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Economic Update – 10th October 2014

We are compelled to look beyond the headlines and examine the substance about the Australian economy and property market. We find the Australian property market is, on the whole, sound as security and we welcome the RBA’s approach. Nevertheless, as commercial lenders we remain selective, vigilant and maintain conservative loan to value ratios based on independent valuations, just in case of surprises. Such an approach served our investors well through the GFC and beyond.


While The Economist, OECD and IMF inform the world about property market dynamics in different countries, they do not bring attention to the difficulty in comparing statistics across countries and the limitation of the two measures they use to determine if property is under or overvalued, namely price-to-rent and price-to-income.[1] Unfortunately, their information fuels sensationalised media commentary.


Ian Macfarlane, respected economist and former RBA governor, ended his 10 year term in September 2006, a time of rapid appreciation in Australian property prices.  Yet, unlike many countries, Australia steered away from a property price collapse in part, due to the efforts of the RBA under Ian Macfarlane’s stewardship.

Ian Macfarlane’s comments are worthy of careful consideration. In 2011 he lamented the “bias towards sensationalism” by many financial media commentators and “their tendency to concentrate on pessimistic news”[2]

In May this year, Ian Macfarlane had the following to say, ”Small problems are really exaggerated.  The financial press and others tell a more compelling story about a crisis than the muddle through story. People who have held a steady course have done a lot better than people who are too influenced by the scare stories“. His comment on property prices was, “I think we faced a risk in 2003, not 2014. In 2003, we had lending for housing and prices rising at 20%, half of it speculative lending, negatively geared.” [3]

Property prices will fluctuate, that’s normal. The RBA points to inner city Melbourne apartments and Sydney’s CBD inner fringe as locations at risk.[4]But overall, the property market can avoid Australia wide extreme fluctuations as a result of the RBA’s and APRA’s pre-emptive actions – both have proven to be better managers than most other central banks and prudential regulators.


Are Australian property prices reasonable? The question is addressed in a recent RBA research discussion paper that compares the cost of renting and buying as a way to determine if property prices are reasonable.

[5]The RBA Research Discussion Paper concludes:

Recent data do not show signs of a bubble”.

The Economist and OECD estimates vary widely.  For example, the OECD estimates overvaluation by between 30% and 50%.[6] Such large variation suggests incomplete analysis, although in fairness, they intend their information to be thought provoking rather than conclusive.

While financial commentators seek media exposure, the RBA is required to make sober assessments. The RBA research discussion paper concludes the following about The Economist and OECD measures.


About the price-to-income ratio as an indicator, “Being told that a house is expensive relative to incomes does not tell you whether the purchase is sensible. For that decision you need to know the cost of the alternative”.


The data series used to compare prices to rent makes erroneous comparisons by including owner occupied housing in the ratio.  Owner-occupied housing tends to be larger, more expensive and that distorts the ratio.


An RBA interest rate hike would stymie the pick-up in dwelling construction just as it has started to replace some of the gap left by the decline in mining investment and risk a devastating appreciation of the AUD as exporters finally have some relief – low rates will remain the norm while our economy adjusts from mining-investment growth.

In the first instance, the RBA aims to frighten speculative investors with their public comments. Recent comments suggest the RBA and APRA are alert just like they were a decade earlier. Ten years ago, Australia’s banks were effectively influenced by regulators such as APRA and the RBA, a US subprime market did not develop. Much of the resilience of the overall Australian property market can be attributed to effective regulation.


Recent RBA comments regarding macro-prudential policy look forward and aim to prevent localised bubbles without using higher interest rates. APRA does have powers to undertake such targeting under the Basel III framework – we will find out how they will use their powers at the end of 2014 when a policy announcement is expected.


A forward looking loan-loss provisioning model, aimed at addressing the shortcomings in changes to international accounting standards, was mandated by APRA in 2006.

The policy requirement dampened the impact of deteriorating credit conditions during the GFC.  International Accounting Standards Board, IAS 39 Financial Instruments: Recognition and Measurement, December 2003, delayed recognition of losses until financial assets are close to default. To address this shortcoming, APRA has maintained a forward looking provisioning model to capture expected future credit losses in a bank’s business. [7]Australia’s early adoption of Basel III capital requirements was one positive outcome.


The RBA’s actions are a measured response reminiscent of actions taken a decade ago. The strong reluctance to increase interest rates has driven discussion of unconventional intervention. Australia’s regulators are hyper-vigilant and responding far more quickly than they did ten years earlier, given the memory of the GFC is still fresh in their minds – This a reasonable interpretation of the RBA’s comments when considered with the Minutes of Monetary Policy Meeting, the RBA Bulletin and Financial Stability Review.


Edey and Ellis of the RBA stated “the ratio of housing prices to incomes is at the top of its historical range; but over time, this has been more than offset by falls in financing costs, so that the typical repayment burden as a share of income is not particularly high. This of course does not rule out affordability problems in particular market segments or for particular types of households.”[8]

Credit Connect Capital continues to monitor the condition of the property market, remains selective in the transactions it shows investors.

Commercial lenders mitigate the risk of property price fluctuations by lending with a suitable loan to value ratio determined by an independent valuation. 

Our examination of the Australian property market suggests the RBA and APRA’s actions are likely to result in a continuation of a market that is in the main favourable for skilled commercial lenders.

[2]Ian Macfarlane, Economic News Do We Get Too Much Of It?, Speech Mosman Art Gallery 10 June 2011, 3.50mins-7.10 mins

[3] Ian Macfarlane,  Interview at Morningstar Investment Conference 15 May 2014, Source:  http://cuffelinks.com.au/

[4] Financial Stability Review, September 2014, page 44, source: www.rba.gov.au

[5] Fox and Tulip, Is Housing Overvalued?, Research Discussion Paper, June 2014, www.rba.gov.au

[6] http://www.oecd.org/eco/outlook/focusonhouseprices.htm

[7] Cummings and Durrani, Effect of the Basel Accord capital requirements on the loan-loss provisioning practices of Australian Banks, July 2014 – Centre for International Finance and Regulation

[8] Edey and Ellis, Opening Remarks – Inquiry Into Affordable Housing, 2 October 2014, http://www.rba.gov.au/speeches/2014/sp-ag-021014.html

Disclaimer: This information does not take into account your individual objectives, financial situation and needs. You should assess whether the information is appropriate for you and seek specialist advice from a qualified and licensed advisor.

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