Where is The Excess Property Supply?
Wait for spring they said. Property will flood the market they said. It will pull prices down they said. Yet here we are, one third of the way through spring and national prices up 2.5% for the quarter (ending 30 September 2023). Anyone annualising these numbers? 10% pa. Any takers? I thought not.
Ekam Capital just released their quarterly Market Guide looking at all things related to real estate (you can download it here). Here's what Australian property prices look like since the first rate hike in 2022:
And the annual change over a longer-term perspective.
Bed goes up, bed goes down - Homer Simpson.
And right now, the bed is going up.
Although growth has slowed from a recent peak, we continue to see growth trending steadily across major capital cities.
What's interesting is that we are now seeing growth not in the highest valued properties, but in the lowest 25% and middle 50% of values in most major cities:
While home prices are currently going through an upswing, there is still vulnerability to spikes in unemployment and higher for longer rates due to persistently higher inflation. We're seeing a real slow down in the top 25% of values, which are a leading indicator. In other words, we could expect to see the middle and lowest property values start to really slow down in the months ahead.
One of the biggest risks feared by the market was the fixed rate loan expiry and the impact this would have on mortgage stress. Mortgage arrears, pretty much all around the world, is at historic lows. Interestingly, households are coping with higher interest rates (so far) with households having a significant war chest of savings amassed in COVID (although this is now looking to be running out).
Having said this, we can see that borrowers are not making extra payments onto their mortgages as they have been in the past.
And there are some very early signs that payments in arrears are on the rise.
I don't think we've seen the full impact of the fixed rate loan maturities as we can see by the chart below. We're only part way through the expiration process - but so far so good. Other discretionary spending is usually given up to save the family home.
I personally think we're still on an upward trajectory. Will this last forever? Of course not. But for now, I think we still have a bit to go.
On the supply side in Australia, stock has been gobbled up by demand as a result of strong migration and undersupply.
I bet you're wondering, what about the flood of supply during spring? It's still coming. However, it's up 9.7% on 2022. But for now, demand is gobbling up supply in a heartbeat.
The bottom line is that we have a fundamental undersupply. Until we can resolve this, we're likely to see further price increases and higher for longer rents.
Having said all of this for the residential market, we continue to see some weakness in the Commercial Real Estate (CRE) market given the lag in commercial property prices.
Higher interest rates are also contributing to growing debt-servicing difficulties for some CRE borrowers. Loan arrears and defaults have increased in the (largely US-based) commercial mortgage-backed security market. US banks’ CRE loan quality is also worsening, though from a strong starting point (see chart below).
Having said this, the strong starting point for underlying credit quality, improvements in lending standards over the past decade and high levels of capital should enable most banks to withstand any further deterioration in CRE market conditions - especially if valuations are being done prudently, and LVR (loan to valuation ratios) are managed conservatively.
In summary, this is the one chart that is being watched by many market observers, the 10 year - 2 year curve. It's predicated four of the last four recessions. The thing that most investors don't understand is that the economy doesn't fall into recession until the curve is back in positive territory. So the fact that the curve has been inverted for so long and we haven't fallen into recession is completely consistent with history. We've been inverted deeply and for a long-time, and we're taking our sweet time getting out of this inversion. Which tells me that this market has further to run before we finally fall into recession.
The markets present us with two competing narratives, 1) higher rates for longer, and 2) an imminent recession. My opinion is that these two narratives cannot co-exist. One overrides the other. Therefore, and based on the chart above, history says we're going to be 'higher or longer' rates, for now.