Rate rises to crunch housing affordability and hit commercial assets

Credit agencies have warned that housing will remain out of reach for many and commercial building owners are also under the pump.

The eport found that new home loan borrowers needed an average 30.9 per cent of monthly income to meet monthly mortgage repayments. Picture: Celeste Humphrey

Rising interest rates will slam into both housing affordability and commercial real estate this year credit ratings agencies have warned.

The pressures unleashed by ten straight interest rate hikes are biting household borrowers and are threatening to spill over into previously untouched parts of the commercial market.

A new report by Moody’s Investors Service said that housing affordability for new Australian homebuyers, which worsened last year, would again remain poor over 2023, despite falling prices.

Moody’s said that poor housing affordability increased the risk of delinquencies and defaults for new mortgages, which was a credit negative for residential mortgage-backed securities and covered bonds backed by such loans.

The Moody’s report found that in February, new home loan borrowers needed an average 30.9 per cent of monthly income to meet monthly mortgage repayments, a lift from 26.4 per cent in May 2022, when interest rates began their steep increase.

“We expect that housing affordability will remain poor over 2023, with Sydney being the least affordable Australian city for housing,” Moody’s analyst Si Chen said.

The agency said rising interest rates would continue to weigh on housing affordability with the Reserve Bank of Australia indicating that it expects to further tighten monetary policy to combat inflation. It said that further interest rate rises will weigh on housing affordability for mortgage borrowers.

Moody’s expects that ongoing housing price declines will broadly balance out further interest rate rises in terms of their effect on housing affordability this year.

“If the RBA raises the cash rate to 4.1 per cent, the share of income that borrowers need to meet repayments on new mortgages will hold around the February level if housing prices decline 4.5 per cent,” Mr Chen said.

But it cautioned that income gains would not improve housing affordability while rates are rising, saying wage growth would likely be low compared with the advancing pace of rate hikes and the high inflation.

PropTrack director of economic research Cameron Kusher said the fall in household savings, which is down to the lowest levels since 2017, and the declines in retail trade show the RBA’s actions are beginning to flow through to the broader economy.

“The Reserve Bank’s just so concerned about inflation remaining higher for longer that they’re not going to pause,” he said. “I think the reasoning they’ve stated makes sense. They probably remember back to what happened in the early 1990s when inflation expectations became untethered, and they had to keep raising interest rates and push the country into a recession.”

Mr Kusher said the Reserve Bank knows there are only so many hikes households can take and that some households are more exposed to risk than others. The data firm expects the cash rate to top out at 3.8 or 4.1 per cent in the coming months.

“Interest rate hikes take 18 to 24 months to impact on households fully, so we haven‘t even had the full impact of the first rate hike, let alone the nine we’ve already had and those we’ll probably have after tomorrow,” Mr Kusher said.

“It might cause some people to have to sell property, I wouldn‘t be surprised. People were clearly under the impression that interest rates weren’t going to be going higher until 2024 and some people would have stretched themselves.”

The pain is showing on the commercial side. S&P Global Ratings said that ratings pressure was likely to persist in the interest rate-sensitive REIT sector.

“This is particularly acute in the wholesale segment, where sticky valuations are seeing a growing disconnect between unlisted and listed asset prices,” S&P analyst Craig Parker said.

The agency says that big investors have begun to cash out of wholesale funds at favourable prices and are shifting their capital into the discounted listed real estate markets, when many stocks have slumped.

S&P said that as institutions exited the credit quality as wholesale funds could be hit as they sold off assets or took on debt to help fund redemptions. This could ricochet around the market as deals are struck at lower prices, putting pressure on other owners.

“Asset sales are likely to be struck below net tangible asset values, depressing asset prices across the Australasian real estate sector,” Mr Parker said.

He predicts that higher transaction volumes should help to close the valuation gap between listed and unlisted markets. “We expect that market participants will focus on rent security and cash flow generation to differentiate the stronger players in this dislocated market,” he said.

S&P has already downgraded Lendlease‘s APPF Retail and Queensland-based QIC Property Fund on redemption-related credit pressures, expects other players to face similar challenges in the coming months.

“While redemptions have centred on retail property funds, they will spill to the office space, in our view,” Mr Parker said. ”A tougher macroeconomic outlook and structural challenges from hybrid working will start to weigh.”