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On September 25th, Federal Treasurer Josh Frydenberg announced sweeping changes were coming to remove overly restrictive “responsible lending” rules, in order to make borrowing easier and more efficient.

 

The Treasurer stated in his announcement that “the principles which underpin responsible lending obligations have been implemented in a way that is no longer fit for purpose and which risks slowing our economic recovery.”

 

As a result, the National Consumer Credit Protection Act will be overhauled, with new more flexible lending rules to be implemented from March 1st, 2021.

 

Why the change?

 

According to the Treasurer, the objectives of the change include:

• Simplifying Australia’s credit framework to ensure consumers and small businesses can get timely access to credit as the economy recovers following the coronavirus crisis;
• Enabling a more efficient flow of credit to consumers and small businesses while maintaining strong consumer protections, through a suite of changes to Australian credit laws;
• Improving the flow of credit to support business investment and create jobs.

Treasury and the Reserve Bank of Australia have come to the conclusion that the current rules around lending have led to banks putting in place overly detailed and time-consuming credit approval processes under a “one-size-fits-all” approach.

 

As many investors and home buyers can attest, in recent times getting a loan has become extremely burdensome – often with significant delays (and uncertainties) in obtaining approval.

 

Even the RBA Governor has recently observed that what began as responsible lending principles has translated into “the undesirable consequence of unduly restricting lending”.

 

What is changing, and how will it affect you?

 

By March 1st, the Government intends to “simplify the law through changes to the Credit Act to reduce the time and cost of credit assessments for consumers and businesses, reduce red tape for consumers seeking a credit product, improve competition by making it easier for consumers to switch lenders, and enhance access to credit for small businesses.”

 

A key change is that lenders will be allowed to rely on the information provided by borrowers, such as declarations of living expenses, unless there are reasonable grounds to suspect it is unreliable.

 

This removes the requirement for lenders to painstakingly attempt to verify certain details declared by a borrower, such as their budgeted living expenses.

 

As the Treasurer puts it, borrowers will be made more accountable for providing accurate information to inform lending decisions, replacing the current practice of “lender beware” with a “borrower responsibility” principle.

 

Why this is so important…

 

If you’ve been following our newsletters, you’ll know that I’ve been advocating for this change since 2018 – when I first highlighted the “unintended consequences” on competition and the broader economy that were already emerging from the overly-zealous application of certain responsible lending principles.

 

Pressure from the financial regulators, along with the uncomfortable spotlight of the Financial Services Royal Commission, led most banks to require substantially more supporting documentation for loan applications and to increase their scrutiny of living expenses and existing debts.

 

This increased scrutiny on a borrower’s living expenses by the big banks has meant more paperwork and prolonged delays in processing loan applications, thanks to a lot more manual handling in the application process.

 

Some banks took this to the extreme. For instance, Westpac started requiring loan applicants to provide a specific, itemised and evidenced break-down of their living expenses across 12 categories!

 

Many banks have also been asking borrowers to provide 3-6 months’ worth of bank statements and credit card statements, which the bank then almost forensically examines to cross-check back against what was declared as expenses on the application.

 

“No kebab for you!”

 

Under this rigid “one-size-fits-all” approach, many lenders failed to differentiate between “fixed” versus “discretionary” living expenses when evaluating how much a home buyer or investor could reasonably afford to borrow.

 

This led to bizarre and well-documented instances where loan applicants were put through the wringer, or even had their applications denied, simply because a daily kebab lunch, or a Lite ‘n’ Easy diet, or a gym membership wasn’t included in their declared living expenses!

 

Fixed vs. Discretionary Expenses

 

I’ve argued repeatedly that examining a potential borrower’s expenses should be all about the recurring expenditure that a consumer is actually committed to, NOT the “discretionary” expenses that they can easily give up.

 

Anyone with real-world experience in owning property knows that you can and will sacrifice discretionary spending items in your budget in order to more easily afford the repayments on a home loan.

 

Magazine subscriptions, gym memberships, Foxtel, Netflix, and even takeaways and dining out are all costs that can be eliminated from a person’s budget at a moment’s notice.

 

(Just like they can be added to a person’s budget at a moment’s notice if the person feels they can afford them.)

 

So why should they have any relevance to the assessment of your loan application?

 

The failure of lenders to differentiate between “fixed” and “discretionary” expenses has unnecessarily inhibited the flow of credit in Australia, making it more difficult for home buyers, investors and small business owners to borrow – without any demonstrable benefits to financial stability or consumer protection.

 

The famous “wagyu & shiraz” case

 

This all came to a head last year when financial regulator ASIC took Westpac to court in a high profile case now known as the “wagyu and shiraz” case.

 

The regulator attempted to claim that Westpac had breached responsible lending laws by using a generic “Household Expenditure Measure” (HEM) to estimate borrowers’ living expenses in numerous loan applications.

 

Westpac argued that responsible lending laws did not require banks to use a simplistic formula of “income minus declared expenses” when assessing a customer’s ability to repay a loan.

 

In dismissing the court case, Justice Perram supported the important distinction between fixed and discretionary expenses, stating:

 

“…the mere fact that there are living expenses is not necessarily relevant to whether a consumer will be unable to comply with their loan obligations, because it is always possible that some of the living expenses might be forgone by the consumer in order to meet the repayments.”

 

In fact, Justice Perram went further to really ram the point home – with such quotable quotes as:

 

“I may eat wagyu beef every day washed down with the finest shiraz… but, if I really want my new home, I can make do on much more modest fare.”

 

and:

 

“The fact that the consumer spends $100 per month on caviar throws no light on whether a given loan will put the consumer into circumstances of substantial hardship.”

 

ASIC toyed with the idea of appealing the case, but has now confirmed that it will accept the decision. Case closed!

 

Common sense wins out – finally!

 

It may have taken two years and a pandemic-triggered recession for common sense to prevail, but it seems like change is finally here and will become entrenched in law before March next year.

 

In particular, the assessment of living expenses has been called out in the coming changes, with Treasury making it clear that lenders are expected to move away from obtaining and verifying extensive information about a borrower’s expenses, in order to simplify and speed-up lending processes.

 

Farewell (and “good-riddance”) to those onerous living expense assessments!

 

By allowing lenders to rely more on the declarations provided by borrowers, new loans and refinancing applications should be able to be processed faster, with more borrowers qualifying for more lending.

 

A HUGE change

 

This represents potentially the most significant relaxation in lending since 2010, with the exception of abolishing the 7% minimum interest rate test for loan applications in June last year.

 

That change (abolishing the 7% minimum interest rate test used when assessing a borrower’s ability to afford a loan) had an immediate and very noticeable impact on the property market.

 

Combined with cuts to interest rates at the time, the change to loan servicing tests enabled more potential property buyers to access finance, triggering renewed activity in the property market.

 

The decline in property values witnessed leading into last year’s Federal Election was reversed, and property prices rose in many parts of the country.

 

In fact, values were still rising off the back of those changes when the COVID-19 pandemic hit.

 

How will the new relaxation in lending impact the property market?

 

COVID-19 caused the property market to stall and fall back in much of the country.

 

However, an important driver of demand for property – and property values – is the ease (or otherwise) of access to credit.

 

We saw the impact of this in the second half of 2019, when values in much of the country rose as overly-restrictive servicing requirements were appropriately relaxed.

 

Back in May 2019, when we saw the changes coming, we went on record calling the bottom of the market,and forecast property values would begin to rise strongly.

 

Our forecasts were proven to be correct, with aggregate Australian property values subsequently rising by more than 10%, before COVID hit.

 

It stands to reason that as requirements relating to expense assessments and other “responsible lending” rules are relaxed (making it easier for more consumers and small business owners to borrow), we’re likely to see a similar impact on the property market next year.

 

Good for the property market. Good for the economy.

 

Rising property values are also a driver of positive business & consumer sentiment, and of economic growth.

 

In recent times the RBA and the Government have recognised the relationship between home values, and economic prosperity.

 

It should come as no surprise that when people feel wealthier because the value of their home is rising, they’re far more willing to spend and invest.

 

The window of opportunity is open once again…

 

The telegraphed relaxation in lending in March next year provides sophisticated property investors with one of the clearest signals yet of an impending resurgence in the property market.

 

The question you need to be asking yourself right now is this…

 

How will you position yourself to capitalise on the rebound, as lending restrictions ease and sentiment improves?

 

 

Until next time,

 

Invest Wisely!

 

– Simon Buckingham

 

Woah – deja vu!

Every 12 months or so, the media spotlight picks up on a property market doomsayer predicting the end of the world for property investors in Australia, in spite of the fact that these predictions have been proven wrong time and time again… 

Most recently it’s US author Harry Dent, on a tour of Australia to promote his latest book that predicts a coming global crisis worse than the GFC or even the Great Depression. Mr Dent was quoted in the media last month with his prediction for Australian real estate:

“Your problem is you’ve got the second highest real estate costs compared to income in the world… I think this time your real estate will come back 20, 30, 40, 50 per cent.“

 

Sounds scary! But it’s not the first time we’ve had this kind of apocalyptic prediction (and it won’t be the last)…

Back in February 2016 it was a 60 Minutes article in which US author and ‘macroeconomic researcher’ Jonathan Tepper predicted that Australian property prices would crash by 30% to 50%.

(Since then our largest property markets – Sydney and Melbourne – have boomed!)

In 2014 and 2015, Harry Dent was again on the scene forecasting housing prices to fall in Australia by at least 27%.

(Instead, according to REIA statistics, Sydney’s median house price has risen by around 40% since 2014, Melbourne’s has risen by around 26%, and Australia’s overall median house price has risen by around 22% over the same period!) 

And back in 2010 it was Australian economist Steve Keen who lost a bet with Macquarie Bank analyst Rory Robertson that house prices would fall 40% in a year (and had to walk from the steps of parliament to Mount Kosciuszko wearing a t-shirt that read “I was hopelessly wrong on house prices – ask me how”).
   
There’s no doubt that fear sells, and a cynic might observe that these predictions seem to coincide with book promotions and seminar tours.

However, it’s unfortunate to see that many investors buy into this fear-mongering and make emotional, sometimes panicked decisions about their property portfolio as a result.

Sophisticated property investors keep their emotions in check, and invest not on extreme ‘Chicken Little’ predictions about the sky falling, but on an informed opinion about what is MOST LIKELY to occur in the market.

While no-one can predict the future with absolute certainty (and if you encounter someone who thinks they can, then my advice is to run away very quickly), here’s some of the reasoning behind why we think it’s highly UNLIKELY that the property market will crash.

Much of this I’ve covered before in other newsletters, but it bears repeating as an antidote to fear-mongering, ignorance and sensationalism:  
 
5 reasons why a property market crash is extremely unlikely…

REASON #1: “Affordability”

Some so-called ‘experts’ (again usually from the US) keep telling us that housing in Australia had become so unaffordable that a property market crash is inevitable.

The problems with the affordability argument are many, but in particular they place reliance on an increase in a single measure of affordability, being the ratio of average incomes to median house prices in major cities.

This single measure ignores the facts that interest rates today are less than half what they were 25 years ago, and that most home buyers these days are dual-income households.

Furthermore, inner-city median prices are hardly representative of the true range of property prices to be found across suburbs and regions. For instance, while the Melbourne median house price is currently over $800K according to the REIA, localised median house prices across Melbourne’s suburbs span anywhere from a much more affordable $350K, right up to over $4M! 

Market commentators frequently confuse housing “affordability” with the ability to afford a house in the most desirable and sought-after locations around a capital city. They’re not the same thing!

Just because someone can’t afford to buy a house in the suburb where they’d really prefer to live, doesn’t mean that housing in general is “unaffordable”. If you want a cheaper house, then be prepared to compromise about where you want to live, and expect to commute if you work in the city! Don’t expect the forces of supply and demand in the most tightly held areas to bow to your personal desires.

Measuring affordability is actually a very complicated subject, and I’m wary of over-simplifying. But it’s a fact that wages have generally increased over the past five years (albeit they’re rising at a slower rate presently), interest rates remain at historical lows, and rates are unlikely to trend upwards quickly.

The cost of borrowing is low, and there’s a strong argument that property prices in general are currently around where they ought to be based on the combination of historical wage growth, low interest rates, and the prevalence of dual income families when it comes to property ownership.

REASON #2: Employment

Before seeing mass foreclosures and people flooding the market attempting to offload heavily discounted properties, we’d need to see a significant jump in unemployment.

As long as people have jobs, they are more likely, rather than less likely to hang on to their house.

The most recent unemployment trend statistics published by the ABS sit at around 5.5 percent. This is quite low by historical standards, and far cry from countries like the US and parts of Europe that witnessed property market crashes off the back of unemployment levels in excess of 10 percent.
 
While some sectors of the Australian economy (particularly the resources and retail sectors) are undoubtedly doing it tougher than others, the number of people in jobs and the proportion of the population in work have both been trending upwards.

In fact, the Australian Bureau of Statistics noted last month that “Over the past year, trend employment increased by 394,900 persons (3.3%), which is above the average annual growth rate over the past 20 years of 1.9%.”   

Something very dramatic and unforeseen would have to happen for unemployment to soar to the kind of level that would trigger a property market crash.

REASON #3: Robust Lending Standards

Australian banks weathered the GFC extremely well, and continue to be regarded as some of the most robust and stable financial institutions in the world.

Australia implemented strict responsible lending regulations following the GFC, and our finance environment is a far cry from the lax and irresponsible pre-GFC lending practices of the US that led to the collapse of property values in many parts of that country ten years ago.

Furthermore, as any active investor would know, lending standards have become even tighter in the last couple of years, with higher servicing tests and greater scrutiny of borrower’s existing financial commitments and living expenses. 

It’s worth noting that recent estimates by CoreLogic RP Data put the value of the Australian housing market at around $7.5 trillion – with the value of mortgages only around a quarter of that at a ‘mere’ $1.71 trillion. It can be argued therefore that Australian households are not highly leveraged as a whole.
 
REASON #4: Natural Resistance

What tends to happen when the property market softens is that, unless they really need to sell, vendors who are unable to get the price they want for their property eventually just take their property off the market and sit tight, rather than taking a bath on price. As such, prices tend to drift rather than collapse.
 
As long as a property owner can afford to keep holding their property (which really comes back to points #1 and #2 above), then there’ll be a ‘natural resistance’ to dropping the price too far. Instead, many vendors will simply remove their property from the market, or not list it at all.
 
Fewer properties get listed as time goes by, and eventually the available ‘stock’ on the market comes back into balance with the number of buyers, and prices stabilise. Once buyers outnumber sellers, then we can expect competition to start driving up prices again.

There’s also a culture of desiring home ownership in this part of the world (‘The Great Australian Dream’) and a psychological and social stigma associated with the idea of losing your home that should not be discounted. Aussies tend to sacrifice other things before their mortgages and houses, and as such this creates another form of ‘natural resistance’ towards just taking any price in order to sell a house when the budget gets tight or the market slows down.

History demonstrates that even in past economic dark days such as the Great Depression and – more recently – the GFC, house prices in Australia eased only modestly. And (importantly)  in some areas they even continued to climb!

REASON #5: Economics 101

Most property market ‘doomsayers’ demonstrates a fundamental misunderstanding about how the forces of supply and demand drive price behaviour.

As any student of high school economics would have had drummed into them, prices of goods and services move up and down in response to the balance of supply and demand. And it’s no different for property.

For example, when prices collapsed in many mining towns a few years ago, this was due to a sudden absence of demand combined with an oversupply of property.

The absence of demand was the result of mining companies and supporting industries requiring fewer people in the towns, and therefore needing less accommodation. In other words, the population requiring housing in these towns dropped.

The oversupply resulted from over-development of new housing in these towns, in addition to some mining companies deciding to build their own houses or ‘fly-in-fly-out’ camps to provide cheaper accommodation than what it cost them to rent established housing. Towns like Moranbah were left with a significant oversupply of housing as the mining investment boom ended.

It doesn’t take an honours degree in economics to see that the dynamics are very different in our capital cities.

Yes, there are risky pockets of oversupply (most notably some CBD apartment markets and over-developed outer-suburban ‘greenfield’ housing estates), but in most inner and middle-ring suburbs the problem is more of a lack of housing supply, rather than massive oversupply.

Australia’s population is still growing (now approaching the 25 million mark according to the ABS) so there are plenty of people who need a roof over their heads in most parts of the country.

I’d love to see prices fall 50%… but I’m not holding my breath!

Just in case you think I’m trying to ‘talk up’ the property market, personally I’d be ecstatic if we we’re to see an across-the-board 50% fall in property prices. At current rents, this would mean we’d have positive cash flow rental properties within 10km of the CBD in major cities – a great opportunity for cashed-up investors!

But unfortunately I don’t think that’s very likely… do you?

Until next time,
Invest wisely!

– Simon