APRA signals action for Strata Fund Investments
Updated: Feb 8, 2022
Last month, the Australian Prudential Regulatory Authority (APRA) has signalled what could be the most significant turning point in Australia’s favourite asset class, property, with news this week that it has mandated a higher interest rate to be used by lending institutions (or ‘serviceability buffer’) when considering mortgage applications for residential home buyers and investors.
This has come about after an astounding 20+% rise in national house prices over the last year, flying in the face of the pundits who predicted severe economic concerns during the pandemic. Given the release of Australia’s two biggest economic states from lengthy lockdowns, it is also quite timely, as they run straight into the usually bubbly spring real estate season.
Whilst it is easy to imagine issues with some sectors of the economy, others have had little impact on their incomes. This cohort appears to be leveraging their unspent overseas holiday and pricey dinner surplus into either upgrading their own home or adding to the collection of investment properties. As debt increases, so does its ability to jeopardise the stability of the banking system.
The lifting of the serviceability buffer is material on several fronts. It decreases the borrowing power of the borrower by around 5%, meaning a decrease of $36,000 on the average Australian home loan of $730,000. More importantly, it also means that the Reserve Bank of Australia (RBA) has, for the foreseeable future, stepped down from its secondary role in moderating house prices (its primary role being to influence unemployment and inflation) and handed the reigns to APRA.
The setting of the serviceability buffer this week falls under the broad church of what is called ‘macroprudential regulation’, where more targeted policies are put in force to stabilise and protect various areas of a financial system as required. Whilst the idea of such regulation has been around since the 1970s, the post GFC period is a particular instance where such measures grew in relevance.
This is not the first time we have seen macroprudential policies at work in Australia in the last decade, with other forms, such as limits on debt-to-income levels and caps on lending for investment properties being used in 2014 and limits on interest-only loans in 2017. Both arguably worked (in the absence of comparison, of course) in stabilising and slowing high levels of lending to this cohort of borrowers.
The interesting part this time around is the focus on the actual lending rate itself (now fixed at 3%) instead of previous attempts, such as capping investment interest-only lending to 10%, like in 2017. This tells us that APRA’s view is twofold, interest rates are likely to either remain at present record low levels or potentially fall further, and now a synthetic constraint needs to be applied to arrest the ballooning household debt issue. It also reveals that the problem is overarching across the whole property sector, not just those pesky investors pushing up prices.
Central bank limitations
It is safe to say that the RBA has had its hands full over the last couple of years. That might be an understatement. The enormity and severity of the pandemic’s effects on Australian incomes (in aggregate) are challenging to plan for, even with the skills and experience possessed by the entity at the core of the Australian financial system.
On the one hand, it is reasonable to affect the dramatic drop in interest rates to lessen the debt serviceability costs on the economy. This helped by diverting these savings into gaps in revenue and income caused by lockdowns and temporary business closures. It appears to have worked well in conjunction with record fiscal (government) stimulus measures to both households and businesses.
The knock-on effect is, of course, that many Australians, mainly white-collar workers and businesses, have seen little impact to their incomes and revenues as they soldiered on from their kitchens, benches and settees. In fact, for many, the broad and immediate stimulus measures have meant a rise in revenues and wage increases, along with higher profitability from cost savings (think downsizing offices) and increased productivity (longer work hours from home without the drag of commuting).
This surplus, unsurprisingly, has to lead to higher asset prices, both powering the dramatic reversal of the sharemarket falls in March 2020 and the ability to lever up savings when considering a house purchase. As house prices have risen, so has borrowing levels, with 20% of new loans in the June quarter borrowing more than six times their pretax income. Clearly, something needed to be done.
This is where the job of the RBA now bifurcates, as its primary mandate of targeting low unemployment and controlling high inflation conflicts with the runaway asset price bubble it has created. New measures need to be put in place, and so we see APRA having to move in.
What lies ahead for strata fund investments
We are not going back, not to historic mortgage rates, not to ‘reasonable’ rates of return on cash and other instruments like term deposits and not to the way it was.
This week’s return to macroprudential policy marks what could be the next chapter in Australian financial management at the highest level. A new paradigm of record low (or even negative) rates to help ensure stability for Australian financial institutions and their margins has been, at least for now, locked in by enforcing controls at the mortgage shop floor rather than the supply line in preparation for a prolonged period of near-zero rates.
So now the question remains, how much longer can Australian savers accept the near-zero returns on long term capital? New strategies will need to be adopted to ensure that the impacts of the pandemic and its lasting effects on local and global investment returns are mitigated for the foreseeable future.
As a lot owner, financial controller or just strata committee member, there has never been a more appropriate time to reflect upon the investment plans for your long term capital works, maintenance, reserve or sinking funds. With the advent of protracted low returns (or even negative returns once inflation has been taken into account) from cash and term deposit investments, it is high time to consider any alternatives.
Strata Guardian is here to help. We have recognised this issue for a long time and prepared a series of portfolios directly targeting the needs of the Australian Strata Community. Get in touch, book a callback or send us an email to start the discussion on how we can help you now.