by David Bassanese

The solid growth in investor home lending approvals during July has again raised questions over whether bubble conditions are forming, and the extent to which to the Reserve Bank of Australia (RBA) should be worried.

Excluding re-financing, the value of home lending rose 0.9 per cent in July, after a 1.5 per cent gain in June – to be 15 per cent up on year-ago levels.  Lending to investors, however, rose a solid 3.7 per cent in July, while lending to 1st home buyers slumped 8.3 per cent.  

The share of lending to investors has lifted to 45 per cent - levels last seen during the bubble period of 2003-2003 – while the share of lending to first home buyers has dropped to record lows of less than seven per cent.

The strong share of investors lending is clearly having market implications – rental yields are falling and rental vacancy rate are rising as more properties are placed on the market in search of tenants.  

Yet to my mind, while it’s quite clear the property markets has been running hot – driven in large part by investors – its performance is still within the realms of a normal cyclical reaction to pent up demand and very low interest rates. As a share of housing credit outstanding, home finance approvals are still well below the level of a decade ago.

And compared to 2003, today’s rental markets are starting from a much tighter position.  According to the Real Estate Institute of Australia, the nationwide rental vacancy rate is only a little above 2 per cent (below its average since 1990), while it was just over 4 per cent in 2003.  What’s more, rental yields are still somewhat higher than in 2003, even though mortgage rates are much lower.

The decline in rental yields is part of the broader “yield chase” that has pushed down returns across the global in light of unusually low interest rates – and arguably there’s more to go.  Given low interest rates, it also won’t surprise if the nation-wide house price to average household income ratio also pushes through previous cyclical peaks of the past decade.  

Apart from the cycle, there are also structural features at play.  For starters, more jobs are being created in inner city locations, which demands more high rise developments by those that don’t want to spend their lives commuting from distant suburbs.  

Another structural feature is the growing internationalisation of the local property market, with foreign investors – especially it seems from China - playing a much more active role. Provided they play by the rules – and there is debate over this – foreign investors should be mainly financing new property construction, which adds to the much need supply of properties across Australia.  

Last but not least, growth in self managed super funds – and their apparent strong preference to leverage into investment properties – is another new source of marginal property demand.  

To the extent some of these new structural features are a concern, they can and should be tackled without having to rely on higher interest rate and/or macro-prudential controls. Better suburban transport links would ease demand for inner city properties, while the Governments can always tightening restrictions on buying by foreign investors and SMSFs if deemed a concern.

Despite this apparent positivity, moreover, my greatest fear is that the housing sector cools down more quickly than many economists are counting on.  

Indeed, it’s still a given by most economists that home building will continue to grow strongly, helping offset the downturn in the economy caused by the slump in mining investment. Yet peer beneath the service, and the picture is less healthy.

Although investors demand is still rising, housing finance demand by owner occupiers has broadly flattened since the start of the year. And the number of monthly home building approvals peaked late last year, and have gently trended down ever since.  The quarterly real value of approvals for new homes and renovations actually declined in the June quarter, suggesting dwelling investment in the September quarter national accounts will detract from economic growth.

It is not a given that housing investment will keep rising. After all, Australia’s modern track record in building homes is not strong, given ever intensifying land and development constraints in our major cities.  Affordability constraints are already lowering demand by owner occupiers.

If investors and/or foreign investors are spooked out of building new homes, Australia won’t have many other growth drivers to fall back on until such time as the $A slumps to a much more competitive level.

We should be careful what we wish for.