Property

Auction clearance rates fell sharply across most capital cities as the first interest rate rise in more than 11 years unnerved buyers who are worried about the impact of higher mortgage costs on their household budgets.

The slowing market also spooked vendors who have started to pull out in droves, data from CoreLogic shows.

A week after the RBA raised the official cash rate, Sydney’s preliminary auction clearance rate dropped by 3.6 percentage points to 58.7 per cent, the weakest result in two years.

In Melbourne, early results showed the clearance rate tumbled by 3.8 percentage points to 64.6 per cent, the lowest preliminary result since December.

Average preliminary results across all capital cities dropped 2.5 percentage points to 64.7 per cent, the lowest level this year.

‘‘The interest rate decision has put further pressure on the housing market, which was already slowing prior to the rate rise,’’ said Tim Lawless, CoreLogic’s research director.

‘‘Rising interest rates and high inflation are eroding household balance sheets, which is causing buyers to pull back.

‘‘The correlation between clearance rates and the pace of value growth is really strong, so the falling auction clearance rates portend declines in prices, particularly in Sydney and Melbourne.’’

SQM Research managing director Louis Christopher, said the rise in the cash rate and the prospect of further interest rate increases had turned sentiment towards the housing market negative.

‘‘Fewer buyers would enter the market as it becomes more difficult to qualify and service a big mortgage,’’ he said.

‘‘The overall hurdle rate to test home loan applicants will go up and disqualify an increasing number of would-be home buyers and investors, and this in large part is what is going to drag the market down for the rest of 2022 and perhaps beyond.’’

SQM Research is expecting Sydney house prices to decline by 7 per cent this year, Melbourne by 8 per cent and nationwide by 4 per cent.

As Sydney’s clearance rates continue to weaken, more vendors are withdrawing from the auction market, according to CoreLogic. The proportion of homes withdrawn this week has surged to 25 per cent, the highest level since April 2020, around the start of the pandemic.

‘‘We’re seeing more auctions being pulled from the market and not being rescheduled,’’ said Mr Lawless.

‘‘Since the middle of February, more vendors are shunning the auction market. People who have been looking to sell their home by auction are simply pulling out of the market as conditions start to deteriorate.’’

Sydney-based auctioneer Clarence White said it was becoming harder to get buyers to bid at auctions.

‘‘I’ve really noticed that when there are only a small number of bidders, like what we’re seeing now, people back away very quickly and they hesitate to bid,’’ he said. ‘‘Buyers’ confidence is very low at the moment.’’

Jack Henderson of Henderson Advocacy said vendors were also becoming nervous about selling.

‘‘There are a lot of anxious sellers in the marketplace and some are probably making irrational decisions around the price that they’ll take for a property,’’ he said.

‘‘For buyers, this opens up a great opportunity because this is the peak of the uncertainty for both vendors and other buyers, which means you can take advantage of people’s emotions as a buyer.’’

In contrast to the weaker auction results in Sydney and Melbourne, Adelaide posted an 81.2 per cent preliminary clearance rate, the highest across all capitals. Canberra cleared 75 per cent, while 62.7 per cent sold at auctions in Brisbane.

Among the sales in Brisbane was a five-bedroom house in Ashmore on the Gold Coast that sold for $3.65 million at auction.

Lower demand for housing as a result of higher interest rates and tighter lending is more likely to trigger faster and deeper price falls than any widespread mortgage defaults caused by the rising cost of credit, experts say.

‘‘An increase in the official cash rate would reduce demand for new mortgages and therefore property prices,’’ Eliza Owen, CoreLogic’s head of research, said.

‘‘Higher mortgage rates might put some people off purchasing while prices are still quite high, so prices are more likely to come down off the back of successive increases in the cash rate.’’

Some economists are forecasting interest rates to rise by 1 percentage point by the end of the year and by another percentage point next year, with the first increase tipped to come as early as Tuesday.

A calculation by comparison site Rate City shows that a 1 percentage point rise in the cash rate would slash borrowing capacity for someone earning $100,000 a year by $75,600 and a couple earning a combined salary of $150,000 by $111,100. A 2 percentage point lift would limit a single borrower by $139,700 and would cut a couple’s mortgage amount by $205,400.

‘‘Anyone borrowing at capacity will see their budget shrink, which could be enough to cool things down, particularly in property hotspots such as Sydney and Melbourne,’’ Sally Tindall, RateCity research director, said.

‘‘Rising interest rates will significantly decrease how much the bank will let people borrow. This will have a flow-on effect on property prices, as many prospective buyers will no longer be able to bid as high.’’

SQM Research managing director Louis Christopher said rising mortgage rates and higher assessment rates could knock potential buyers from the market.

‘‘Buyers tend to stay away from the housing market when rates are rising, but more people are going to be rejected by the banks because they haven’t met the higher servicing test,’’ he said. ‘‘Fewer buyers will definitely qualify for a loan if interest rates rise by 2 per cent.’’

Rough estimates by AMP Capital suggest that a 1.5 percentage point to 2 percentage point rise in mortgage rates would reduce home buyer borrowing power and the ability to pay for a house by 10 to 15 per cent. ‘‘Demand for housing is going to be affected immensely, simply because people won’t be able to borrow as much as they did in the past,’’ Shane Oliver, AMP Capital chief economist, said.

‘‘This will have a greater negative impact on prices than defaults by existing mortgage holders because many households are already ahead of their repayments and still pay lower interest rates than new borrowers.’’

Maree Kilroy, senior economist with BIS Oxford Economist, said the buildup in household savings and strong economy would reduce the risk of homeowners defaulting on their loans.

‘‘The risk of homeowners defaulting, which would cause prices to fall more than expected, will likely be mitigated by a strong jobs market,’’ she said.

‘‘We expect the unemployment rate forecast to hold below 4 per cent and almost two-thirds of owner-occupiers have increased their mortgage payment buffers since the onset of the pandemic.’’

Tipping point The double-digit growth in unlisted real estate funds thanks to cheap money could be coming to an end, particularly for newer releases, writes Duncan Hughes.

Unlisted property funds have blitzed other asset classes to generate returns of more than 20 per cent over one and five years by using record low interest rates to invest in retail, commercial and industrial properties.

But some analysts are concerned that accelerating performance with high levels of gearing could create problems for recently launched funds, with tight lending conditions if interest rates begin to rapidly rise.

Unlisted property funds generated returns of almost 22 per cent in the year ended December 31 (the most recent analysis) compared to about 20 per cent for real estate investment trusts (REITs) investing in local property listed on the Australian Stock Exchange and about 18 per cent for shares.

‘‘The period of turbo-charged growth fuelled by cheap money will end as interest rates rise,’’ warns Dugald Higgins, head of responsible investment and real assets at Zenith Investment Partners.

Kevin Prosser, research manager of direct assets at Lonsec, an investment and ratings group, says overall gearing is ‘‘reasonable’’ at 40 per cent to 45 per cent of assets under management.

A high gearing ratio means a trust has a larger proportion of debt compared to equity. A low gearing ratio means the trust has a small proportion of debt versus equity.

Prosser says managers are aware of the potential impact and many have hedged against the risk for up to three years, fixed rates with their lenders or are reviewing potentially vulnerable variable costs.

Potential problems are likely to come from recently launched funds involved in construction projects that might not have hedged their borrowing and are facing rising costs, or disruptions, because of shortages in the building sector, say analysts.

There are estimated to be about 600 unlisted property funds with assets totalling about $20 billion, says Zenith’s Dan Cave, a senior investment analyst.

At least 30 funds are estimated to have been launched in the past 18 months with assets totalling about $3 billion. These include about 12 office funds, five retail and four industrial funds with the remainder a mixture of sectors.

Listed property trusts and unlisted funds are similar to the extent that investors contribute capital for a share of the assets either in shares (for listed) or units (unlisted).

Investors receive income (called distributions) and, if asset values increase, a capital gain on their original investment from either the rising share price (for listed) or the sale of the asset (for unlisted).

Listed funds typically yield 3-6 per cent and unlisted about 6-8 per cent. The premium is because there is little or no liquidity.

Property Funds Association analysis shows that unlisted funds rebounded from the pandemic, helped by low rates, economic growth and a recovery in corporate earnings.

Performance was underpinned by buoyant rental income that was boosted by recovering rental incomes for assets that had been affected by the COVID-19 lockdown.

Surging property prices for industrial and logistical property, particularly warehouses, more than doubled total returns to about 30 per cent.

Prime industrial rents are expected to increase about 11 per cent this year (more than double the growth in 2021) and to keep rising at double-digit rates over the next three years as the e-commerce boom drives up demand for warehouse space, analysis by CBRE and JLL shows.

Total returns for offices nearly doubled to more than 9 per cent as employees returned to work as lockdowns eased.

Retail, which slumped by more than 10 per cent in the pandemic, bounced back to post 6 per cent growth.

Strong price growth means capitalisation rates (a key measure for investors calculated by dividing net operating income by property value) are at historic lows for most markets.

Investment adviser Alex Jamieson, founder of AJ Financial Planning, says investors need to consider the impact of rising interest rates, particularly for aggressively geared funds involved in building projects under pressure from sharply rising costs.

Interest rate increases are likely to be rolled out over the next year or two and for many funds the impact could be offset by earnings recovery as the economy strengthens, according to analysts.

For example, higher wages might be inflationary but could boost demand for retail assets as retail spending among low and middle income earners increases.

But Zenith’s Higgins says: ‘‘There are many funds we feel that are high-risk propositions when considering that we are probably coming out of a high-growth environment and entering a period where the easy gains from rising markets will be harder to come by.’’

Higgins believes many smaller operators are underestimating the challenges and costs involved in achieving the higher benchmarks for sustainability required by tenants and potential future buyers.

‘‘We are essentially at a point where any company or fund that cannot demonstrate deep environmental, social and governance credentials, which naturally spans a wide range of sustainability and social issues, will simply be ‘uninvestable’ to institutional investors,’’ he says.

‘‘We know from experience that many businesses with less in the way of resources to devote to these disciplines are increasingly at greater risk of being stranded by capital markets that are demanding greater transparency on how these issues are addressed.

‘‘These views are likely to increasingly flow down to retail investors as scrutiny on these

House prices in some suburbs on Sydney’s northern beaches and the Gold Coast have doubled every three to four years in the past decade, fuelled by low levels of stock and a growing number of affluent buyers, data from Suburbtrends shows.

The more expensive housing markets with the median price above $2 million also outperformed, gaining 13.3 per cent each year on average in the past 10 years. This is more than twice the capital growth of 4.8 per cent posted by the affordable end of the market with a median price under $500,000.

‘‘The premium end of the market performed strongly in the past decade, driven by scarcity, being located near the beach or the harbour,’’ said Kent Lardner, director of Suburbtrends.

‘‘Housing inventory levels in these suburbs remained very low, especially in recent years. The increasing levels of wealth and low interest rates have also created near perfect conditions.’’

The number of ultra-rich Australians with net worth of $US30 million ($40 million) or more surged by 124 per cent over the past five years, and they allocated nearly a third of their wealth to their homes or second dwellings last year, according to estate agency Knight Frank.

House prices in suburbs within the Manly area such as Balgowlah, Balgowlah Heights, Clontarf, Fairlight, Manly and Seaforth surged by 21 per cent each year on average during the past decade – essentially doubling every three years and five months.

House values in the Broadbeach area on the Gold Coast have also doubled within four years, after surging 19 per cent each year on average in the past decade.

House prices in Broadbeach Waters, Burleigh Heads, Burleigh Waters, Mermaid Beach, Miami and Broadbeach jumped by 42 per cent to $1.6 million in the past year.

‘‘Many of the commutable coastal locations boomed in the past 10 years, and in the case of those near Sydney, we did see the ripple effect shifting demand from the eastern suburbs, spreading over to the north shore and up to the Central Coast,’’ Mr Lardner said.

‘‘It is normal to see price gaps start to close between markets when this happens, but the premium markets kept on growing at phenomenal rates as well.’’

A separate analysis by CoreLogic found the top-performing market segments were generally skewed towards houses over units.

‘‘The stronger long-term performance for houses is a trend we have seen historically and is likely a reflection of the underlying land value being driven higher by scarcity factors,’’ said Tim Lawless, CoreLogic’s research director.

‘‘House values will probably continue to appreciate faster than unit values due to the scarcity of supply and what is likely to be persistently strong demand for lower density housing options.’’

Hobart outperformed other cities, with dwelling values surging 101.8 per cent across the greater capital city region over the 10 years to March. Sydney was the only city to record a higher 10-year growth rate, with housing values increasing by 109.5 per cent, according to CoreLogic.

Perth and Darwin were the weakest housing markets over the past decade, as values moved through a long-running downturn, Mr Lawless said.

But Mr Lardner said worsening affordability and higher interest rates could slash capital growth by more than half in the next 10 years as buyers grapple with bigger household debt and lower borrowing capacity.

‘‘Australia’s property market bull run may end this year as the two decades of falling interest rates are about to end,’’ he said.

Shane Oliver, AMP Capital chief economist, said falling demand due to lower immigration could also weigh on house price growth in the coming decade.

While immigration was starting to pick up, he said, ‘‘it may not get back to the highs we saw pre-pandemic, so the underlying level of demand for housing may not be as strong as it has been’’.

Foreign investors who fail to report their investments in Australian assets have been put on notice by the Australian Taxation Office and face significant cash fines after a landmark legal win in which the judge said his intention was to ‘‘wipe out’’ the profits of a serial property buyer.

Between July 2016 and April 2018, Vijay Balasubramaniyan spent more than $1.4 million on three residential properties and a block of residential land in Melbourne’s west.

Justice Barry Beach agreed with the ATO that Mr Balasubramaniyan, who had a temporary visa, breached foreign investor rules six times – four times for the purchases, which occurred without permission, and also for owning two established properties.

Justice Beach, following the first prosecution of such a case, ordered penalties of $250,000, broken down into four $30,000 penalties and two $65,000 penalties. The amount was well above the $162,839 that Mr Balasubramaniyan argued was his net gain.

‘‘The judgment provides a strong base from which we will progress our penalty litigation work as part of the ATO’s overall compliance approach,’’ ATO assistant commissioner Keir Cornish told The Australian Financial Review.

The judgment sets a precedent for how the law treats foreign investors in Australia who do not alert authorities to their acquisition. It is the first such ruling since the Foreign Investment Review Board Act was rewritten in 2015 to introduce civil penalties.

Previously, penalties for international residents acquiring Australian assets without alerting authorities were largely a slap on the wrist. They were forced to divest but could keep any profits gained.

In the three years to June 30, 2020, there were more than 1100 penalty notices for contraventions of the FIRB Act in residential property alone.

‘‘This serves as a clear deterrent to other foreign investors who believe they can operate outside of the law,’’ Mr Cornish said.

‘‘The ATO promotes voluntary compliance of the rules by foreign persons, but where foreign investors resist compliance action, stronger enforcement action is taken.’’

In his judgment, Justice Beach said Mr Balasubramaniyan had made gross capital gains of $710,300.

‘‘This is a significant fact for penalty purposes. General deterrence will only be achieved by a penalty that puts a price on any contravention sufficient to deter others who might be tempted to contravene the Act,’’ he said.

The ATO argued the net gain was $425,000. Justice Beach accepted some of the ATO’s calculations, but cut the number further.

‘‘I do not propose to linger on the arithmetic, save to say that I am satisfied that a figure of around $250,000 represents no less than the respondent’s net gain,’’ Justice Beach said in his judgment.

‘‘I propose to wipe this out by the total penalty that I will impose . . . Indeed, the sum of $250,000 is considerably more than the respondent’s own calculation of the net gain.’’

Lachlan Molesworth, a barrister and specialist in taxation and foreign investment, who represented Mr Balasubramaniyan, said he expected it to become routine for the Commonwealth to seek penalties for people who breach the act.

‘‘There is no doubt this will very much embolden the regulator, and I think it will send a clear message that if you hold assets in Australia without relevant federal clearances, those assets are very much at risk,’’ Mr Molesworth said.

‘‘The Commonwealth were probably waiting for a clear-cut case. The next frontier may well be into other assets classes, commercial investments where there have not been contraventions, and there will be a new level of confidence, we know what considerations will apply.’’