In light of rising house prices, subdued income growth and unmanageable household debt, the Australian Prudential Regulation Authority (APRA) has sought to cool Australia’s hot property market by clamping down on interest-only loans and tightening investor lending.
In this special episode of The Smart Property Investment Show, host Phil Tarrant is joined by top Aussie broker Ross Le Quesne and guest co-host Jim Hall to discuss what this means for investors and how these changes will affect portfolios, as well as arm them with essential information on how to prepare for change and protect their wealth creation efforts.
Tune in to hear all of this and much, much more in this episode of The Smart Property Investment Show!
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Phil Tarrant: G’day everyone. It's Phil Tarrant here. I'm the host of The Smart Property Investment Show. Thanks for joining us.
Got two people in the studio today who I've asked to come and join me on a bit of a conversation around something which impacts and affects every single property investor and that is The Big M, the mortgage, being able to borrow. You have to be under a rock or switched off in the world to have not seen anything in the media recently around many of the forces which are impacting, affecting, the way in which Australians are investing in property. Whether they are property investors or they're owner occupied.
The whole issue around housing affordability and it's nearly impossible for Aussies to realise the Great Australian Dream because property's unaffordable. Driven in many parts by the evil property investors who are pushing up prices. Is there merit to it? Maybe a little bit. The whole issue of housing affordability is a tough one and I don't intend to tackle it today, but suffice to say, there's a lot of research around affordability issues and most of the time most policy or legislation typically impacts or affects the people in the city markets, and often forgets to look outside of Sydney and Melbourne that there is many markets within Australia, all perform differently in housing affordability. Normally applies to the major capital cities rather than other parts of Australia, but I don't want to get into that.
What I do want to get in to is finance and the longevity of property investors to be able to ensure they can, not only sustain their current levels of debt in their financing, but to also grow their portfolios through securing new mortgages. APRA who everyone is familiar with, the Australian Prudential Regulation Authority, which essentially keeps the banks in check and makes sure that the banks are doing the right things, has come out recently with some sweeping sort of comments in terms of how they hope the banks are going to operate in the future.
So on that basis, I've asked two people to come into the studio. I've got Jim Hall. Jim Hall's one of my colleagues here at Smart Property Investment and Mentor Media. He's also a property investor so I've asked him to come on to give us the voice of the property investor on the street. Jim, how're you going?
Jim Hall: I'm very well, thanks Phil. Yep. Good to be back. It's been a while.
Phil Tarrant: It's been a while and I've also got Ross Le Quesne. He's a mortgage broker from Aussie Parramatta & Rouse Hill. Aussie's one of Australia's largest mortgage brokerages and Ross is their number one mortgage broker so he knows what he's talking about, and I turn to him personally to arrange all my own mortgages and I think he's also your broker?
Jim Hall: He certainly is.
Phil Tarrant: I've asked Ross to come in to have a chat to us about mortgage lending at the moment and how we can just arm our listeners, investors, to think critically about their portfolio right now and how it might impact or lending requirements might change in the future that will impact their ability to grow wealth through property. How you going Ross?
Ross Le Quesne: Great! It's great to be here.
Phil Tarrant: It's a long intro, wasn't it?
Ross Le Quesne: It was a long intro man, you're normally not short of a word, but you've outdone yourself today.
Phil Tarrant: I pump a few into me and mate, I'll talk all day, but this is going to be a tough one because there's many different issues. I touched briefly on housing affordability and we get a lot of Millennials on the show generations wise and they're the guys banging a drum about, you know, they're never going to realise their ability to own property in Australia and so lots of pros and cons and for and against this argument and I get a lot of these guys coming in who have four, five, six, seven, ten properties. So irrespective of how old you are, you can still realise the greatest the ‘Great Australian Dream’ of property ownership.
You might not own a property within five kilometres of the CBD worth four million dollars that you can walk into town in though, so let's not go there I think, but APRA. So APRA recently, I think it was back the late March so we recording this early in April, they sort of wrote an open letter to all ADI's. So an ADI is an Authorised Deposit Institution, what that means is essentially a bank that takes money of you and has sort of deposits, right? So you have the same account right? Good description?
Ross Le Quesne: Anywhere you can open a bank account.
Phil Tarrant: Anywhere you can open a bank account.
Ross Le Quesne: Yeah.
Phil Tarrant: So essentially what APRA's done...APRA is concerned about mortgage lending practices in Australia. There's a number of different things underway right now and what I'll do, I'm going to use his letter, this open letter that APRA put together to help us shape this conversation Ross, but essentially they preface some points they make in this by saying, "ASIC recently has acted to address responsible lending practices. They're talking about an environment which remains one, high housing prices, high and rising household indebtedness, so people get more in dept. Subdued household income gross, so salaries aren't going up at the same speed as what? Indebtedness is.
Historical low interest rates, which we know is the lowest cash rate we've had in many, many years, or forever or in recent history and strong competitive pressure. So there's all this, this is a big macroeconomic factor right, which are shaping the way in which a punter can get a mortgage. You deal with investors every single day Ross, do you think most people are aware of some of the pressures being placed on the banks to just keep an eye on mortgage lending and make sure it doesn't spiral out of control, because they're saying that, "If money is easy to get, more people will get it and it's going to push up property prices".
Ross Le Quesne: Yeah, exactly. I mean this started a couple of years ago when APRA first introduced these measures and lending has got a lot tougher since then, so if you've been out of the market for four or five years, you may not realise what has been going on. If you've been borrowing in the last two years, then I'm sure you're aware of the restrictions and it has become a harder market place to get money in.
Phil Tarrant: So that restriction, back in I think it's 2014, can you please explain to our listeners what they were and what the purpose of those restrictions were?
Ross Le Quesne: So as you said, given what's happened in the macro economy, the GDP is just bubbling along around that sort of two percent and it's not getting to the two to three percent range which would warrant a rate increase. So basically ASIC and APRA have go together with the Reserve Bank to put some other measures in, to restrict borrowing in terms of, as you said, to slow down the property market. So whereas before, banks would be able to assess on interest only repayments, they said on all existing debts and new borrowings, let's put a minimum cap and it's round about seven per cent principal and interest on all their loans.
So for an investor on a million dollars, they might pay four and a half percent interest only, forty five thousand dollars a year at principal at interest that's seven percent, they're looking at around about ninety thousand dollars a year in repayments, so that's an extra forty five thousand dollars that person has to earn on that million dollars of borrowing, to be able to qualify. It really restricted investors in terms of how much they could borrow.
Phil Tarrant: So that's not a bad thing, so pretty much you should be factoring in that anyway in your own personal finances. So you can get money at four percent, they're saying pretty much, "Well, we're going to assess you on at seven and a half percent to see whether or not you can afford to take on this debt and repay it comfortably", and that's not a bad thing. Back to 2014 or was it 15 where APRA was trying to put the brakes on the increase in investment lending and they said to the banks or ADI's, you can only grow your investment loan book by 10 per cent per annum, is that correct?
Ross Le Quesne: Yeah, that's correct.
Phil Tarrant: And that was a mechanism to say, "Banks, don't push investment lending too hard. It's okay to grow your book, but don't push it above 10 per cent otherwise we're going to start asking a lot of questions".
Ross Le Quesne: Exactly and your seeing that play out in the market at the moment where several of the major lenders have pulled away from doing refinance or reduced the loan devalue ratio they're prepared to lend investors at the moment, because they're putting brakes on, and we're also seeing that it's a lot harder with some of the banks to get loans approved at the moment, because where it was the norm to make acceptations to policy and be more flexible. Now they're drawing a line in the sand and saying, "If it doesn't fit our box, we're not going to approve it", and the whole reason that you're seeing that in the market today is because the banks are getting really close to that 10 per cent cap that APRA have said. So they want to be as close as possible and I've heard of some lenders actually delaying settlements through to the next month so they're not going over this 10 per cent cap.
Phil Tarrant: It's a bit simple, really? Really?
Ross Le Quesne: It's bit of a catch-22 for banks, because investment lending is important for them. If you invest in equities, if you invest in banks, you see that their mortgage books are pretty much to the bedrock of strong balance sheets and strong profit returns and therefore dividends to investors, so banks want to be lending money, right? They want to be as close to this cap as possible, so they want to be at 9.99 per cent of that 10 per cent growth cap because a lot of profitability and seeing they've just increased rates for investors in the last month or so. Most of our investors would've received the letters that their rates have gone up by about .25 per cent. These loans are very profitable for the banks, so they want to continue to ride them.
Phil Tarrant: Put your heart in but don't put your head above the parapet so you get shot. So they're going to push you right to the top.
Ross Le Quesne: Exactly.
Phil Tarrant: But the bank will use, therefore, different levers to try and stay within that 10 per cent growth. So one you mentioned was push out rates and that might deter a couple of people?
Ross Le Quesne: Exactly, and you've seen higher rates for all investors. You've seen higher rates with some lenders for interest only facilities, which predominantly affect your property investors. So there's policy, as I said, in terms of what the banks will approve. So there's a number of different ways and levers that they can pull, reducing loan devalue ratios is another example of some of the levers that they're pulling to restrict the flow of investment lending. Some of the lenders as I mentioned, won't do refinances for new to bank customers for investment loans at the moment.
Phil Tarrant: See, that makes sense to me though like they want to reward loyalty with their current customers, so if they've got to give up some business then they might as well do it with new business, but anyway, I'm not a bank executive. But this is really important because it's contextually quite relevant to this open letter that APRA's put together and if anyone wants to check it out, go to the APRA website, dated 31 March 2017. The heading of it is "Further measures to reinforce sound residential mortgage lending practices".
Practices pretty much to summarise this letter, what it says, what APRA expects ADI's to do is to limit the flow of new interest only lending to 30% of new residential mortgage lending and within that, they want to replace strict limits on the volume of interest-only lending to loan-to-value ratios above 80 per cent. So they don't want to lend too much to people above 80 per cent and then also insure there is strong scrutiny and justification of any instances of interest only lending at a LVR above 90 per cent, which is pretty important. Right, so these two, they want banks to be lending at 80 per cent LVR. If you go up to 90 per cent there's got to be good reason to do it. It's pretty much what they're saying. That would probably curb borrowing.
Ross Le Quesne: Yeah, I mean we see a lot of investors and part of the strategy is to increase leverage, to use more of the banks money than their own money, so quite a lot of our investors will lend at 90% loan-to-value ratios and being investors, they like interest only repayment. So we do see a number of our clients using that strategy to say rather than buy one property at 80 per cent means they potentially can buy two properties at 90 per cent. So if they've got two assets growing in the marketplace, let's say it's a 300 thousand dollar property, they've got two properties growing.
That's an extra 15 thousand dollars a year if the property's growing at 5 per cent a year, so it makes sense from a leverage perspective for our investors to do that. But from what you're seeing from the APRA letter that has been released, they want to restrict the interest only lending above that 80 per cent, so it will be certain clients that will be affected or you may see some lenders not even offering interest only above 80 per cent.
Phil Tarrant: Well the thing is also, and you've seen it recently Jimbo, the big mortgage insurers are probably struggling a little bit with this as well, because if you limiting investment lending above 80% then after 80 per cent Ross, you need lenders mortgage insurance which insures the lender against the loan are going into default. Some of those guys are hurting, right? The mortgage insurers, because of this.
Jim Hall: They are yes. Yeah, one in particular you keep hearing about, yeah, losing some big deals.
Phil Tarrant: It is sort of flow on effects from these recommendations from APRA, but within this letter they're saying they want the ADI's to manage lending to investors in such a manner so as to comfortably remain below the previously advised benchmark of 10 per cent. That's what we spoke about and that's fair enough. They also want them to review and assure that service delivery metrics including interest rate and their income buffers are set at appropriate levels for current conditions. Now it's a bit vague and you touched on the fact that serviceability now is seven and a half percent at PNI?
Ross Le Quesne: Minimum 7 per cent or 2 per cent above whatever the higher is, so most banks are adopting around that sort of 7 or 7.25 per cent at principal and interest over the remaining term. So if it's interest only for five years on a standard 30 year term, they'll assess it over 25 years.
Phil Tarrant: Okay. And the last point really in summary on the APRA letter is that they want to continue to restrain lending growth in high risk segments of the portfolio, so high loan to income loans, high LVR loans and loans for very long terms. To me it all makes pretty good sense, right? As an investor you should be personally embracing some of these own measures to make sure you're keeping yourself prepared for a rainy day if things change, so what might happen right, you might have...they actually use the term in this letter and it's a bit like shock and awe back in the Iraq war, they're calling it "payment shock", where investors get to a point where they get payment shock and they go, "Shit! I'm in a lot of trouble here", right?
And that might be a shift of principal and interest only loans, if might be rate increases, it might be price drops. So something happens which is materially impacts your ability to hold on to your mortgages right, payment shock, so they don't want people getting into that situation.
Ross Le Quesne: Yeah, and you know we were talking about it before with our own portfolios and the size of our own portfolios and you look for an investor that's coming that's got his loan taken five years ago and the standards weren't as what they are now. They're rolling off their interest only period and they're going to go through another assessment with most of the lenders. So you know, for a million dollars it's going to increase their monthly repayment by $1,800 per month.
We see a lot of investors with three, four million dollar portfolios. So you look at that, that's an extra one of four million dollar portfolio, that's an extra seven thousand two hundred per month.
Phil Tarrant: So open up the ashtray, the home commodore to be there mate, couple of coins.
Ross Le Quesne: They have to, so that's close to $90,000 in net income difference between what they're paying. So that's a bit of a shock if you're not prepared for it.
Phil Tarrant: It's a big shock.
Ross Le Quesne: So you need to be sitting down with your advisors and working out well, what's your plan? What buffers in place do you have? Do you have the income to be able to continue to hold your properties? Do you have the equity in your properties to be able to create buffers, you know, put some money in offset accounts to give you choices, so you're not in that shock position.
Phil Tarrant: Well it is generally shock, because if that happened, fixing that is not as simple as, oh, I'll just give up my daily coffees right and save myself six dollars. To try and dig out seven, eight thousand dollars a month, it's a lot of money to find.
Jim Hall: You have to be knocking at the door of your boss, asking for a big pay rise wouldn't you.
Ross Le Quesne: Yes, so it's an important thing to do every now and then, every 10 years to ask for a pay rise Jimbo, but I think it comes back to your point, Phil, in terms of you should prepare for a buffer and when you're taking out your mortgages to make sure that you can afford on a 2 per cent increase on a principal in interest basis. It's about taking responsibility for yourself and your own portfolio.
Phil Tarrant: I'm really happy that you say that because it annoys me many times when you see people end up in payment shock, right? Whether it's a property or whether it's a mobile phone, whatever, it's like, "Oh dear, poor me. Look at the situation that I'm in. It's not my fault, it's everyone else's fault". It's the banks fault, because they made it too easy to get mortgage, it's the phone companies fault because they shouldn't have given me that much credit. It's this persons fault, that persons fault. So you're saying you need to be responsible for yourself.
Ross Le Quesne: It's interesting because we always say a big part of your show is about educating investors and that's the key thing that comes before you start investing, is the education around that and this is a great point and a point of education for especially those newer investors that are getting in, whilst they're interest only for the first five years, what are your plans if the rate turns to a principal and interest?
Phil Tarrant: So this talk around the fact that after the interest only term, that the bank will switch you to PNI or you need to actually go back through the process of reapplying for an interest only loan. Is that so?
Ross Le Quesne: So going back five years the process to switch over, extend your loan by another five years interest only, was most of the time just a phone call to your lender and they would extend the term by another five years. Now a lot more of the lenders are assessing you under the new guidelines. If you took a loan out three or four years ago, before the APRA guidelines and you may not qualify under your current lenders interest only qualify under those new APRA regime of serviceability. So you've got to look at your options in terms of does that mean you need to refinance your loan to a lender that will provide you an interest only, or are you limited in your options?
So there's no point worrying, it's too late by the time your loan's just come off the interest-only period. It's something you have to plan in advance of your interest only period expiring by speaking to your lender or mortgage broker and working out a plan and working out what is your strategy to be able to do that.
Phil Tarrant: So has any lender yet put them in place? Have you heard of anyone trying to renew their interest only period and the lenders gone, "No, I want a full new application"?
Ross Le Quesne: Yeah, there's a number ... at least two of the majors are requiring a full assessment to switch over to interest only at this point in time, and a lot of the smaller players also require full assessment to go over to interest only. So it's happening right here and now.
Phil Tarrant: That must be a real hassle for mortgage broker right, because that means you have to do a whole new loan application you guys don't get paid for it. Is that how it works?
Ross Le Quesne: Yeah, it's part of service to the clients and looking after your current clients and their portfolio in terms of doing that, yeah.
Phil Tarrant: How many of your clients have come to you saying, "Ross, I understand that this is taking place and is it going to happen, I'm not too sure, but I want to be prepared and planned for the worst, hope for the best", but are they proactively coming to you saying-
Ross Le Quesne: Yeah, definitely. This only came out a week ago. This letter was delivered to the banks a week ago and it's been in the press over the last week. The savvy ones are reading that and we're getting a lot of phone calls.
Phil Tarrant: Are they panicking? Are people panicking?
Ross Le Quesne: I think they're just interested in understanding where they sit and what it means to them as property investors.
Phil Tarrant: And when you look at your portfolio of clients, so you specialise in investors. You obviously do a lot of work in owner occupied stuff, but you're one of Australia's top brokers for the investor segment. By in large we say most investors could cop in on the chin and weather the storm, what do you think, there'll be a lot of people in trouble?
Ross Le Quesne: Yeah, from what I've seen a lot of people will be fine and have the appropriate buffers and income in place to be able to handle principal and interest payments. There is a percentage of clients however, who run pretty fine in terms of their affordability in regards, and rely on those interest only because, again, when they originally took out the loans, it was just a phone call they always have imagined that they will be able to have an interest only loan.
So I think for those people that aren't prepared it will become as quite a shock to them that if they go to their bank and apply to roll it over and they can't do it, then they'll be scrambling for options at that point of time.
Phil Tarrant: Can you go fast and say, say if your five year terms expiring in a year, can you go to a lender now say, "I want to renew it now for another five"?
Ross Le Quesne: Yeah, I did that with one of my loans that was coming up. It still had six months to run, but I thought given the changes that are in the market, I may as well extend it for another five years now, because just it mitigates the risk on that particular loan for me.
Phil Tarrant: That's a good point, so your five year interest only term, how far through that would you want to be before you start thinking...if I called up my broker tomorrow and say, "Could you call of all the banks and say I want to extend for another five years from now", is two and a half years too early, should it be three years, four years?
Ross Le Quesne: I think it's worthwhile sitting down with your broker and coming up with a plan, because as I say, everyone's financial circumstances are different and it might be prudent for some people to start paying principal and interest, especially if rates have increased to a level where they're more comfortable in terms of making principal and interest repayments, so it's really case by case. And some people have big buffers and appropriate money sitting in an offset account, where if something was to happen, then they've got the buffers to ride it out for a period of time.
Phil Tarrant: Yeah, I think the important point here also is that, depending where you are on the lifecycle as investor. So if you're in acquisition phase this is probably a big deal, but if you're in consolidation phase and trying to drive down debt, moving to principal and interest probably ain't a bad thing, as well as trying to off load some properties as well. So it's going to be different things for different people.
Ross Le Quesne: Yeah, exactly. It depends on what stage are you in. Are you in that consolidation phase, are you moving into a retirement phase? So based on where you are on your journey, your decision is going to be different.
Phil Tarrant: One of the key things I'll pull out of this APRA letter Ross and Jim, is...so essentially they want banks or ADI's to limit new investor lending to about 30 per cent of total new mortgage lending. Traditionally it's been running about 40 per cent of interest only loans representing 40 per cent of the stock of residential mortgage lending by ADI's. So 40 per cent of their book is investment lending, sort of moving forward they want ADI's to limit that to about 30 per cent. That's got to just curb the amount of money they're putting out to investors and we've spoken about the reasons and how they can do that.
Ross Le Quesne: It's not just investors, it's a lot of owner occupies as well.
Phil Tarrant: Not interest only.
Ross Le Quesne: Yeah, I think the bigger worry for them is the owner occupies, because that's about affordability. Sure some owner occupies would do it and reduce their principal by doing other things like putting money into an offset account, but I think a key focus will be on interest only and there's got to be a good reason to give an owner occupied loan as interest only, but for your investors - yes, it's going from 40 per cent to 30 per cent, and they've mentioned above that 80 per cent, so that's a natural target for the lenders, but I think it will be case by case, borrow by borrow. So your stronger clients will be able to get the interest only for sure.
Phil Tarrant: Jim, you're sophisticated investor, you've been at it for quite some time. You've got a pretty large portfolio. I think you've spoken about it on the show before, and I know it's quite a large portfolio. First question, how wary are you of what's happening here, would you say you sort of get it or you-?
Jim Hall: No, I'm quite aware because of my work and who I talk to on a day to day basis. I've just recently attended a roadshow put on by the NAB, talking about this exact same thing. It was a room full of 600 mortgage brokers and the thing that was coming up was around the interest only side of things and what's going to happen.
Phil Tarrant: Limiting interest only lending.
Jim Hall: Correct, yeah. So now, I'm very aware of it. I mean a number of my loans are one interest only. Talking to Ross, just prior to the show and it's good to hear what Ross has said just regarding about having a plan, having a strategy in place for I guess worst case scenario, which has-
Phil Tarrant: Plan for the worst, hope for the best.
Jim Hall: -which has always been my case when building my portfolio as well. Try and build a portfolio that's relatively low risk and obviously things are changing at the moment. I've just extended a couple of my interest only loans for another five years and I'll be sitting down with Ross pretty soon and discussing a lot of work, discussing the rest of my life with him!
Phil Tarrant: So are you worried, are you concerned about this?
Jim Hall: I'm I worried? Not hugely worried, no, not hugely worried because I know that I have got buffers in place.
Phil Tarrant: So you can weather any sort of financial storm?
Jim Hall: Yeah, I could do. I'm just in a process of looking at buying another property, this is obviously sort of making me have a bit of extra think about things.
Phil Tarrant: So you might second guess whether or not you want to go ahead doing that?
Jim Hall: Yeah, it just made me sort of have a think perhaps a little bit more than I was maybe a couple of weeks ago. I've been looking for the right place for a few months now and I've actually found somewhere, so I'll sort of reassess things, but I've managed to create a decent portfolio with some buffers in there and cashflow’s not too bad, so.
Phil Tarrant: For you your buffer is it the fact that you know what your income is and if you had to dedicate more of your income to mortgage repayments, you could cop that without it impacting on your life too much?
Jim Hall: Yeah, it's a bit of a mixture. Mostly that, yeah, mostly that. I'm pretty frugal with my spending really, most of the time. My wife not so much, but I've got some buffers in place, got some savings in place, I've got money in offset regional facilities. Fortunately I've got some equity behind me as well, so there's a few things that I've got that make me not too concerned.
Phil Tarrant: So that's where asset selection comes into it, doesn't it? You know and I know Jim's portfolio quite well, and looking at Jim's portfolio, a lot of his properties are in that affordable price range. So should he want to put any of his properties on the market, because he's got a number of properties in his portfolio, he could put a number of properties on the market at any given time and one of those properties, given that it's affordable to the most, it's got pretty good returns based on the price that he should be able to off load those properties.
And in the meantime, if he doesn't, as he said he's got that cash buffer sitting in offset accounts that would buy him 12 to 18 months to sell something and of those assets, they're going to sell within a couple of months. So having a bigger portfolio of lower priced properties helps, whereas you're ... got some lumpy assets and higher priced, it may be harder to off load and you may have to take a hit in price if you're selling at the wrong time.
Jim Hall: Yeah, and that always came down to the good advice I got from early stage by surrounding myself with the right people, getting the understanding, listening to shows like this surrounds, you know...I guess sensible investing.
Phil Tarrant: So but with the scenario that would be to ... if you started off loading properties, would it be to limit your exposure to mortgage debt and therefore give you greater cash flow to service your other stuff, or would it be, sell so you can create yourself more money to sustain the portfolio, which probably I don't-
Jim Hall: Well it would depend really, I mean up until recently and as I still stand now, I haven't thought of selling anything. My goal is not to sell, it's to hold for the long term, maybe sell in 10 to 15 years to decrease the debt then, but if banks start changing the way that they calculate serviceability, if all of a sudden now I do have to find thousands of dollars extra each month then who knows, but I've got that option but that's not something I'd like to do. I hope that I don't have to sell any properties.
Ross Le Quesne: Yeah, I mean it's like anything. You buy with the worst case scenario, what is my exit strategy should I need to do that? That's the last case scenario as Jim mentioned, but it's an important decision when investors are purchasing. And looking at some of the statistics with off the plan properties and CoreLogic are saying that in Brisbane and Melbourne and those oversupplied areas, up to 40 per cent of properties the valuations are coming in under purchase price. So if you're highly leveraged into some of those assets, then you can't afford the repayments and you go to sell your property and you're selling them for less than what you actually paid for it, then we've got a problem.
Phil Tarrant: But just in the basis though, if at the time when you need to fork out the cash to pay for these properties, if they're under valuation, the lenders are going to just dump you right? There's an easy way to get rid of this lender, they're just going, "Mate, I'm not lending you the money", or they'll do it at such a rate where they'll lend you 40 or 50 per cent of the actual value of it right? It gets tricky.
Ross Le Quesne: These off the plan stuff is not something that I do very much of, but what I do see in the marketplace is quite often the one thing which is kind of the family home is quite often tied up in these investments, so whilst the valuation on the new investment property of the plan may come in under, what's wearing the shortfall on equity is the family home, because there's a bigger reliance on-
Phil Tarrant: They take your money out of your family home to prop up more cash to go into it, so the lender will only lend on 80 per cent of the valuation of the property and not the actual purchase price.
Ross Le Quesne: Exactly.
Phil Tarrant: See, this is why I highly recommend you listen to The Smart Property Investment Show, Jim.
Jim Hall: Yes, I second that.
Phil Tarrant: But just the mind boggles how people get themselves stuck in these situations, and I'm not going to have a go at off the plan apartments, because some people have done exceptionally well. If you buy off the plan apartments at the right cycle, you can absolutely kill it, right?
Ross Le Quesne: Exactly.
Phil Tarrant: If you buy at the wrong side of the cycle, this is what happens where people find themselves committed to a property and they're either going to off load it for absolutely nothing to get out of dodge, but all these factors working together influence the way in which the banks and APRA view the marketplace.
Ross Le Quesne: Yeah and as we said before, it comes back to education and knowing that if you are buying off the plan, it's a lot more speculative than buying a property that's existing that you can walk straight into.
Phil Tarrant: Running out of time here guys, but this APRA letter also touches on warehouse facilities, so a lot of listeners might be thinking, "Well, it's ADI's that this is going to impact. It's all right, I'll use the second tier lender or a non-bank lender or a specialist lender and it won't affect me". Ross, can you just explain sort of what a warehouse facility is and how other lenders use that.
Ross Le Quesne: So a non-bank lender will use a warehouse facility to initially lend, based on using a banks warehouse facility and then they will then go and sell it in the wholesale markets as a mortgage backed security and investors will then buy these securities and nothing's as safe as a Australian residential mortgage, touch wood-
Phil Tarrant: That's what's they said in America back in 2000...
Ross Le Quesne: But in order to bundle those up, they need funds in the first place. So these funds normally come from a warehouse facility which normally are provided by the banks. So even though the second tier lenders aren't deposit taking and may escape these APRA rulings, under this letter specifically addresses those warehouse type facilities. What, me reading between the lines, is saying that some of these second tier lenders that aren't using the APRA guidelines, may soon be doing that. So it may shut down a few options that investors have, that are getting closer to that serviceability caps with the big lenders.
Phil Tarrant: I don't want to give you a plug here Ross, but my recommendation would be, Jimbo, if you don't really understand what's going on here, speak to your mortgage broker.
Jim Hall: A 100 per cent, yeah.
Ross Le Quesne: Thanks for the plug mate.
Phil Tarrant: Yeah.
Jim Hall: That was an anti-plug.
Phil Tarrant: There's a lot of very good brokers in Australia isn't it Jim, there's thousands of them out there, so go and speak to your mortgage broker or your lender. My recommendation would be, and it doesn't cost you anything, if you bank directly, so if you walk into a high street bank and you have a bank manager there, go and have a chat to them, but also see a mortgage broker. Just to pick their brain around your financial position.
And everyone's financial position is different. It's good to get a number of different views on it, but do speak to a broker and ask them about these questions and how it might change the way in which you might shape the growth of your portfolio or alternatively look to maybe minimise and downsize your portfolio to decrease your risk at exposure against property. But I think what this is all about to me and reading through this letter I sort of sit here and go, "Well, yeah, that makes sense", right?
There's so many obvious things in this letter which everyone should be doing anyway, and that is limiting your own LVR where possible, so if you buy at 95 per cent, question why you're buying at 95 per cent. Is there a reason, really, you need to be buying at 95 per cent? Ross, why would you borrow at 95 per cent? If you're on a super-duper accelerated growth in building a portfolio, maybe, but-
Ross Le Quesne: Yeah, it's very rare that we're seeing ... back in the day, like four, five years ago, we did see a lot of it, seen very few lenders do that now. I mean unless you knew that you were getting them out of property significantly under market value, you would stay away from doing 95 per cent. A lot of investors are, say at 90 per cent, but again you want to make sure your buying well, because that puts an extra buffer in it as well and as we know, a lot of investors and ... you're try to make your money on the way in. Obviously you've got to take those factors into account when you're borrowing.
Phil Tarrant: If you're borrowing at 80 per cent, you essentially you've got a bit of an insurance policy there, because if you miss time the market and you buy perhaps above market value, you've still got a buffer in there should it come down a little bit and are we going to see a wholesale ... is there a massive property bubble in Australia, I think there's a guy out from the UK this week from one of the major real estate firms saying, "What's everyone complaining about? Property in Australia is so affordable compared to other markets in the world", right? So is there a bubble, that's a decision that you need to make. Is there a chance that property prices will come off in certain markets? Maybe there will be.
Ross Le Quesne: Maybe and might provide opportunities for our investors-
Phil Tarrant: So I'd be really questioning the rational for investing at high LVR's, I think that's just good practise. I think also having your own personal serviceability ratios. You know, some people are comfortable looking at a serviceability at 10 per cent, rather than what we get money for 4.5 per cent, but some people and I imagine some of your clients Ross, are a lot more conservative than most and they like to think, "Well, I like to look at my ability to repay this debt on this investment property. If I don't get any income at all for a whole year, and I want to feel safe and comfortable knowing I can meet those repayments, I'll look at it at 10 per cent", you know. Self-reflection, self-awareness, maybe that's on an extreme side 10 per cent, but some people need that to sleep at night. Everyone is different.
Ross Le Quesne: Yeah, and it's those... I've got clients that want an $800,000 cash buffer, and I've got clients that run on a lot smaller being a $50,000 or less as a buffer in terms, so everyone's comfort levels are definitely different.
Phil Tarrant: Other than that, I think to be fair to APRA, I think all this makes a lot of sense, you know?
Ross Le Quesne: Given where the economy is and it's flat lining at the moment and there's not a huge prospect of us going over that three percent GDP, so rates are going to remain flat and that's why you've seen the banks increase outside of the Reserve Bank cycle, because they don't see one in the distant future, which means money is going to remain relatively cheap. So there does need to be something to be done to keep things in check. So ultimately, as you say, whilst it's not great for me as a mortgage broker, makes my life a bit tougher. In the general property market it's a good thing.
Phil Tarrant: But this comes back to choosing a broker right? It's like the broker that will stick with you during this period of time, and for our regular listeners they probably hear me say it all the time, a client might like me is a hard client for you Ross, because I'm asking for $250-$300,000 loans and to get that money for me would be quite a lot of work. But anyway, you should be leaning on your broker for this sort of information you need to feel appropriate to maintain the way you see your portfolio and the risk appetite your about to have or want to have, so go and check this letter out. It's on APRA's site, it's called "Further measures to reinforce sound residential mortgage lending practices".
If you don't know what it means, you can send some questions through to me and I'll flick them over to the relevant people to get them answered for you, or if you need any help at all, just touch base and hopefully I can point you in the right direction. We're writing about this on smartpropertyinvestment.com.au a lot, so make sure you check it all out. Anything to finish up with Jim?
Jim Hall: No, I think it's important to realise for existing investors out there that you know, it does say to limit the flow of new interest on your lending to 30 per cent, so I don't think that we all need to start really panicking and thinking that all of our interest only loans are going to all of the sudden get...but again it's just prepare for the worst case scenario perhaps is probably the best advice.
Phil Tarrant: You never know, yeah. Ross, anything to finalise with mate?
Ross Le Quesne: I think there will be some opportunities that will come from this in terms of ... for the savvy investor as well.
Jim Hall: So get yourself finance ready then?
Ross Le Quesne: Exactly.
Phil Tarrant: Get yourself finance ready and what does that mean? It means get yourself a pre-approval so if these opportunities-
It's good. All right, remember to, yes, smartpropertyinvestment.com.au. Do go and check us out. We're on all social stuff, Facebook, Twitter, LinkedIn, just search "smartpropertyinvestment". If you'd like to follow me on Twitter, @philliptarrant – Jim, you don't have a Twitter do you?
Jim Hall: I don't, no.
Phil Tarrant: No? You don't have a Twitter do you?
Ross Le Quesne: It's just @rosslequesne.
Phil Tarrant: There you go, and keep those reviews coming in on iTunes, do appreciate them. We'd like the five star variety, that means we can keep growing this community, Jim, but I do appreciate the feedback. It's nice to know that what we're doing really resonates with the marketplace and as I've spoken about before, you know it's important for me that we can help create more informed and educated investors that can make better investment decisions, so we'll keep going at it.
Thanks for joining us, we'll see you next time. Bye bye.