team at InvestorKit releases new research papers. They're all totally for free. You can grab them from investikit.

com. au. And alongside that, every single week, we really release data-driven technical blog posts, and they are also on investikit. com. au.

So if you love some reading, you're into your numbers, want to nerd out with me, please check out investikit. com. au. Back to this purchasing power index, there is a sea of green across regional Victoria. Shepparton has another 40% rise in repayments before they reach fair value.

Bendigo, we have another 27% rise. Warrnambool, 25% rise. So these are markets when I say it could rise repayments to another 40% increase for them to reach a fair value of that after-tax income at 30%. And from that perspective, regional Victoria's Mornington Peninsula is the only one that was overvalued at just over 50%. But with the overvalue of our coastal regions and our regional markets that are attached to capital cities, the income data has some flaws because you're taking that local area's income.

But what we're often seeing is people who live away from that local area in the major city, like Central Coast versus Sydney data or Melbourne and Mornington Peninsula data, it's skewed because they do live in those various areas. But when isolating it to the regions, we've definitely got some undervalue markets across regional Victoria and regional Queensland. Most of our regions actually are still fairly undervalued when you consider their price, repayments, and local incomes. Even at lower incomes than your capital markets, most of the regions have a far lower purchase price in comparison to our capital markets. On the capital front, Brisbane undervalued at 13%, Adelaide undervalued at 24%.

So Adelaide remains the most undervalued market out of our greater capital cities in the big four cities. Perth, our data is still in review for various parts of Perth. Sydney at the moment is looking a little bit odd in terms of data, and this happens because Sydney's income at a local level is such a big disparity from the eastern suburbs and northern beaches to the far west or southwest. This is why the greater city level data is a little bit dangerous. We've actually started looking at it at SA3 levels now, and that's going to be our next wave of release.

But at a greater Sydney level, it's looking scary.