Thursday, September 30, 2010

Australia's 2009 First Home Buyer Bubble


With Gold & Silver hitting fresh highs tonight (in USD) I feel a little annoyed that I'm writing about housing, but if I don't do it now I might never get this completed! 

In February 2010 I started to write an article, after several nights and 1700 words later I felt I'd hardly scratched the surface of the topic, but I lost interest in completing it at the time. I am going to try and condense what I have into a blog here.


Introduction

In 2009 a surge of first home buyers (FHB) flooded the Australian property market. They bought housing in record numbers, using high leverage, with record loan size (both nominal dollar amount & compared with non-FHB buyers) and in an environment of historically low interest rates.

This was driven by a variety of factors, including but not limited to: low interest rates (including honeymoon interest rates under 4%), lenders relaxing their credit requirements after a squeeze in 2008 & the introduction of the First Home Owners Grant Boost.

Keep in mind this article is not so much about property prices and whether Australian housing is over valued; it is about the bubble in first home buyers numbers, you will have to make you own conclusion about what these numbers might mean for the market and prices to come.


The First Home Owners Boost Scheme

The First Home Owners Boost (FHOB) was introduced in October 2008. For those not familiar with the scheme, this was provided on top of the original First Home Owners Grant (FHOG). The two schemes combined provided a total of $14,000 for the purchase of established homes and $21,000 for new homes. Further to this, other smaller grants and stamp duty concessions were (and in some cases still are) available through state and territory governments.

Initially the FHOB was introduced with the view that it would run to the middle of 2009, but in May 2009 it was extended, with partial removal scheduled for  October 1st 2009 and the complete removal of the boost on January 1st 2010 (with the FHOG of $7000 remaining).

Also in early 2009 came Kevin Rudd’s Household Stimulus Package with many young couples receiving $900 each and families receiving even more in some cases where they had multiple children ($950 per child).

These boosts, grants, stimulus packages & concessions acted as a multiplier, increasing the deposit available to first home buyers which pushed up the prices not only of property in the range of first home buyers, but also in higher price brackets. The increase of prices in lower price brackets provided higher deposits for those upgrading and so on, hence the multiplier effect.

It bought thousands of buyers forward in their decision to buy property, where they may not have otherwise considered buying. It was a terrible decision to introduce this boost and I think the consequences of the decision will be not be fully realised for some time to come.


Introductory/Honeymoon Rates

AFG Figures - AFG makes up approximately 10% of the entire mortgage market

Introductory rates (otherwise known as honeymoon rates) are exactly as the name implies, an introductory period where the interest rate on the loan is lower. Usually this is for a 6 or 12 month period, following which the loan reverts back to the standard or discount variable rate.

An unusually large percentage of these loans were taken up during the period of increased FHB activity. While there is no conclusive evidence that I can find linking first home buyers to this abnormal take-up in intro loans, it does seem likely FHBs were partially driving this increase.

It’s interesting to compare February 2008 to February 2009 where there was an increase of over 300% of this loan type taken up. The increase could likely also be attributed to the aggressive deals that were available at the time with some financiers offering rates as low as 3.99% for 12 months to attract borrowers.

Most of these loans, although attractive on first appearance, have clauses that ensure the bank is appropriately compensated if the borrower decides to break the loan within a short period of time (generally if they refinance or payout the loan within 3-5 years there will be additional exit fees on top of any standard costs/fees).

An example of this type of product was FirstMac’s “Fight Back” loan with a 12 month fixed rate of 3.99%, reverting to the standard variable rate following that period. For this product there were exit costs consisting of: Year 1 – 2%, Year 2&3 – 1.5%, Year 4&5 = 1.2%. So in a situation where the buyer wanted to refinance after the first year, but before the end of the third year this would have incurred a $4500 exit fee on a $300k mortgage.

That same FirstMac loan is likely now charging an interest rate around 7%, this is quite a jump from the rate these borrowers would have been paying only 6-12 months ago. An increase of 3.01% is an extra $179 per week on a $300k loan.

While serviceability would have been calculated on the full rate + buffer it still does not instill confidence that the first home buyers that chose introductory rates are now paying a lot more than they were.

At worst these intro rates resetting could cause a large number of defaults and forced sales as the owners realise they cannot afford the increased repayments (especially in a situation where rates continue to rise, which as of September 2010 is looking quite likely). At best these resets will reduce the amount that the borrowers had potentially been spending on consumer goods & discretionary items which could have negative effects on the greater economy.


Leverage

In early 2009 over 55% of FHBs were borrowing at an LVR of 90%-100% (with over 30% at 95% or higher).



What does this mean? An increase in LVRs coupled with the FHOG boost caused these situations:

A) Buyers who didn’t have a large enough deposit to buy were now able to with the increased grant.

B) Those who were already looking to buy with a deposit used the extra boost to further leverage their buying power.

Some might disagree that the above two situations occurred in large numbers, but the increase in LVR by first home buyers shows that they must have. If first home buyers had simply used the boost to pay a larger deposit on a property they had already been considering then we would have seen a drop in LVRs.

Leverage can be a useful tool to the seasoned investor. Many investors use leverage and interest only rates to increase their exposure to property. In the wrong hands however leverage can be a very dangerous tool as while there is increased exposure to rising prices on the upside there is also increased exposure to falling prices. For those that have borrowed at an LVR of 95%, a 5% increase in house prices would see a 100% gain on their amount of equity, a 5% drop would completely wipe out any equity.

The following is an example of just how much difference to purchasing power the low interest rates, increased FHOG & easy credit can make for an average couple.

Jane & Johnny (Income $40k pa (each), $34k net ($5660k net combined pm)
$4k subtracted for stamp duty/costs to borrow/pest & building inspection/misc
Calculator & Rates used - 30 Year Loan Term (no other commitments)

Feb 2009
Rate: 5.65%
Saved Deposit: $20k
FHOG: $14k (-$4k costs)
Total Deposit: $30k
LVR: 95%
Serviceability Allows: $534k
Deposit Allows: $570k
Purchasing Power (Incl. Dep): $564k
  
January 2010
Rate: 6.65%
Saved Deposit: $20k
FHOG: $7k (-$4k costs)
Total Deposit: $23k
LVR: 95%
Serviceability Allows: $485k
Deposit Allows: $460k
Purchasing Power (Incl. Dep): $483k

As you can see in the above example using high leverage, lower rates & an increased grant Jane & Johnny were able to increase their purchasing power by $81k. This is by no means an extreme example. With the extra 16% purchasing power they can then use this to bid up the price of properties against others in the same situation, is it any wonder that property prices rose in 2009?

Something else to consider when looking at LVRs is that some financial institutions have started to reduce what they will provide to borrowers. While 100% LVR loans were commonplace in 2007, over 2008/2009 many lenders reduced their maximum lend to 90-95% and some lenders have tightened even further.

A huge increase in enquires for 100% mortgages during the first 2 months of this year shows that first home buyers were still keen to purchase, but simply didn’t have the ability to do so with the reduced deposit.


Breaking Records

During 2009 there was several records broken by FHBs (ABS data).

The first record was a comparison of average loan size, FHB vs non-FHB. Normally they were within a couple of percent of each other in terms of loan amount, however in February 2009 FHB loans peaked at 14% more than non-FHB loans. Although February was the peak against non-FHB loans, FHB average loan size continued to increase over the year, rising from $245,500 in February 2009 to $278,700 in November 2009, an increase of $33,200 (13.5% increase).

The second record broken was the number of dwellings financed FHB vs non-FHBs. The percentage of  FHBs peaked in May 2009 at 28.5% of all dwellings financed; this was the highest percentage in the history of the figures available from the ABS (1991).

Along with the record loan size and percentage of finance we also had record numbers of FHBs taking up the grant over the grant period (and 2009).

ABS statistics show a record number of first home buyers took up the grant while the boost was available, this is also confirmed by the Minister for Housing office in their statistics:
ABS data shows October 2008 – September 2009 (185,546)
ABS data shows October 2007 – September 2008 (123,513)
An increase of 62,033 buyers (over 50%) of the previous years numbers.

The Minister for Housing at the time said that 190,050 took up the grant over October 2008 to October 2009.


Conclusion

What does this all mean you must be thinking...this information wasn’t gathered with the intention of convincing you of anything, so in conclusion there is no conclusion.




September 2010 Update

Many of the factors that drove housing growth over 2009, including low interest rates, the FHOB and relaxed foreign buyer laws have now once again reversed with the FHOB ending, rates back on the rise and due to public outcry the foreign buyer laws were re-tightened.

Market conditions are looking very similar to 2008, with:
It's just a question of whether this is just another short term blip down on the house price chart before they take off again or the start of something more sinister. Will the government intervene again in the market like they did with the boost? Will it be effective a second time? Time will tell.


BB.

2 comments:

  1. This article points out some interesting facts with not a hint of bitterness or hype. Thanks.

    ReplyDelete
  2. This is what a FHB bubble looks like.

    http://users.on.net/~thefirstbruce/FHB%20%25%20of%20all%20dwellings%20financed.gif

    ReplyDelete