Interest rate rises and the Sydney residential property market – don’t drink the Kool Aid

There’s nothing like four consecutive monthly interest rate rises to whet the appetites of media and armchair Sydney property commentators ravenous for eye balls and headlines.

Since the first interest rate rise on 3 May 2022, screens, feeds and in boxes have been bombarded with tales of a Sydney residential property market ‘crashed by the RBA’ as it attempts to contain inflation.

Often penned by the same catastrophists who got the impacts of the GFC and Covid-19 on Sydney’s property market badly wrong, these tales usually:

• assume a single and synchronised macro residential Sydney property market

• ignore:
  • a 28% growth in their macro market over the last 12 months
  • a maximum cash rate of just 3.35% forecast by the four major lenders which, for years until more recently, have been approving loans on an assumed 7%. Current forecasts are 3.35% by November 2022 and February 2023 from ANZ and Westpac respectively; 2.85% by November 2022 from NAB and significantly, only 2.6% by November 2022 from the biggest lender of them all, CBA
  • a consensus, even amongst those four major lenders, that the number and duration of interest rate rises will be finite and short with the CBA forecasting interest rate cuts in late 2023; in early 2024 according to Westpac and for UBS, as soon as the second half of 2023
  • the large cash balances in off set and other accounts accumulated during Covid-19 lock downs offering many borrowers buffers of at least two years
  • statistically insignificant mortgage default rates with none seriously predicted unless the RBA slams on the brakes too hard
  • one of the lowest ever recorded unemployment rates
  • opposite trends in Sydney’s non residential property markets despite their exposure to interest rate rises
  • rapidly increasing residential rents which, as we are experiencing, has led to a sharp increase in interest from yield seeking investors keen to exploit a market correction before interest rates reduce again
  • contrary data and analyses from a chorus of experts and commentators.

Looking closer at three of those topics:

“A single and synchronised macro residential Sydney property market”

Macro analyses are undoubtedly important.

More important for Sydney residential property buyers is knowing that their market is NOT synchronised.

Instead, it is a maze of micro markets which, like bobbing corks in an ocean, neither move in unison nor react in the same way as each other to interest rate rises.

Everything depends on the quality of the asset.

In a correcting market like this, the sellers who come in from the sidelines with poorer quality properties find few buyers willing to do likewise.

The story is different with higher quality assets and while buyer numbers are likely to be lower than before the correction, the prices are still strong.

As one of several examples, for current Supreme Court proceedings in which Chris Curtis has provided expert evidence, our detailed analysis of several high end, developable Maroubra property sales in the 83 days before the first rate rise on 3 May 2022 relative to sales in the following 83 days and after two more rises, found a 21% increase in median prices and a 29% fall in the time to sell.

The tale is the same across town as shown by the latest preliminary auction results published by Adrian William whose bespoke data gathering efforts informed our last and proving to be very popular newsletter: A deep dive into Sydney’s auction clearance rates – how they are reported has got to change

While the miserable 30% preliminary clearance rate they recorded on 6 August 2022 for 20 inner west properties will be manna from heaven for the catastrophists, the devil is again in the detail which these results for the three quality offerings amongst that 20 reveal:

“Opposite trends in Sydney’s non residential property markets despite their exposure to interest rate rises”

While yields for some industrial properties have started to decompress, other quality commercial properties continue to attract strong prices and interest.

565-567 Willoughby Road, Willoughby is an example.

One of just six corner retail freehold shops left on Willoughby Road, Willoughby and only one of three with double retail frontage, it sold this month pre auction for a confidential price consistent with our bullish evaluation for the client.

Similarly, despite new waves of Omicron variants and the hybrid WFH model now entrenched, Sydney’s CBD strata office micro market continues to power along as the auction on 11 August 2022 of Suites 211, 212 and 213 in the iconic and tightly held 350 George Street, Sydney will test.

The $175 million price expectation for The Oaks Hotel in Neutral Bay will be an interesting test of the hospitality asset class (more on that hot spot suburb in a later Newsletter).

“Contrary data and analyses from a chorus of experts and commentators”

We’ve curated a few:

Ross Gittins, SMH, 27 July 2022

“[Prices have] risen not primarily for the usual reason – because economies have been “overheating”, with the demand for goods and services overtaking businesses’ ability to supply them – but for the less common reason that the pandemic has led to bottlenecks and other disruptions to supply.

The point is that these are essentially once-off price rises. Prices won’t keep rising for these reasons…

So, while it’s true we do need to get the official interest rate up from its lockdown emergency level of virtually zero to “more normal levels” of “at least 2.5 per cent”, it’s equally clear we don’t need to go any higher to ensure the inflation rate eventually falls back to the Reserve’s 2 to 3 per cent target range”.

John Kehoe, AFR, 29 July 2022

“Inflation could turn negative by late next year as petrol prices decline and supply chain pressures ease, allowing the Reserve Bank of Australia to avoid being too aggressive on interest rate rises… 

An expected easing of inflation pressures next year meant the RBA should not lift the cash rate too far above the estimated 2.5 per cent neutral rate, said Outlook Economics director Peter Downes.”

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University, The Conversation, 7 June 2022

“Australia has a history of aggressive interest rate hikes to tame inflation.

In 1994, Reserve Bank Governor Bernie Fraser rammed up the cash rate from 4.75% to 7.5% in a matter of months. But that was when wage growth was well above inflation and the bank was trying to dampen “demands for wage increases” to prevent a wage-price spiral.

We don’t even have the beginnings of that yet. Unless the bank wants to needlessly impoverish Australians, and keep going until it pushes them out of work, it will increase rates cautiously from here on”.

Jonathan Shapiro, AFR, 4 May 2022

“Central banks will be forced into a dramatic “back pedal” and will be considering cutting rates within 12 months just as markets expect policy rates to peak…

That is the view of Macquarie’s global head of strategy, Viktor Shvets, who is of the view a slowing global economy and a winding back of government spending will mean the inflationary forces will subside and economies will need support…Mr Shvets…is widely followed in global markets for his big picture insights”…

James Kirby, The Australian, 29 July 2022

“How much have house prices around the nation fallen by this year? The chances are you’ll guess a number which is dramatically worse than reality…

The reports of the housing price collapse have been greatly exaggerated…

More important is what’s going to happen next. The consensus is that Australian house prices are going to drop dramatically peak to trough.

The estimates have worsened of late with a 20 per cent reversal now a common call.

But what if the consensus is wrong? House buyers waiting for the drop will be punished, investors will miss an opportunity to buy an inflation-protected asset.

Think back – the consensus said interest rates would not change for years. The consensus said oil and coal investments would be the biggest losers. The consensus view can lose you money. In fact it would be downright silly not to allow for consensus forecasts to miss the mark in the months ahead…

Emmanuel Datt is a fund manager at Datt Capital…and manages around $60m of investments and he’s more than ready to fly in the face of conventional wisdom.

“Honestly, I think many of the forecasts out there on house prices are nothing short of ludicrous,” he suggests. He points out that rent rises on the back of a very low vacancy rates makes residential attractive to long-term investors.

Rents are now rising at more than 10 per cent a year offering an inflation proof asset class to long term investors or those who own investment property outright.

Datt says homeowners will respond as they always do when mortgage rates move higher: That is, they will do anything but default: They will cut spending on discretionary items and shop around for cheaper deals, he says.

“This is not the GFC, this is not a recession,” adds Datt. “Household saving rates and balance sheets have improved materially since the Covid crisis.”

He estimates that around half of all households with variable rate mortgages have enough prepayments to service their current loan repayments for two years.

“Where are the factors that would give us this plunge – I don’t see it,” he says…

Economist Nerida Conisbee is… chief economist at real estate agency Ray White, having worked previously with REA, Colliers and Jones Lang.

“For now we are seeing very little evidence that the market will see a sharp correction in pricing – distress is still not evident among homeowners or banks,” she says.

“Of course sentiment has shifted, but I don’t know where these forecasts declines are going to come from,” she says. “The conditions are just not in place for the sort of house price declines that people are putting out there.”

Conisbee cites the lack of hard evidence to date that a serious housing downturn has arrived”.

Simone Fox-Koobs, SMH, 3 August 2022

“On Tuesday, leading banking analyst Jon Mott from Barrenjoey estimated homeowners with about $200 billion in mortgages – about 10 per cent of the Australian home loan market – would be at risk of falling behind on their repayments if official interest rates climbed to 3 per cent.

Mott underlined the risk of mortgage delinquency among borrowers who had borrowed at or near their capacity, singling out those in the high-priced Sydney and Melbourne markets. If the cash rate climbed to 3 per cent and stayed at this level, Mott said, “a large proportion of these customers are likely to become delinquent”, as their financial situation would reach the limits of the stress tests undertaken by banks.

Atlas Funds Management chief investment officer Hugh Dive said he was starting to think the Reserve Bank might not go as hard or as fast as some financial markets were tipping. He sees it topping out around 3 per cent, “potentially with a bit of a pause to see the impact because monetary policy is a very blunt instrument”.

“They don’t necessarily want to send a lot of homeowners to the wall,” he said”.

Our takeaway

Guided by our experiences of the GFC and Covid -19, buyers in the Sydney residential property market have about six months to take advantage of the current correction before animal spirits again cause fellow buyers to stampede its many micro markets.