Prime times coming for cashed-up investors

Posted on 13/10/2008  

Debt is the Anti-Christ - that much is obvious. The international meltdown of money markets against a background of a slowing domestic economy and a mountain of household debt may well have been the catalyst for the Reserve Bank's decision to lower interest rates by a full 1% this week.

Most economists (who failed to predict the extent of the interest rate cut) are now in hindsight predicting further radical cuts in coming months as the RBA seeks to pump prime the economy.

One could waste a lot of energy trying to figure out why the RBA (which in February and March decided it needed to slow the economy further by lifting rates by 0.5%) is now apparently trying to reverse its position on monetary policy.

One could ask if the RBA's concerted campaign to keep a lid on inflation by raising rates 12 times since 2001 had a point at all, when clearly it did not stop consumers going in over their heads and taking on debt which now threatens to bury them.

Later in this article we will look at the opportunities in Australia's housing market for investors who are either cashed up or can leverage their way into real estate without much risk. Right now it is a buyer's market and with the RBA now tipped to cut rates again in November, those with a cash deposit at hand are in a strong position.

But first let's look at what's happening in the money markets. Debt, whether it runs to four or eight figures, is the source of a global economic stand-off where banks refuse to lend to each other, thus jamming the system. The banking crisis in the US, UK and Europe, the collapse of global equities markets and the plunging Australian dollar are among gloom and doom topics that have dominated the news for months now.

It is not too difficult to understand the big picture - entrepreneurial banks sold off high-risk loans to other banks. It's a bit like the junk bonds of the 1980s. Nobody wants to play pass-the-parcel anymore and the internal system by which banks lend to each other has broken down. The situation is much worse in the UK and the US than it might ever be in Australia, but it's sending all the wrong messages.

Little wonder the latest Westpac/Melbourne Institute Index of Consumer Sentiment dropped 11% from 92.2 points to 82 points this month (a reading below 100 means consumers are very negative). Westpac's usually-positive economist Bill Evans said the survey was 22.3% below its average reading in the 1990s recession. Evans says the reading sends a chilling message to retailers as we head into the Christmas season.

Yep, it's all doom and gloom - The Economist came out this week with an update of the "Depression Index" - a survey of key financial newspapers such as the Wall Street Journal and The Times showing how often economy-related articles mention the word Depression. At this time, the index is above 250. In 1987 it was just above 200 and the next highest (the Dotcom crash in 2000) just over 150.

Well, that's other countries - what's happening in the Pacific? Hmm. Well, New Zealand is already in recession and Australia is not too far behind, the pundits say. If you sat through the 7.30 Report's interview with UWS academic Steven Keen on Wednesday night you might feel inclined to hand the keys over to the bank and call the repo man to come get the car before things get any uglier.

Twelve months ago Keen was one of the few commentators who predicted the coming crisis when he described Australia's debt bubble (160% of GP) as unsustainable. He told the Sydney Morning Herald in October 2007 that the level of private debt in Australia was twice as high as it was in the Great Depression. "Interest payments alone are now consuming 15 cents in every dollar of disposable household income."

No wonder the media wants to interview Keen now. He is unremittingly bearish about the housing cycle and sees prices continuing to drop. Keen's closing words of advice to ordinary Australians - "get out of debt".

On the other side of the ledger, people with no debt and cash in the bank have never been in a better position to invest. The housing market is trending down and interest rates are definitely on the way down (some now say cash rates could be down to 2% by this time next year). RP Data's national research manager Tim Lawless says that if banks pass on only half of a 100-basis point cut it should net home owners on a $300,000 mortgage a saving of more than $120 each month. Some banks have already passed on 80% of the 1% interest rate cut, which is a boon to those choosing to go into a new mortgage.

Lawless says the rate cut will lift consumer confidence and it's likely to result in more buyers and investors returning to the marketplace.

"With housing finance trending downwards since November last year, it's likely the interest rate cut will motivate more buyers back to secure their pre-approvals and dip their toe into the housing market. Market conditions still remain in favour of the buyer. However, with activity likely to build, this window of opportunity may be closing earlier than most would have expected."

Lawless predicts the western Sydney mortgage belt will be among the first markets to respond. "Demand has been building in these areas from first-home buyers, low-income families and investors. Prices are less of a barrier to entry in these locations and renting is losing some of its charm due to the steep rises in weekly rental rates. For investors, the yields in the outer west have improved significantly, to be averaging between 5% and 6%."

On the other hand, those who decided to lock in their mortgages at prevailing fixed rates may be regretting their decision. Interest rate research house Cannex says those who opted for fixed rate loans earlier in the year are now paying up to $190 more each month than fellow home owners on variable rates. Cannex estimates there are 400,000 fixed-rate home loans in the system at the moment. Senior financial analyst Harry Senlitonga says there were 64,000 new fixed-rate loans opened in the first half of 2008 at a time when fixed rates for a three-year term were as much as 9%. Borrowers can break a fixed-rate agreement, but it can cost up to $6,000 to do so.

As Lawless says, housing finance data paints a more accurate picture than the lagging median house price surveys, sometimes misleading historical snapshots. Owner occupier housing finance approvals fell 2.2% in August to 48,903 - the first time this figure has fallen below 50,000 since 2001. The volume of home loans fell in all states and territories except the ACT for the second month in a row.

Price-wise, we'd expect the September 2008 quarter to be worse than March 2008, when the average median prices for houses and other dwellings experienced their largest quarterly fall in five years. According to the Mortgage Choice/REIA Real Estate Market Facts, the Australian median house price decreased from $471,300 in the December quarter 2007 to reach $458,488 in March quarter 2008, down 2.7%. However, for the year to March, house prices increased by 8.3%, reflecting the strong increases in prices recorded in some cities during 2007.

But only two capital cities, Sydney and Perth, recorded a median house prices above $450,000, compared to four capital cities recording this figure in the December quarter. The picture improved slightly in the June quarter, with house prices increasing to $459,216, up 0.05% over the quarter, and 6% over the year.

Most commentators with a vested interest in the health of the housing sector approved of the 1% rate cut, but with some reservations. The Housing Industry Association says its survey of business expectations shows the rate cut was justified, given that 70% of respondents expect some degree of credit tightening in the next six months.

The REIA says RBA attempts to stimulate economic activity will mean little unless these reductions are passed on by the banks. REIA president Noel Dyett says Australian banks should pass on the full rate reduction to provide a stimulus to the economy, and particularly for the property market.

"The banks may need to trim their short-term profitability but the benefit will be longer-term returns from an active market," Dyett says. Interestingly, Dyett cautioned borrowers to use any surplus funds the interest rate cut created to further reduce debt and achieve the right balance between debt and spending.

Residential property analyst Michael Matusik put some of the issues in perspective when we spoke to him this week. Matusik agrees it is a buyer's market and has been for some time, but the fundamentals of Australia's housing market are strong.

"One of the positives of the Australian housing market compared with what‘s happening in the US and the UK is that we're not over-supplied and demand is pretty strong," he says. "I think the affordability issues are overdone and that's not going to put a brake on the market. The next 3-6 six months may be pretty sloppy and some owners might not get the price they want or even lose money when they sell.

"But from June next year onwards, I expect this (housing) market will be quite strong with double-digit growth and rents will increase between 13% and 15% over the next 18 months."

Unlike some commentators, Matusik thinks the RBA did the right thing in using interest rates to put the brakes on the economy between 2001 and 2007, although he believes they overdid it in the earlier part of this year. Now, however, with the rate trend clearly down, there will be good buying opportunities for those (with cash or equity and a good relationship with their banker) who sit tight and don't panic, Matusik says.

Postscript: October 9, 2008: This story is a moving target, as I read online as this piece was being written that the central banks of the US, Europe, Britain, Switzerland, Canada and Sweden all lowered official rates by 0.5%. Radio Australia's Connect Asia program reported that the People's Bank of China also participated in the globally coordinated interest-rate move, albeit with a modest cut. The Bank of Japan, with its cash rate at 0.5%, supported the co-ordinated action but did not lower rates. Hong Kong, however, slashed the borrowing rate it charges banks by a full percentage point. So Australia's Central Bank has proved to be a market leader, in going alone to cut interest rates by the biggest margin in 16 years.


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