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Friday, 25 September 2015

Foreign capital helps drive record household wealth

Vital organs

Having grown up in the United Kingdom I can recall there were strong television marketing campaigns for folk to carry donor cards so that in the event of untimely deaths their organs could be used to help others live.

Despite this push, until recently only around a quarter of Britons effectively consented to organ donation. 

On the other hand the effective consent percentage has been close to 100 per cent in some European countries with similar cultures, including Austria, Sweden, Belgium, France, Portugal, Poland and Hungary. 

Is this because Brits are thoughtless and uncaring when compared to those on the continent? Hardly!

The real reason is that as Poms we've had to opt in to consent to organ donation while the inhabitants of the other aforementioned countries must instead opt out.

It's an interesting observation of behavioural economics that when faced with challenging and emotionally complex decisions we often lurch for the default option or the perceived safety of following the herd. 

Not opting out

As an analogous observation it has been fairly common for employees in Australia to choose superannuation fund managers based upon the default recommendations of their employer - checking the default option box without due consideration of the fund's past or likely future performance.

Interestingly a somewhat similar dynamic is impacting Aussie housing market right now, and in turn therefore the Aussie economy.

Mortgagees are often inclined to shop around or push for discounts when interest rates are rising, but when borrowing rates are declining - as they have been now for some years - borrowers can tend towards a much more laissez faire or "set and forget" approach.

With the cash rate having been slashed from 7.25 per cent to just 2 per cent since March 2008 existing homeowners have benefited from an enormous mortgage affordability dividend.

In the process it has transpired that a large number of Australians have taken what is effectively the default option of allowing their mortgages to be paid down at the same rate as before the financial crisis.

In turn this uniquely Australian dynamic has generated aggregate mortgage buffers on an scale unprecedented for this country, with the average home loan up to 30 months ahead of schedule depending upon your preferred data source.

Of course more recent entrants to the market have not experienced this luxury, although they have often accessed borrowing rates close to record low levels.

As a result of he above repeated cuts to the cash rate have not to date generated the boost to household consumption that might have otherwise been expected, which itself has served to maintain downward pressure on interest rates.

Gearing ratios decline

The latest Finance & Wealth figures from the ABS released this week for the period to Q2 2015 showed that the debt to assets ratio of Australian households has actually been declining for more than three years now from a peak of 22.1 per cent to 20.5 per cent.

Naturally rising share markets (until earlier in this calendar year at least) and house prices in Sydney and Melbourne have accounted for much of the decrease in the gearing ratio.

Similarly the ratio of residential mortgage debt to land and dwelling values declined further in the June 2015 quarter to 28.4 per cent from a peak of 30.7 per cent in Q3 2012.

Foreign capital 

Growing aggregate mortgage buffers have played a key role here, but perhaps so too has the volume of foreign capital pouring into our property markets since 2013.

We do know for certain that the value of approved foreign purchases leapt in FY2013/14, but data released by both APRA and the ABS in the past week has implied that significantly more foreign capital may have leaked into Australian housing.

The Foreign Investment Review Board's FY2015 Annual Report is due to be released soon, which will shed some further light.

Since dwelling prices are driven and set by leveraged activity at the margin - and because only a small fraction of the dwelling stock typically transacts in any given financial year - it is of course easily possible for total asset values to be driven higher by comparatively smaller increases in debt.

However the data over the past three years nows shows that residential land and dwellings asset values (+$1,245 billion) have outpaced the increase in mortgage debt (+$273 billion) by a surprisingly high ratio (4.6 times).

Although the figures not directly comparable for a range of different reasons, this is materially higher than the equivalent ratios we saw in the heady three years to December 2007, for example, while accounting for the fact that today we are springing forth from a higher base.

Although it is impossible to measure accurately this suggests to me that the level of foreign capital leaking into Australian housing markets may be somewhat higher than is commonly reported. 

Record household wealth

The ABS data series estimated the net worth of Australian households surged by +$225 billion over the June quarter to be 13 per cent higher than one year ago.

Remarkably household net worth has now jumped by +65 per cent to $8.4 trillion since the Q3 2009 nadir of $5.1 trillion.

It has been a torrid year to date for Aussie share markets with equities, superannuation and other financial assets essentially contributing zip to the net gains in household wealth this quarter.

On the other hand residential land and dwellings values ripped by a staggering +5 per cent in recording the largest quarterly gain since Q4 2009, adding another quarter of a trillion dollars to be a whopping $0.6 trillion higher than one year ago. 

Put differently, rising property markets accounted for more than 100 per cent of gains in Australian household wealth over the June quarter. 

It was widely opined that housing would be a dud asset class post financial crisis, yet since Q4 2008 the total value of residential land and dwellings has burst higher by well over $2 trillion.

The gains in the June quarter were driven by an explosion in land and dwelling values in New South Wales - refer here for my analysis of the Residential Property Price Indexes for Q2 2015.