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Thursday, 20 July 2017

ABC Lateline: Modelling the downturn

Modelling downturns

Housing market modelling shows that a more responsive supply of property to rising prices tends to generate dynamics that can ultimately lead to financial distress.

In Sydney's now-record construction boom this is most likely to mean markets on the city fringe where land is abundant, and the high-rise apartment sector of the market where the sky is almost literally the limit to the response in supply.

The overhang

Why is this so?

The short explanation is that in supply responsive markets large volumes of property are built during the boom period, thus creating a larger overhang of excess dwellings when the market turns down.

This alone can amplify the downturn in prices.

And since by definition more people will have bought near the peak of the market cycle, then more of the loan book is accounted for by borrowers that are liable to experience negative equity, magnifying market risks. 

Time-to-build lags add to risks

Where time-to-build lags are longer in highly responsive markets the impact on loan performance can be exacerbated.

That is, where supply is highly responsive to rising prices but production delivers new housing supply over a longer period. 

This implies that some of the greatest risks are likely to be in the new apartment market, particularly in inner city Brisbane.

Characteristics of loan contracts

In Sydney's case, there is a further concern that if homebuyers are borrowing up to $1 million to buy new homes on the city fringe, then rising interest rates could eventually cause financial distress.

Housing market models unanimously show that the trajectory of interest rates during the downturn is likely to be pivotal in determining the extent of negative equity. 

Note that in Australia many investors have used interest only loans to fund purchases, which due to APRA's new regulatory measures may now be flipped into principal and interest loans at the end of the initial interest only period. 

I discussed this in a summarised fashion on ABC Lateline last night (click image to view video). 

Obviously this is a short excerpt from a considerably longer interview.

The statistical analysis sitting behind our views of the risks broken down to the LGA level can be found in our market reports