There’s a new breed of investors using interest-only loans from the four major banks to speculate on the property market - and it’s worrying financial analysts and regulators.
Interest-only loans to property investors have grown significantly over the last few years. In 2012, such loans tallied around $88.7bn, but ballooned to around $155bn by 2015, according to the Australian Securities and Investments Commission (ASIC).
In the past, interest-only loans were often seen as being too risky, and homeowners and investors looked to pay back such loans as quickly as they could. Interest-only loans currently account for about 40% of all lending to property investors, according to John Abernethy, chief investment officer at Clime.
Analysts like Abernethy are concerned because very little thought is being given to how such loans will be repaid, and many investors are recklessly betting that property prices will just keep shooting up.
But what happens when prices eventually stop growing and start declining? And how would investors cope with higher borrowing costs when the lenders revise their interest rates?
Clime took a closer look at the Commonwealth Bank of Australia’s latest profit result, noting that interest-only loans have grown from 37% of residential assets to 40% in the past year.
“No one should be deluded,” Abernathy told The Australian Financial Review. “Excessive residential property prices, driven by greed, envy or excessive debt, will not create a good outcome for Australia.”
Abernethy said that the astronomical growth of house prices along the southeastern seaboard is due to a toxic mix of factors: envy, greed, the poor regulation of debt, excessive taxation breaks for property investment, lack of restrictions governing non-resident investment, population growth and high immigration, poor infrastructure development, poor urban planning, and uncoordinated land release.
The local economy is also generating more part-time employment, which encourages many investors to take out more of these seemingly cheaper, interest-only loans.
Abernethy warns that the party can’t go on forever. “High residential property prices may be maintained for long periods when governments and regulators support them, but eventually either affordability or intrinsic value will bring prices down,” he said.
Record low interest rates, borrowers’ borrowing capacity, and investors’ expected yields all combine to make up the intrinsic value of a residential property. Rate changes can also change the value of a property.
There have been plenty of property booms and busts over the years, including a credit squeeze in the early 1960s that led to a boom in the 70s, particularly in CBD office space, said Abernethy.
Higher interest rates were the downfall of all these property booms. In the current environment, with interest rates set at record lows and poised to rise again in the near future, many experts, including Abernethy, are worried about the rampant speculation in property, and what a major hike in interest rates would do to house prices and the economy in general.