Sydney property bubble to pop when rates rise, says HSBC

In a research note released yesterday, HSBC economists Paul Bloxham and Daniel Smith predict strong national housing price growth to continue at seven to eight per cent, driven by record-low mortgage rates.

“We see Sydney prices rising by 9 to 10 per cent in 2015 and expect that, when rates do eventually rise, there is now a high risk that Sydney will see price falls,” the economists said.

“Although we do not see a national housing bubble, we believe that growth in Sydney housing prices is currently running at an unsustainable pace and that any further growth is likely to be met by housing price declines in future years, when interest rates do begin to rise,” they said.

A signal of the growing risk of overinflation in the Sydney market is the high level of investor demand, according to HSBC.

Housing loan approvals for investors currently account for a record-high share of new loan approvals in NSW, it said.

“The high involvement of investors suggests that there is a speculative dynamic in the Sydney market that may be worrisome.

“Investors are typically seeking capital gains, rather than rental yield, as Australia’s tax system favours capital gains.

“Investors themselves tend to be lower-risk borrowers, as they typically have equity in another owner-occupied property and have lower loan-to-valuation ratios than first home buyers. In this way, it is not clear that investor involvement is leading to increased financial system risk.

“However, it does seem likely that increased investor activity is driving housing prices to rise faster than fundamental factors suggest they should in the Sydney market,” HSBC said.

Housing prices have risen by 23 per cent over the past two and a half years and are currently growing at 8 per cent year on year.

In Sydney, they are up 33 per cent and rising at 13 per cent year on year.

Meanwhile, building activity is also booming, with national residential approvals reaching a record high of over 200,000 dwellings over the past year.

While the RBA cut the official cash rate by 25 basis points this month, further fuelling investor demand with the promise of cheap money, APRA is monitoring mortgage lenders after raising concerns about the high proportion of investors in the market, particularly in Sydney and Melbourne.

These measures include: the prudential regulator ‘paying particular attention to’ higher-risk mortgage lending such as higher loan-to-income loans, high loan-to-valuation loans, interest-only loans and loans with long terms; the prudential regulator noting that if banks grow their lending to investors faster than 10 per cent, the regulator may consider ‘further action”; and that all new borrowers need to incorporate an interest rate buffer of ‘at least 2 percentage points’ above the loan product rate and a floor of at least 7 per cent, which banks need to consider when assessing a borrower’s ability to service a loan, HSBC explained.

“The challenge to these measures is that the RBA has just delivered a further cash rate cut, which has seen Australian mortgage rates fall to new all-time lows.

“It is unusual in Australia for prudential policy and interest rate settings to be working in opposite directions.

“As the RBA noted last week, it is ‘working with other regulators to contain the economic risks that may arise from the housing market’.

“Time will tell if these measures are successful; however, historically, the interest rate setting has had a far more powerful influence on Australia’s housing market than other factors," HSBC said.