Death spiral for the housing market

East Coast residential property continues to soften as credit tightens, but in this interview with Charlie Jamieson, CIO at Jamieson Coote Bonds, he warns that property investors might make matters worse by becoming forced sellers in a falling market.

Charlie outlines the mechanics of margin calls and forced selling, and told us that: “…not a lot of people have that excess liquidity readily available, so they need to sell and they need to sell in a hurry. And if this happens en masse, clearly you can see the death spiral effect occur very quickly”. He also flags a catalyst in February next year that could see credit contract further still. Watch, or read on, for the full story. 

Edited transcript 

“So the Aussie economy is actually doing okay. It's a bit of an idiosyncratic economy in that terms of trade remain very good, unemployment has come down, which is welcomed. We still haven't got those wage gains that everyone is hoping for. 

We're just starting to see them in the U.S., but everywhere else in the world once we've got below what we consider to be full employment, they haven't materialised in this cycle, and so we're still probably a long way from getting that in Australia. 

There are reasons for cautious optimism, I guess, we've got a Federal election and two state elections coming up. You would expect there would be some fiscal spending to try and buy your vote, so that does help things like infrastructure and the like, it should help the employment picture. 

But on the flip side, we've got a material tightening in credit conditions that we haven't seen in a long time, where credit growth will go from something like 5% or 6 %, we estimate down to 2% or 3%, and clearly that takes a lot of velocity out of the economy. Now we're already seeing that have a material effect in East Coast housing markets that are in decline and look to be continuing into decline. 

And so it's really a balance and a trade-off between these two type outcomes where, whilst the global cycle continues to roll on, albeit late, Australia is participating and that's welcome. But at the same time we have our own story. 

We have the second highest household debt levels in the world. We are going through these incremental out of cycle rate hiking lifts, and that's because of the international cost of capital going up, we've spoken a lot about that previously. 

Plus we're getting this tightening in credit availability, and that's probably going to get tighter when the findings of the Royal Commission come out in February 2019. So a real balance there. 

The difference could be the need for forced sellers to sell property. 

Those leveraged property investors, if they are forced to sell property quickly because their portfolios are being revalued, or they simply can't make the switch from interest only to principal and interest, that can cause an asymmetric dislocation, and we have to be very careful around that. 

Australia's unusual in the way that it allows borrowers to essentially have floating collateral over a series of loans and so, everybody knows the story very well, they buy an investment property, the property price goes up, they can release some of that equity and they can go on and buy another property, and it's a very, very virtuous investment theme and structure whilst the market is rising. But it's powerful, equally, in reverse. And so if banks get concerned that property valuations have slipped a material level, there can be a request for additional equity to be put up against the loans. 

Or certainly if investors feel that they're running out of availability and they do start to sell off parts of those portfolios, there is a bit of a slippage between what borrowers can now borrow, the numbers are between 20 or 30% lower as the result of this very tight due diligence coming out of the Royal Commission where essentially expenses are really heavily critiqued by banks now. That should very simply lead to material recalibration, as we're already experiencing. 

It's that off-the-plan buyer which is probably the most likely to be caught in this forced selling situation where, they've made a commitment a few years ago, whatever the time has been, on the expectation that they could borrow X amount of dollars. And when they come to actually settle the bank says "well we can now only give you 70% of X", and that leaves them, obviously, with a material shortfall. 

The problem there is that it's already into a declining market, and so they're going to have to make this difficult choice, do they stump up the extra cash, do they find the excess liquidity. We believe that not a lot of people have that excess liquidity readily available, or do they need to sell and they need to sell in a hurry. And if this happens en masse, clearly you can see the death spiral effect occur very quickly. 

Now we did see this in New York and London, in the GFC, where you get some really wacky outcomes versus what people have experienced in the prior 12 or 18 months, but it's a function of the fact that these must trade and the economics of it is really not in question, it's a matter of getting yourself out of a very tough bind and avoiding that repossession moment or that bankruptcy moment. 

And that's forced selling, and it's a horrible thing when it happens to people, but it can really have a very asymmetric outcome on markets and pricing”.

Further insights

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