How the hangover could look now that APRA has shut down the party

In the fine tradition of public policy in Australia, we leave things until it’s long overdue. By this time, instead of a manageable slow-down, it often results in a screeching halt followed by a fast u-turn. APRA’s recent moves to stem the flood of finance to speculative housing investors could be a case in point. What might this mean for investors and for the industry generally?

Some years ago, Reserve Bank Governor Glenn Stevens expressed caution that low interest rates, which ought to lead to an increase in housing supply, might simply lead to a run up in prices. See for example this analysis of mine back in 2009. This year, in a vindication of those earlier fears, he described the market in Sydney as ‘crazy’. You don’t get stronger hints from the RBA Governor that things are a bit out of control than that. 

In December, the Australian Prudential Regulation Authority started to tighten the screws on lending, and it made further moves this year targeted more particularly at investors, who for the first time account for more than half of new lending for housing. Banks are responding by quickly tightening their lending criteria and some – AMP Bank for example – have now announced they have banned loans to property investors, effective immediately. Others are offering loans to investors at higher rates of interest than to owner occupiers. How might this play out for the legions of speculators who have invested in the so-called ‘generational shift’ to apartment lifestyles?

It’s not a pretty scenario and it’s all happened before, but for the ones with short memories or without the benefit of having been through a serious downtown before, here’s how it can pan out. 

Think of the investor who’s been sold the story of a generational shift to inner city apartment living. They see demand rising for this type of product and lifestyle and figure that this is a good market to buy into. They purchase a $500,000 unit ‘off the plan’ with a $50,000 deposit, when the banks are happy to lend 90% of the value. They may be thinking that, by the time settlement is due within maybe three years, that unit could be worth maybe 10% more, so their equity will have gone from $50,000 to $100,000. Happy days. Plus they’ll be getting a rising rental return, at least in line with CPI. After all, this is how - and where - everyone wants to live, isn’t it?

Fast forward three years to settlement time. The banks are no longer prepared to lend 90% but our investor’s bank will still lend to 80% of the valuation. That valuation has come in a few months before settlement and the bank now has a piece of paper that says the home unit is worth $450,000. Values have fallen because there is a very large volume of similar stock on the market at the same time, in roughly the same location, and there are more sellers than buyers.

So as far as our investor’s bank is concerned, they will now lend 80% of $450,000, which is $360,000.  The investor now needs to fund the remaining balance of the contract price of $450,000 ($500,000 less his deposit). So our investor needs to find another $90,000 to make the settlement. They could walk away and lose their deposit, or they could try argue their way out of the contract, but both aren’t exactly appealing options.

They could sell the apartment but that would mean taking a loss in that market. They could rent it as planned but vacancies are high (there’s a lot of similar product out there) and rents have fallen (supply over demand). So their return on renting is nothing like they imagined it could have been. Plus, by now, interest rates have risen so the gap between the rental income and the repayments is much wider than they banked on. It’s called ‘negative’ gearing for a reason but there’s a limit to how much most people can lose.

If our investor decides to sell and realises $450,000, they still have their transaction costs to take into account so their net realisation may be closer to $400,000 on the ins and outs of the deal. They can pay out their $360,000 loan and have $40,000 left. This looks pretty ordinary if they had to sink $140,000 of their own savings into the deal. That $140,000 is now worth $40,000 – not including any losses on the cash flow if they’ve been renting it (or trying to) for a time.

This is a worst case scenario and I am not predicting financial Armageddon. But I do come across plenty of people in the industry who seem to be in denial that this is remotely possible. Yet it has happened before and may well happen again.

Who’s to blame if this does eventuate? Accountants and some financial advisors, who promoted investment property deals because on paper they look tax effective, will have questions asked of them. Accountants love things that look good on paper but in my experience aren’t very good at understanding property. Urban planners and policy makers that promoted high density living at the expense of other options paved the way for the supply-side response. Developers have done pretty much exactly what most metropolitan planning schemes called for – extensive high density urban infill. That’s precisely why so much of it has been approved. And they have met the market price points. The fact that market was driven by investors buying into a financial product not owner occupiers buying into a lifestyle product, isn’t the developers fault. The banks too should shoulder some blame but good luck trying to make that stick. And the investors who could lose out will be busy for looking for anyone else to blame but themselves.

And what’s the impact on the industry if this happens? That will depend on whether any problem - if it occurs - will be contained to a certain type and style of investor housing product, or if the property industry generally suffers the hangover -  even if large parts of it weren’t part of the party in the first place. This is a question that’s going to occupy a lot of minds in coming months and years.

Aged care & retirement living: are they immune to market and economic cycles?

Much has been written about the ageing of our population but less is known about the implications for housing and caring for them. In the past, this has been left to not-for-profit groups like religious organisations or charitable institutions and a handful of smaller private operators. But the numbers that are coming in terms of ageing Australians will render this cottage industry approach entirely obsolete. Demand is likely to be so strong, for so long, you have to ask if this is one part of the property industry that will be immune from cyclical gyrations because it will be one long upswing lasting more than 20 years.

If you were born in 1900, you could expect to live on average to around 50 years of age – less than today’s retirement age. If you were born in 1945 that rose to around 68 years of age. If you were born in 2009 you can expect on average to live to 79 for males and 84 for females – a good way past retirement age. The United Nations has estimated that every second child born in a developed economy from 2000 onwards could live to 100. So one in two of today’s children in Australia may somehow have to work out how to live without an income for some 35 years. Good luck with that.

They - and today’s ‘baby boomer’ generation - will also need to find somewhere to live – and this is where the property industry comes in. There are two types of product and generally two types of operator servicing the needs of the 70+ population: retirement living (also known as independent living) and aged care (once called nursing homes). Neither are for everyone and take up rates in Australia are still low by developed nation standards. However, even based on those low take up rates, demand is going to quickly outstrip supply.

Leading Aged Services Australia is the peak body representing aged care providers. They estimate that there will need to be an extra 83,000 new aged care places in Australia in the next nine years alone. Let’s adopt an average of 80 beds per facility which is typical of most existing aged care operations. That equates to 1037 new aged care facilities for the next nine years, or around 115 per annum for that period. Mostly they will be needed in the larger capitals. Some research I coordinated for Calibre Consulting shows that in Brisbane, Sydney and Melbourne will all need something like 20 to 25 new facilities each year to 2031 and probably beyond. Each place costs roughly around $250,000 in development costs (building plus land plus other charges) so each facility of 80 beds will on average be around $20million. The 115 new facilities needed nationally work out to an annual development budget of $2.3 billion. And this is just to keep pace with the demand we know is coming, without any increase in take up rates. And these are only the development numbers for aged care. Add in the retirement living market and you could potentially double that. Or maybe more.

The thing about this market is that demand is fairly predictable. You will not find an aged care or retirement living operator complain about a lack of demand. They will however complain about high operating costs and high site costs, if they can find the sites. After all, it’s one thing to reel off statistics about projected demand but the industry still has to find places to develop these facilities. And because most seniors (and their families) want to age in the communities they are used to living in, this does not mean they’ll be interested in shifting out to some bleak cow paddock on the urban fringe. Nor will they (or their families) be interested in trotting off to some aged care facility that has all the charm of a 1930s insane asylum, or if a retirement living facility, all the design flair of a post- war workers housing scheme, complete with vinyl floors.

Not all of them will be able to afford to be choosy of course. But there will be enough of today’s boomers with enough cash to support a large and growing industry that will appeal to their needs and advanced tastes.

(What though will happen to today’s generation of kids? They are renting longer, entering the housing market later and with much higher mortgages. They are projected to retire with a mortgage and will need to live that much longer without an income past retirement. Today’s boomers are often multiple property owners having grown up in a post-war era of extraordinary opportunity. Today’s millennials by contrast, when it comes their turn to find a retirement living or aged care product, may not have the assets to fund their lengthy senior years. For them, is it time for Logan’s Run?)

The other aspect of demand in this market is that it is typically unrelated to market or economic cycles. True, most people entering a retirement living product do so by selling their family home, and they will try maximise the price for that by waiting for the right time to sell. But ageing has its own immutable clock, which doesn’t wait for market cycles - especially if people suffer from loss of a partner, a fall, or stroke or rapid onset of dementia or other debilitating conditions that can’t be forecast. They need new living arrangements, or they need care, and they need it now. Family members are often left to find somewhere and they need to find it quickly. Market or economic cycles are immaterial to finding suitable places for loved ones to live in. And there will be an increasing wave of seniors in precisely these situations that will drive a long upswing in the aged care and retirement living market.

How will the industry respond? Here are a few thoughts.

Consolidation by merger or acquisition is inevitable. The top two or three largest operators in the aged care market, for example, control only around 5% of the market. Contrast that with retail where the two majors receive 80% of the retail dollar. There are literally thousands of facilities and operators nationwide and many of them with only one or perhaps two facilities. They will not survive, except perhaps for the elite end of the market, because they do not have the economies of scale to provide cost-efficient operations. Everything from the cost of meals to laundry to staff:patient ratios counts and larger operators will win out.

There will also be more professionalism. No disrespect to the many well-meaning and long standing charitable and religious providers but in terms of property development or redevelopment, many don’t have the skills. Their business models were based on noble but often uneconomic commitments to provide care at ‘affordable’ prices. Their cash balance sheets are often incapable of supporting new development to meet demand even though they may be paper rich in land assets. I suspect many will start joint venturing with private developer-operators to fund their future – indeed some are already doing so.

Planning schemes and community attitudes must also change. There are virtually no undeveloped sites suitable for retirement living or aged care facilities in areas of our cities where demand is most acute. Under-utilised land like shopping centre carparks or even that second school oval are going to need to be available to meet demand. Otherwise we may as well put up signs in our cities saying “hey oldies, thanks for building all this but you can piss off now you aren’t welcome anymore.” Height restrictions will also need to give way to provide for higher density facilities especially in areas where land or sites are particularly scarce. The NIMBY attitude of some community groups that I’ve seen actively oppose new aged care facilities is nothing short of disgraceful, and the politicians giving them encouragement should be given an advanced ageing pill so they know what it’s like to be the wrong side of 80 with nowhere to live and no going back.

The other thing that will change dramatically is design. The next generations will demand higher standards that more closely resemble a Balinese resort. Or their children will demand it for their parents. We are all becoming increasingly spoiled and those with the money will want to remain spoiled in their senior years. Already we are seeing cinemas, resort style pools, quality cafeterias and dining areas with high standard menus, hairdressers and beauty salons, resort style landscaped gardens and a host of other features that bear no resemblance to the ‘retirement homes’ or ‘nursing homes’ of years past.

All this presents challenges and the prospect of enormous change for the industry on a scale that is hard to imagine. But that change will come because it is being driven by a tide of demand that is irresistible and inevitable. 

Quite possibly that wave of demand is something that for this part of the market at least, economic or market cycles won’t be the main drivers: demography will.