With pockets of real estate all over Australia booming and interest rates at historic lows, it could be easy to get caught up in it all and buy something way over reserve. In fact, this is not just a hypothetical – barely a week passes these days without news breaking of a house selling for some scintillating sum.
Alongside this has come a debate about what constitutes being ‘over leveraged’ as more and more Australians want to become landlords (as the ABC reports: “Twenty years ago only one in 15 of us were landlords. It’s now one in 10 – more than two million of us”).
This leaves first home buyers competing not just among each other but also property investors, pushing prices in popular areas to crazy highs.
I regret to inform you of today’s Sydney auction results:
– Vaucluse house sells for $24.6m, $10.6m above the reserve https://t.co/rf5lCh0w6D
– Two run-down Glebe houses sell for $8.13m combined, $2.13m above the reserves in total https://t.co/IAe8Uo97K7 @TawarRazaghi pic.twitter.com/5JtwgL7Akf— Elizabeth Redman (@elizabethredman) September 26, 2020
Weighed up against these intimidating highs though is the widely spouted (and in many suburbs, so far validated) fact that if you’re not getting in on the housing market you’re missing out.
This has been hammered home by revelations like that of one Australian school teacher, whose house earned more just sitting there over 50 years than she did in her entire career. This has also become a modern Australian cultural myth (based, and exaggerated, on fact), arguably propelling it even further still (see: Egypt Had Its Pyramids, Sydney Has Suburbia).
So, what exactly constitutes being over-leveraged, you might ask, before jumping headlong into a 50-year mortgage to join the club (or before casting judgement over your friends and neighbours’ latest purchase)?
Mortgage broker Scott Baker told DMARGE: “It’s important not to over leverage when looking at a mortgage and what this means will be different for everyone’s personal circumstances.”
“You always want to make sure you have plenty of buffer income to allow you to live.”
“This could be for normal living expenses, enjoying a nice meal out or keeping regular holiday plans in your calendar.”
“If you’re having to make significant reductions to your lifestyle then this could mean you are over-leveraged and consider whether a mortgage that size is right for you.”
Regarding the notion that if you can’t afford for interest rates to go back to ‘normal’ (say, 7% or so) Mr Baker said: “I couldn’t agree with that as it’s not something you can put a black and white number on. Every person’s individual circumstances are very different based on their income, liabilities and the goals they are looking to achieve.”
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According to RateCity, “If you’re in the market for a home loan, whether it is your first mortgage or if you’re refinancing, then it’s a good idea to create a budget before you sign up for your loan. In this budget give yourself a rate rise buffer of 2 percent, or 200 basis points.”
“That’s because if rates rise by this much you’ll know that you’ll still be able to service the loan and live comfortably. If not, then you may face mortgage stress so you’d be wise to consider borrowing a smaller amount.”
Investopedia says: “Just as it is wise to keep your fixed-income portfolio liquid, it is also prudent to lock in your mortgage at current [low] rates before they rise. If you are eligible to refinance your house, this is probably the time to do so.”
Mozo, in April 2020, wrote: “While interest rates are at record lows, economists predict a rate rise in the near future, so it’s a wise idea to always have room in your budget for a market movement.”
James Whelan, Investment Manager at VFS Group in Sydney recently told DMARGE people’s risk horizons have shifted as they still seek to get approximately 5-7% return on their investment portfolio (which should be varied), in a climate where interest rates are unusually low.
He told DMARGE we’ve had two generations of people get used to a certain risk vs. reward dynamic and now that has “come down from something that was very easy to invest in – 5-7% – where a part of your portfolio sits in that area [normally].”
“But because that’s now down to zero it means that your investments… everything needs to shift a bit to the right [imagining on the right-hand side we have our riskier investments] to get more because people still need to get their annual 5-7% return to be able to live and grow their portfolio.”
“So… people are taking more risks.”
What are the consequences of this? According to Mr Whelan: more risk-taking investment behaviour (plus government stimulus around the globe to combat the pandemic) means money is freer: “A whole lot of money has been pushed into the market – what that has done is pushed asset prices – up so it has inflated the stock and property markets.”
“It is easier for people to borrow at a lower interest rate.”
The question then, according to Mr Whelan, is: “Do you think that our financial regulators are doing enough to ensure people will be able to repay those loans should the underlying interest rates go up (which they inevitably have to do, as they are not normal right now)?”
“Just as 18% is not normal (when it’s up there it needs to come down), 0% is not normal either – it needs to go up.”
“If the answer to that question is, ‘no; we can’t afford to have that changed,’ then absolutely we are over-leveraged.”
On the other hand, the banks don’t want to foreclose “on an entire nation of people who can’t afford normal interest rates” either, Mr Whelan relates.
“No one has a really good answer for what happens if that happens.”
He also points out that there is a difference between the US housing finance system and the Australian one: “Right now usually what happens in a standard system – in America you can walk away, but in Australia the rest of your life is attached to [this investment] – you can’t just walk away, that’s your entire life.”
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“Knowing that and knowing that if there were some sort of calamity and knowing you couldn’t just let an entire nation of people suffer… it’s not the way we do things anymore – not since the GFC when they decided to bail the banks out (and they decided to fix a pandemic using the same solutions they did for the GFC) – they physically can’t let things fail any more.”
“By ‘they’ I mean every central bank and government in the world now especially if we’re all taking the lead from The Fed and the US government on these ones.”
“If we were at a stage when people physically couldn’t pay this mortgage on their place then… there are varying [ways that could play out].”
“I don’t think the people would be left footing the bill immediately but some future generation would be left footing the bill for it.”
“In short: yes we are over-leveraged to buying into this property market.”
“I would love to see a market and I think the economy would love to see a market that would be fundamentally ‘investible’ if more young people could buy their first home more easily and it was a place they wanted to stay. We don’t currently have that system in place and that’s a shame [both personally and as an investor].”
“It does really seem that it’s like a stack of cards but one that doesn’t seem like ever coming down.”
“That’s the problem. It would be nice (as an investor in things in this nation) to have young people buying a home and filling it with stuff – new stuff that they buy.” Instead, we have a lot of old people “buying investment properties at cheap money and renting them out.”
At the same time: “Ownership of your own home is the fundamental requirement of a good strong economy.”
As the ABC summed up recently, “In Australia housing is two things: accommodation and a form of speculation.” So this tension point doesn’t look like going away any time soon.