Provision Newsletter

Great news for the economy

While it took a bit longer than usual, the housing sector has responded just as it should to lower rates:

• lower interest rates led to improved housing affordability;

• which has led to increased home buyer demand (housing finance is up 23% year on year and new home sales are up 40% from their September 2012 low);

• which in turn has led to higher house prices;

• which has signalled to home builders to build new homes – with building approvals now about as high as they ever get pointing to a construction boom on the way; and

Source: Bloomberg, AMP Capital

• rising house prices, which boost wealth, and stronger housing construction are positive for retail sales.

This is all good news as a stronger housing sector is critical if the economy is to rebalance away from mining investment.

But is it turning into bubble trouble?

While a housing recovery is necessary to rebalance the economy, a concern is whether it’s becoming another bubble. The home buyer market has started the year strongly with auction clearances high and house prices surging. According to RP Data capital city house prices are up 10.6% over the year to March with Sydney home prices up 15.6%.

Source: Australian Property Monitors, AMP Capital

Property prices are on the rise again in other comparable countries, eg the US and UK. The trouble is that Australian house prices are turning up from a high level.

Source: Case-Shiller, Nationwide, ABS, AMP Capital

Asset price bubbles normally see overvaluation, excessive credit growth and self-perpetuating exuberance. On these fronts the current readings for housing are mixed.

Australian housing is overvalued: Whilst real house price weakness through 2010 to 2012 saw this diminish the problem has returned again with a vengeance:

• Real house prices are 13% above their long term trend.

Source: ABS, REIA, Global Financial Data, AMP Capital Investors

• According to the 2014 Demographia Housing Affordability Survey the median multiple of house prices to household income in Australia is 5.5 times versus 3.4 in the US.

• The ratio of house prices to incomes in Australia is 21% above its long term average, leaving it toward the higher end of OECD countries. This contrasts with the US.

• On the basis of the ratio of house prices to rents adjusted for inflation relative to its long term average, Australian housing is 27% overvalued.

So Australian house prices meet the overvaluation criteria for a bubble. Other criteria are less clear though.

Credit growth is a long way from bubble territory: over the year to February housing related credit grew 5.8%. This is up from recent lows, with 7.6% growth in credit for investors leading the charge. But it is pretty tame compared to 2003-04 when housing related credit growth was running at 20% plus and 30% for investors. Related to this we have yet to see much deterioration in bank lending standards.

Similarly, the self-perpetuating exuberance that accompanies bubbles seems mostly absent at present:

• House price strength is not broad based. Whereas prices in Sydney (+15.6% year on year) and Melbourne (+11.6% year on year) are very strong in every other capital city they are up 5% or less;

• Related to this there has been only one year of strong gains, whereas the surge into 2003 ran for seven years;

• Australian’s don’t seem to be using their houses as ATMs at present (ie where mortgages are drawn down to fund consumer purchases and holidays). Rather they still seem very focused on paying down debt.

• We have yet to see property spruikers out in a big way.

• There is little sign of buyers rushing in for fear of missing out.

• The cooking shows are still out rating the home related shows on TV!

For these reasons I don’t think it’s a bubble yet. However, the acceleration in price gains means the risks are rising.

What’s to blame for high house prices?

Whenever house prices take off and affordability deteriorates there is a tendency to look for scapegoats. A decade ago it was high immigration and negative gearing. Now it looks to be foreign buyers (from China), self-managed super funds and as always negative gearing. However, none explain the relative strength in Australian house prices:

• Foreign and SMSF buying is no doubt playing a role in some areas but looks to be relatively small overall. Chinese interest in Sydney seems to be concentrated away from first home buyer suburbs.

• Such simplistic explanations ignore the fact that when interest rates go down, Australian’s borrow to buy houses and prices go up. We don’t need to resort to foreigners to find a reason why house prices have gone up!

• Negative gearing has been around for a long time. It was removed in the 1980s but was reinstated as it was clear its removal worsened the supply of dwellings. Restricting it for property would also distort the investment market as it would still be available for other investments.

Rather the fundamental problem is a lack of supply. Vacancy rates remain low and there has been a cumulative construction shortfall since 2001 of more than 200,000 dwellings. The reality is that until we make it easier for builders and developers to bring dwellings to market – and hopefully decentralise our population in the longer term – the issue of poor affordability will remain.

Implications for monetary policy

As things currently stand the risks to financial stability flowing from the surge in house prices are more than balanced by sub trend economic growth, falling mining investment and risks to Chinese economic growth. As such it remains appropriate for the RBA to keep interest rates on hold at 2.5% for now. However, our expectation is that the RBA is likely to step up its jawboning of the home buyer market by warning buyers not to take on too much debt and not to expect ever rising prices, ahead of a move to higher interest rates probably starting around September/October once economic growth has started to pick up.

While talk of so-called macro prudential controls, such as limits on loan to valuation ratios for mortgages may hot up, the RBA would probably prefer to avoid such retrograde approaches (they didn’t work in the days pre-deregulation) in favour of jawboning and an eventual rate hike.

Against this backdrop we expect further gains in house prices but at a slowing rate over the remainder of the year, particularly once interest rates start to rise again.

Longer term, the overvaluation of Australian housing will likely see real house prices stuck in a 10% range around the broadly flat trend that has been evident since 2010. This is consistent with the 10-20 year pattern of alternating long term bull and bear phases seen in real Australian house prices since the 1920s. See the fourth chart in this note.

Housing as an investment

Over long periods of time, residential property adjusted for costs has provided a similar return for investors as Australian shares. Since the 1920s housing has returned 11.1% pa compared to 11.5% pa from shares. Both have been well above the returns from bonds and cash.

Source: ABS, REIA, Global Financial Data, AMP Capital Investors

They also offer complimentary characteristics: shares are highly liquid and easy to diversify but more volatile whereas residential property is illiquid but less volatile and shares and property tend to be lowly correlated to each other. As a result of their similar returns and complimentary characteristics there is a case for investors to have both in their portfolios over the long term. At present though, housing looks somewhat less attractive as an investment being overvalued on several measures and offering lower (cash flow) yields. The gross rental yield on housing is around 3.3%, compared to yields of 6.5% on unlisted commercial property, 5.7% for listed property (or A-REITs) and 5.8% for Australian shares (with franking credits). So for an investor, these other assets continue to represent better value.

Concluding comments

The recovery in the housing sector is playing a key role in helping to rebalance the Australian economy. However, while the house price recovery does not appear to have entered bubble territory yet, the risks are rising. The RBA’s first line of attack is likely to be more intensive jawboning, warning home buyers not get too giddy in their house price expectations and not to take on too much debt. Later this year though this is likely to be followed up by a couple of interest rate hikes, all of which will likely see house price gains slow.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

A person’s home is their castle and any equity in it is the owner’s to use as they wish.

But the large amount of untapped wealth that is tied up in homes around the country has not gone unnoticed by the Government and others.

Two high profile reports as referred to below have raised the possibility that one way to help fund the rising costs associated with an ageing population, is to bring the family home into the equation when it comes to aged care.

New funding models

Both the Productivity Commission in its An Ageing Australia: Preparing for the Future research paper[1] and The Grattan Institute in its Balancing budgets; tough choices we need report[2], have raised the possibility of using the equity in one’s home to help meet the costs.

A government equity release scheme where individuals contribute half the annual real increase in their home values towards aged care was the Productivity Commission’s suggestion. The Grattan Institute suggested wealthy retirees draw down some of the value of their owner-occupied dwellings before accessing the age pension.

People who failed the asset test due to the value of their dwelling would be allowed to receive the aged pension, but they would accumulate a debt to the government, to be paid when the home was transferred or sold.

Both schemes are not too dissimilar to existing reverse mortgage arrangements where a home owner can access the equity in their home for any number of reasons, repaying the amount when they leave or the home is sold.

Under current arrangements, a person moving into an aged care facility requiring an accommodation bond does not have to sell their home to raise the necessary entry costs. The home is also exempt from the age pension assets test – two years from the date a person moves into care.[3]

Indeed, a home will remain exempt beyond the two year period if: a partner or dependent child lives in the house; a carer who is eligible for an Australian Government income support payment has been living there for at least two years or a close relative who is eligible for an Australian Government income support payment has been living there for at least five years.

The family home and the Age Pension

There are times when a person does need to sell their home to fund the sometimes large accommodation bond and this amount is also exempt from the age pension assets test. Any other proceeds from the sale of a home may impact how much age pension a person can receive.

While it has been possible to pay a higher bond to ensure any age pension is still paid, significant changes to aged care funding which take effect from 1 July 2014, means this strategy may not be possible.

Renting out the family home

An accommodation bond can also be paid in regular instalments which may be funded through the principal residence being rented out. In this case the value of the home remains exempt from the age pension assets test, and the rental income is exempt from the age pension income test, while the periodic payments are being made. The rental income is not counted towards the calculation of income-tested daily care fees at an aged care facility. 

The family home often plays a large role in financial planning because at most times it is your largest asset. For the moment at least, it remains sacred. If you are considering strategies that involve you or your loved ones contemplating aged care accommodation, don’t hesitate to call us today on 07 5447 7740.

[1] http://www.pc.gov.au/research/commission/ageing-australia

[2] http://grattan.edu.au/publications/reports/post/balancing-budgets-tough-choices-we-need/

[3] https://www.moneysmart.gov.au/life-events-and-you/over-55s/aged-care

There are 5.2 million boomers in Australia born from 1946 to 1964. This compares with six million generation Xers born between 1965 and 1983. Generation Y, born across the 18 years to 2002, is expected to peak at about 7.4 million next decade.[1]

With Australia’s population expected to swell by mid-century and the first wave of baby boomers reaching retirement, building up the nest egg has become more important than ever.[2]

Late boomers, generation X and Y have contributed to their superannuation fund for most of their working lives and are expected to be largely self-funded in retirement from the mid-2020s onwards. However, there is a large gap for the baby boomers retiring now between the superannuation they have and the amount they need for retirement. Either generation X and Y will be forced to support them in the form of more taxes, or Australia will need to import more taxpayers to spread the load.[3]

Generational financial strategies

Each generation has its own financial challenges and strategies vary depending on the stage of life people face.

Source:  ‘Super success achieved in stages;, 28 July, 2013, The Sydney Morning Herald, viewed 15 November

Market conditions

Whether the retirement age should be lifted to 70 along with compulsory superannuation being increased from 9.25% to 12% are among the policies being explored[4] to cope with a “big Australia”. The Australian Bureau of Statistics recently projected the population would surge to 38 million by 2051.[5]

The future for Big Australia

A chart that featured in a November 30 article in The Australian by demographer Bernard Salt shows two possible pathways beyond 2012. One assumption puts net overseas migration at 140,000 a year and the other at 240,000 a year. The second chart shows the net addition to the retirement population averaged about 40,000 a year between 1950 and 2010. From 2010, more than 100,000 people annually joined the retirement ranks, with the number tipped to rise to 140,000 a year.

Salt argued net overseas migration of 242,000 people a year in the next 40 years could provide the skills and tax required to support the transition of baby boomers into retirement. Government spending across housing, health, infrastructure and pensions will have to increase further to accommodate greater boomer numbers.

Whatever stage you are at in your life, there is never a better time for you to plan your future.  Speak to us today on 07 5447 7740

[1] ‘ We are at a population tipping point’, 6 December, 2013, The Australian Financial Review, viewed 15 November, 2013

[2] ibid

[3] ibid

[4] Commonwealth Government – Department of Treasury

[5] http://www.abs.gov.au/ausstats/abs@.nsf/Lookup/3222.0main+features52012%20%28base%29%20to%202101

Will your insurance stretch to cover the needs in your life? Most Australians fall way short – as you’ll read here.

Over 95% of Australian families don’t have enough insurance, meaning we are underinsured by a collective $1.37 trillion.1

But just take a moment to think about what would happen if you were out of action. How would your family pay the bills, put food on the table and keep up with the mortgage?

It doesn’t bear thinking about. Accidents and illnesses can have a devastating effect on your finances, as well as your health.

Insurance can protect you and your family from the financial effects of illness, injury and death. And most importantly, it can help you sleep at night.

How much do you need?

It could be less than you think.

A 30-year-old man earning an average annual salary of $65,910 would pay around $2 a day to insure his income.2 That’s about half the cost of a cup of coffee.

It’s likely you’ll have some insurance cover within super, but is it enough? It’s worth checking your super plan to see how much insurance you have.

An experienced financial planner can help you work out how much extra cover you need to fully protect yourself and your family.

• Trauma insurance pays a lump sum if you’re diagnosed with a medical condition such as a heart attack, cancer or stroke.

• Total and permanent disability insurance pays a lump sum if you can’t go back to work for good.

• Life insurance pays a lump sum if you were to die.

• Income protection—also known as salary continuance insurance—pays up to 75% of your regular monthly income if you can’t work due to sickness or injury.

Super or not?

You can either increase your cover inside super or take out a separate plan outside super.

Insurance in super can help with cash flow and save on tax. But insurance outside super can help you access disability benefits more easily. You can mix and match for the best of both worlds.

If you have any questions or would like to discuss your individual circumstances, please contact us today on 07 5447 7740.

1. Rice Warner Actuaries, quoted in The Lifewise/NATSEM Underinsurance Report – Understanding the social and economic cost of insurance, Feb 2010.

2. Premium calculated using AMP Elevate Online Desktop, Income Insurance Plan, stepped premium, male office worker, non-smoker, age 30 years, benefit period to age 65, 30 day waiting period. Premiums are not guaranteed and may vary in the future.

With a Transition to Retirement strategy you can continue working and access your super.

Retirement used to represent a sharp break with the past—one day you were working full time, the next you were sitting at home with the rest of your life ahead of you. These days, the transition doesn’t have to be quite so abrupt.

Many Australians are keeping themselves active and engaged by continuing for longer in the workforce on a part-time or contractual basis. In fact, more than two in five Australians who work full time and intend to retire are looking to reduce their hours first.[1]

The good news is that in the few years prior to retirement you can start to draw an income from your retirement nest egg while you continue working and contributing towards your super.

Access your super the smart tax way

If you’ve reached your super ‘preservation age’ (currently 55 but rising to 60), you can take some of your existing super as an income stream to help make your transition to retirement a smooth one.

This is called a transition to retirement (TtR) strategy. And it can be very tax effective.

• You can continue to work and contribute towards your super using tax-effective salary sacrifice contributions.

• You can top up your income with a tax-effective income stream from your retirement account (between 4% and up to 10% of the account balance can be drawn each year).

• And there’s even a way to ‘refresh’ your TtR strategy every year for potentially even more tax benefits.

There are two main ways you can use a TtR strategy.

1.    Less work, potentially the same after-tax income

The first option is a TtR strategy that may allow you to cut down your working hours while maintaining the same level of after-tax income.

Let’s say you’re over 55, you earn $75,000 a year before tax and you have $250,000 in your super. You want to cut back your working hours, which will reduce your before tax salary from $75,000 to $53,500.

As shown in the table below, by using a TtR strategy, you can maintain your after-tax income, despite reducing your work hours.

But it does come at a price—your super balance may dwindle over time as you draw down your pension payments.

2.    Same hours, more super

The other option is a TtR strategy that may allow you to maintain your work hours, but increase your salary sacrifice contributions to super, and supplement your income with a TtR pension so that there is no reduction in your after-tax income.

So let’s say you’re over 60, earning $60,000 a year before tax and you have $200,000 in your super, and you choose to use the full amount to start a pension.

As shown in the table below, together with your pension income, you can salary sacrifice $24,380 a year and still receive the same amount of after-tax income in your pocket.

What’s more at the end of the year, you’ve boosted your super by $953. If you do this for ten years, that’s potentially an extra $9,530 for your retirement, simply by managing your money in a different way.

Finding the right balance

A TtR strategy can be an effective way to boost your super savings, but it also has superannuation, taxation and social security implications.

We can help you strike the right balance and work out how to make your transition to retirement.

To find out more about TtR strategies or whether a TtR strategy may be suitable for you, call us today on 07 5447 7740.

What you need to know

Any advice in this document is general in nature and is provided by AMP Life Limited ABN 84 079 300 379 (AMP Life). The advice does not take into account your personal objectives, financial situation or needs. Therefore, before acting on this advice, you should consider the appropriateness of this advice having regard to those matters and consider the Product Disclosure Statement before making a decision about the product. AMP Life is part of the AMP group and can be contacted on 131 267. If you decide to purchase or vary a financial product, AMP Life and/or other companies within the AMP group will receive fees and other benefits, which will be a dollar amount or a percentage of either the premium you pay or the value of your investments. You can ask us for more details.

The examples provided are illustrative only and are not an estimate of the income you will receive or fees and costs you will incur. The examples are based on the following assumptions:

• $35,000 p.a. concessional cap for individuals aged 60 and over, and after allowing Superannuation Guarantee contributions of 9.25%, the concessional cap is not exceeded.
• Tax rates for 1 July 2013 have been applied
• Individual earns less than $300,000 pa

[1] http://www.ausstats.abs.gov.au/ausstats/subscriber.nsf/0/61A0264E827F59C4CA25768E002C8F72/$File/62380_jul%202008%20to%20jun%202009.pdf

Dr. Shane Oliver shares his thoughts on interest rates, the death of car manufacturing in Australia and the opportunities for investment markets this year. Read on for some insightful answers.

Why are interest rates so low and do you expect to see rates increase this year?

The interest rates we now have are necessary to support the economy as the mining boom slows and the Reserve Bank seeks to boost growth in areas such as housing, retail, construction and tourism.

Low interest rates are not so much a sign of weakness, more a sign of changed attitudes. Australians have a lot more debt than 20 years ago. And since the GFC they have become more cautious about spending. So given higher consumer debt and greater caution, you need lower interest rates than might previously have applied to get the economy going again.

The official cash rate will probably stay at 2.5% for another six months or so as we’re seeing tentative signs of improvement in the economy. By September or October we’re probably going to see stronger growth leading to rate increases to 2.75% and then 3% by the end of the year.

Why are Australian house prices so high in global terms? Are we in danger of creating a property bubble?

We’re building about 7,000 fewer dwellings every year than we need. Combined with the absence of an economic crisis, this lack of supply means house prices have stayed relatively high—unlike many other developed countries, where the housing market collapsed during the GFC.

Our house price to income ratio is well above the global average. One day that may fall back to the global norm but in the absence of a big supply surge or a major economic crisis, it’s hard to see that happening via a collapse in house prices.

There is always a risk of a property bubble developing and in fact we have had local bubbles in parts of Australia over the last decade.

But even though house prices are quite expensive, I don’t see a bubble at present.

I’m not sure this is the best time to buy an investment property as the rental yields are so low. If you allow for costs, the net rental yield for a house is about 1% and for a unit 2.5%, which is quite low. Term deposits deliver 3.5% and shares are yielding around 5.5% with franking credits.

You’ve got to get spectacular capital growth to make it stack up, which seems unlikely. So I don’t think we’re going to see a crash but I don’t see fantastic returns from residential property investment either.

What implications does the death of the car manufacturing sector have for the wider Australian economy?

It’s obviously bad news, particularly for those directly affected, but also because it comes at a time when the economy is struggling to pick up and the mining boom is slowing down.

But we need to keep it in perspective. Manufacturing has been in long-term decline since the 1960s. The manufacturing share of employment 50 years ago was about 25% and today it’s down at around 8%.

So it’s just a just a continuation of what we’ve seen over many years. I think it does make sense to let these industries go although like many Australians I would like to know we still make cars. But unlike me not enough Australians buy them so we only have ourselves to blame.

Other countries can make cars more efficiently than we can so we should move on to making other things. Over the next few years the bulk of new jobs will come from other areas like construction, services, health, education, finance and tourism.

Where are the best opportunities in investment markets this year?

International shares are likely to continue to provide good returns as the global economy continues to recover, especially if the Australian dollar maintains its downward trend, as I suspect it probably will.

Australian shares should also enjoy a good year, underpinned by stronger profit growth—which we’re already starting to see with some good company results.

At the other end of the scale, the returns on fixed interest and cash are quite low and these asset classes are going to remain constrained.

And then in between you’ve got commercial property and infrastructure probably doing OK but more in the 8-10% range.

What you need to know

This document was prepared by AMP Capital Investors Limited (ABN 59 001 777 591, AFSL No 232497). This document, unless otherwise specified, is current at Tuesday, 25 February 2014 and will not be updated or otherwise revised to reflect information that subsequently becomes available, or circumstances existing or changes occurring after that date. While every care has been taken in the preparation of this document, AMP Capital Investors Limited makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance.

This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.