Some 1.9 million investment properties could come under selling pressure as speculators with multiple properties and soaring debt, or those nearing retirement come to the realisation they need to sell, Citi research says.
Citi states the traditional response of investors to ride out selling pressures was now less viable due to high debt levels, particularly among investors aged in their 50’s and 60’s.
The analysis of Digital Finance Analytics data revealed a surprisingly high level of property speculation, with around 12 per cent of residential investors owning six or more properties, a risk factor also highlighted by the Reserve Bank on Friday.
Martin North, co-author of the report and principal of Digital Finance Analytics, an independent consultancy, said regulatory attempts to curb an estimated $680 billion of interest-only mortgages had come too late.
Compare this with other avenues to property investment, and the varied risk profile and barriers to entry are stark. An investment via the CFMG Capital Land & Opportunity fund is also a direct investment in the property market, however requires just a $25,000 investment without ongoing holding costs or exposure to fluctuating lending practices and interest rates. If there is a market downturn, a contractual right to 12% return per annum remains, while a market downturn, while considered unlikely, carries far more significant risks where an investor may be left with a mortgage even greater than the value of the property it is secured against.
Mr North said prospect of rising interest rates, stagnating incomes, record levels of household debt and weakening sentiment are coalescing to increase the vulnerability of lenders and borrowers to interest only. "The risk chickens are coming home to roost," he said.
Household consumption contributes to about 55 per cent of the nation's gross domestic product. "A highly indebted household sector brings a whole new risk profile to the economy," the report concludes.
Taku Ekanayake, 29, has bought six investment properties in the past 30 months around Australia, primarily the suburbs of Brisbane, but has not been able to afford a home in Sydney.
The properties are tenanted and his mortgages are variable interest only.
"At the moment rental income is covering mortgage repayments. Interest rate increases are inevitable from current record lows. It is a concern to the general public because wage growth is flat. But in my case I can sit it out," Mr Ekanayake said.
"I will have to negatively gear the properties if there is an interest rate increase. I would also have to reassess the use of interest only variable rates," he said.
Options include reassessing the portfolio, switching to fixed rates, or increasing negative gearing, he said. Negative gearing is used used when the gross income generated by the investments is less than the cost of owning and managing the investment, including depreciation and interest.
He said another concern for investors is increase in supply of apartments and units around inner Melbourne and Brisbane that could put pressure on rents and make it tougher to find tenants.
Three of his mortgages are with the Commonwealth Bank of Australia and the remainder are spread across Westpac, ANZ and National Australia Bank.
He has five properties in Brisbane suburbs while the other property is in Adelaide. By investing in something like the CFMG Land & Opportunity Fund, Mr. Ekanyake could have gained exposure to the same markets, but without taking on in excess of $1million in debt and would have the protection of a fixed rate of return of 12% per annum on his investment.
The Citi report says a fall in property prices would force more owners to sell, as their "belief in ongoing capital gains evaporates".
It describes mortgage debt as "the most important economic and social issue of our time". In the past 14 years household debt to household income has increased from 140 per cent to 194 per cent.
Westpac, with about 50 per cent, and Commonwealth Bank of Australia, with around 40 per cent, are the most exposed to interest-only loans, the report states.
Taking into consideration the contents of the report, it is clear that Australians quite rightly retain their love affair with residential property and a key investment asset class, but its time to start thinking about the varying ways to gain exposure to residential property without the need to take on significant risks and debt in the process.