Over recent weeks, we have observed a wave of activity in the major Australian property markets that suggest the recent downturn may well be over. At the heart of the apparent resurgence, as is usually the case, is: policy, policy and more policy.
First on the monetary side of things, policy from the Reserve Bank of Australia (RBA) has resulted in the lowest cash rate on record, at just one percent. All else being equal, lower interest rates will push up asset prices. There are a number of ways to think about this. Financial analysts will think about the effect a lower discount rate has on the future cash flows generated by any asset. Simply reducing the discount rate by, say, one percent (forever) on the set of rental cash flows that a property will generate in the future could increase its value by more than 50 percent.
The other way to think about the effect looser monetary policy has on asset prices is to conceptualise a greater supply of money (which is a corollary of lower interest rates) chasing the same quantity of assets in an economy. Naturally, asset prices are bid up.
Second, we have macroprudential policy which, in Australia, is effected by the Australian Prudential Regulation Authority (APRA). Among other financial institutions, APRA oversees the Australian banks and recently moved to loosen the rules around serviceability tests for mortgage applications. This is another impediment removed by policy makers to enable the creation of more mortgage credit in the Australian property market.
And third, we have fiscal policy. Or in this case, following Labor’s defeat at the recent federal election, the elimination of the prospect of certain tax policies (around negative gearing, in particular) designed to reduce the incentive to invest in property.
Putting this all together, it’s hard to argue with the Aussie property bulls who contend that our policymakers have returned to being aligned and supportive of renewed housing price appreciation.
Do our policymakers even have a choice? This is an interesting question asked far less frequently.
On monetary policy, how can the RBA do anything other can keep interest rates low? Inflation is nowhere to be seen. And with stagnating domestic wages and an aging population, wouldn’t you expect disinflation to persist?
On the fiscal side, the election result effectively locked in favourable tax incentives for property investors. Said another way, any move to now reduce these tax incentives for negative gearing would be political suicide.
And what if property prices in Australia’s major cities were to fall for some other reason? The extent of the financial leverage on the balance sheets of Australian households today means that there would be very negative knock-on effects to the real economy. Lower property prices could well translate into reduced consumption and higher unemployment rather quickly. This, in turn, would force the RBA and the federal government to step in with even more supportive policy stimulus.
Indeed, it would almost appear that we have passed the point of no return – that the only choice is to keep going. This is great news for Aussie property bulls. Longer term, however, this may not be great news for Australia. Splitting society between those who own property and those who don’t (and increasingly may never due to near-impossible affordability metrics) will create a very different Australia to the one in which most property owners grew up. We are also much more likely to misallocate our nation’s resources (to relatively less productive property speculation, for instance) and, taking things to an extreme, we may well face a painful property bust at some point down the road.
Andrew Macken is Chief Investment Officer with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.