2023 and Beyond - Some Observations
STAC Capital
Unlocking Opportunities for Businesses, Property Developers & Investors, as well as individual personal financing needs
Heaven knows we’re all happy to see 2022 behind us… boy was it one for the books; some memories include:
STAC Capital Director Mark Trayner shares some of his observations for the year ahead.
Being financiers, we can’t help but focus on interest rates and some Economics 101…
Firstly, it is lovely this time not to see the blame being put on one political party or the either – in every previous rise or fall cycle, the politicians and media seem to love blaming or taking credit for their efforts with interest rates moving – which in most instances is complete and utter BS. Well, that’s not entirely true. Blame can arguably be laid on the Libs for having over-fed the economy with all that freshly-printed cash that did play a meaningful part in the [over-]stimulation and subsequent inflation. But of course, there were two other [probably bigger] factors at play, (1) global inflation of just about everything?(nothing little old Australia can do about that)?and (2) ultra-cheap credit.
On point two –?ultra-cheap credit?– unfortunately for most, we’re now seeing the reality of economic swings (or perhaps roller-coasters this time). The housing market right now is seeing the very stark reality of what drives “supply vs demand”, which is another case of utter BS that most property pundits have argued for as long as I can remember. Australia has a massive housing undersupply issue right now – the rental crisis is widespread, with many renters under severe financial stress and/or struggling to keep or find a roof over their heads; every stat shows that there are not enough houses being built for the existing population, let alone the immigration wave that is undoubtedly coming.
And yet house prices are declining, even though there’s a massive under-supply. Most residential developers have seen a significant drop in enquiry from investors and owner-occupiers. Does that mean that Econ 101 “supply vs demand” is hogwash? Absolutely not. The reality is (and always has been!) that just because you WANT or NEED a home doesn’t mean you are part of the demand side of the equation. You have to be able to AFFORD to buy a home to be part of the demand. Herein lies the problem…
At the start of 2022, when home loan interest rates were 2 – 2.5% when you applied for a home loan, your affordability would get assessed based on principal & interest repayments over a 30-year term with an interest rate of 5.25%, or 2.5% above actual rate, whichever was the higher.
Fast-forward to the end of 2023, banks/lenders have to assess your affordability based upon 3% above the actual rate, which now equates to at least 7.5%, if not 8% or more.
In dollar terms, that means that for a $1m home loan:
Two harsh realities are rearing their heads as a result of this:
Ultra-cheap fixed rates coming off will be the interest rate “thing to watch” in 2023. Rumour has it?(sorry, data seems to be challenging to verify!)?that while “most” people are feeling the pinch of escalating interest rates, about 40% of mortgage holders are still partying hard with 2% fixed rates. They’re still eating out (or ordering Uber Eats!) four times a week, going on lovely holidays, having two new cars in the driveway, and blowing cash like it’s being printed for free by the government!
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But what a hangover they’re going to cop – what will be an almost tripling of their interest bill each month, roughly a 45 to 50% increase in monthly P&I repayments. That’s a smack in the face with a cricket bat if ever I’ve seen one.
When people compare Australia’s RBA rate rises to those of the US and NZ, they usually fail to consider the material differences in how central bank rate movements affect borrowers between the different countries. In the US, most people get a 30-year fixed-rate home loan – so when official rates go up, you don’t feel a thing unless you buy a new home or need to refinance. In NZ, they’ve typically had 90+% of borrowers on fixed rates – maybe not 30 years, but still, there’s a significant lag between central bank movements and hitting the borrower’s pockets. But in Australia, we’ve never seen 40+% of borrowers being on cheap fixed rates – so we usually feel it a lot more and a lot faster, but not so much this time.
What do you reckon will be the impact of all of this on the households themselves, but also the broader economy?
The little shining light out of that is my two cents on where we might be by the end of 2023. Although I’ll caveat this very clearly – I always say that “forecasting is a mug’s game” and that being an economist is kinda like being a weather forecaster – what other jobs can you get it wrong half the time and still keep your job?! I’ve been saying for the last six months that there’s a very good chance of the RBA having to drop again in late 2023 once they realise how much pain they’ve inflicted on the economy by going so hard and fast. Particularly once the massive hangover hits for the 40% of borrowers still partying on 2% fixed rates, don’t bet on rates coming back down by a heap, though – as much as I think the RBA is drunk at the wheel peeking through a blindfold, I highly doubt they’ll want to risk over-priming the economy again.
What does this do for housing demand? Based upon all of the above combined with the countless conversations I’ve had with developers, sales and buying agents, my gut feeling is that CONFIDENCE has been the real problem for most potential buyers. They do have the ability to buy, and investors really should be happy enough to buy given how strong the rental market is, but the uncertainty as to how high-interest rates will go has been holding many back. Hopefully, once the market realises that we’ve just about hit the peak – and the media no longer has a scare-mongering line to run – the buyers should return.
And take note –?if you want to try to pick the bottom of the market?– history has almost always proven, with both property and shares, that?the bottom tends to be very, very short. I’ll bet there will be bargains in the short time between real pain being inflicted and the reprieve being provided, but once the wider market realises there are bargains to be had, that old supply vs demand equation kicks in and jacks the prices back up. Probably not at the meteoric rates we saw in the last two years, but enough for it not to be in bargain territory for long.
As for non-residential property – i.e. most asset classes that get valued based upon a yield (or capitalisation rate)… In our view, it’s all over the place and probably will continue to be. A fundamental point to remember – no matter how much people want to make up reasons for why this won’t apply at this point in the cycle – is that cap rates have, forever and a day, trended with interest rates (note the term “trend” as it’s not an instant nor exact direct effect). If you need to generate investor returns of x% per annum, your debt costs y%, your management fees and all other operating costs are z%, then the most you can pay for a property is a cap rate of [x + y + z]%. With y going up, the cap rate has to go up. Ceteris paribus (all else being equal, i.e. if the property's net rental income doesn’t increase commensurately), the property value MUST come down.
A few observations and thoughts on this on various asset classes and buyer types:
However, it will be a slower hit this time. The last time we saw material drops in commercial property values was during the GFC when the banks forced many sales quickly. Post-Royal Commission, though, banks are complete wussies regarding forcing sales; we won’t see a wave of covenant defaults triggering asset sales this time. Banks will instead lower the covenants for struggling borrowers or waive them together whilst relatively politely requesting their borrowers to do something.
It will be the non-bank lenders that go hard on forced sales. They’re not a large percentage of the commercial investment debt market, though, but they are a very material part of the development site market…
Suffice to say, every loser has a winner.?There will be pain and even a little blood in the streets – but that creates opportunities for those who are ready, willing and able. We’ve had many conversations recently with clients, starting the process to get them ready to be able to pounce when an opportunity arises. Restructuring finances is often not a quick process, so if you try to do it when you want to offer attractive terms to a buyer, you won’t be in the best position.?Prepare for opportunities now.
Get in touch with us to chat about what’s possible.
Interesting article thanks. Agree the property market fundamentals are strong and owner occupier and investor confidence will return to the market once the RBA signals stability (or reductions) in the Cash Rate. Importantly for confidence, we need to see positive media reports filter through when that happens.
Really great article. one of the best
? Project Sales and Marketing Specialist ? at Podium Project Marketing
2 年Good insight. Well written mate!
Partner at Balmain / Private Credit
2 年Great insight Mark????