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First dollars out of the wallet

By Dermot Ryan
Sydney, Australia

Falling house prices and rising debt costs are causing financial stress for highly leveraged Australian home owners, impacting patterns of consumer spending. In light of this wallet tightening, investors should take care that their equity exposure is concentrated on those businesses capturing the first dollars out of the wallet each pay day.

Where did all the wealth come from?

During the upwards phase of the economic cycle, Australians took on greater levels of debt, especially mortgage debt as they bought property.

This gave rise to a massive wealth effect as home purchases were followed by expenditure on furniture and home improvements. In addition to banks, real estate agents and law firms, a whole range of trades such as builders, decorators and landscape gardeners also reaped the benefits of the boom.

Property price rises led to increasing levels of home equity which was often recycled into the wider Australian consumer economy, either upon property sales or remortgaging. These benefits were seen not just in spending related to moving or home improvements, but also in wider consumer spending. This was demonstrated by rising sales of new cars, holidays and furniture. Children and grandchildren also benefitted from the receipt of direct gifts as property wealth was spread around.

However, over the last 12 months this trend has reversed, with most of Australia, but especially Sydney and Melbourne, seeing property price increases give way to a downwards correction.

Who looks vulnerable?

It is worth considering three distinct groups that find themselves at particular risk in the current climate:

1) Young families under pressure from all sides

This cohort arguably poses the greatest risk to consumer spending as it is both the largest and most vulnerable of the three groups.

Many have very weak personal balance sheets, having typically exhausted their savings to finance the deposit and fees to buy their first home. Those that purchased later in the boom without experiencing much in the way of growth in their home equity stake as prices rose, now see their sliver of housing wealth getting progressively skinnier. Meanwhile, their super-sized mortgages have barely diminished as they generally have little spare cash to make additional repayments beyond the minimum.

Furthermore, their cash-flow position is also highly stretched as mortgage repayments account for a large portion of their take-home pay. Those in this cohort who find themselves being transferred from interest-only mortgages to principal and interest mortgages will take a particularly big hit to their disposable incomes. Future increases in interest rates are likely to be especially painful.

Compounding these pressures, young families face a non-discretionary inflation rate materially higher than the headline consumer price index (CPI) rate. Insurance premiums, school fees, utility bills and petrol have all increased faster than CPI at a time when much of the Australian workforce has been experiencing meagre wage growth.

2) Serial property investors – over-geared and over-allocated

Whereas most private buy-to-let investors own either one or two properties, there is a significant group of amateur landlords who have established more sizeable portfolios.

However, this group is not typically comprised of high net-worth individuals. Rather it consists of those who having entered the market a bit earlier in the boom and have used market gains as collateral for their second and then subsequent investment property purchases. They may now own a portfolio with significant value – at least in nominal terms – but their equity may be very modest as gains in value have been largely ‘spent’ on subsequent buy-to-let deposits.

This group of investors who might typically own three to six properties are essentially speculators whose portfolios are likely to be cash flow negative. This has a number of implications.

High mortgage costs relative to rental income leave these owners very vulnerable to adverse developments, such as higher interest rates, an interruption in their rental income or disruption to their regular salaried income from which they may be covering negative rental earnings.

Professionals on higher salaries are highly dependent on Australia’s generous negative gearing system. This permits rental losses to be effectively shared with the government as losses may be deducted from their salaried income when calculating their taxable income. There is currently much speculation that should the Labor Party win the next federal election this benefit will be curtailed.

Their main motivation for property investment is capital appreciation, which appears unlikely to be realised in the medium-term. They may look to sell in a falling property market, but negative equity and/or mortgage lock-in periods may render this impractical for highly geared investors.

3) Over-reaching young pretenders

The final group of at-risk property owners are characterised as a minority of ‘smashed avocado brunching millennials’ who through a combination of high incomes, disciplined saving and the benevolence of the ‘Bank of Mum & Dad’ managed to scrape together the funds to enter the property market.

They have been among the last to enter the real estate market during the boom and typically hold very little home equity, which is now diminishing daily as house prices fall away.

This group appears to face a similar situation to the young families. However, their predicament is typically less dire as they are likely to be at a stage in their careers when they are more likely to experience rising incomes over the next few years. They are also likely to have greater capacity to curb their discretionary spending as this is likely to comprise a larger part of their income when compared to cash-strapped young families.

What are the implications for investors?

While these groups face different challenges, all are now approaching situations where their discretionary spending should be considered to be at risk.

A consensus is now emerging that an extended period of falling house prices is the base case for the Australian property market; this should be highly concerning.

These three at-risk groups tightening their belts simultaneously comes at precisely the wrong time for the economy. This is because it will coincide with the impact of a slowing housing market on home purchase-related expenditure.

Therefore, it is reasonable to expect that falling property prices may well soon impact consumer spending. This can be expected to have a significant impact on those directly affected by price falls such as banks, real estate agents and property portals. It will also create second-degree impacts on big-ticket electrical goods retailers, suppliers of kitchens and bathrooms and hardware store chains that benefit from house purchasing activity.

Yet it is perhaps the third-degree impacts that are least understood but most important as the three identified groups face a material change in their circumstances, leading to an immediate re-assessment of household spending priorities.

This will put discretionary spending at immediate risk. Stepping aside from trite clichés about cafes and avocado traders, businesses such as restaurants, bars, cinemas, fitness clubs, leisure travel and fashion will be amongst those impacted.

In response, Australian equity investors should think about positioning their portfolios so that they are exposed to ‘the first dollars out of the wallet’ non-discretionary spending each payday. This includes utility companies, insurance companies and non-discretionary retailers, such as supermarkets. They may also consider companies that are negatively correlated to consumer confidence, such as manufacturers of own brand groceries, value retailers or low-cost dining chains. 

  • Economics & Markets
  • Opinion
  • SMSF News
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Important notes

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)  (AMP Capital) 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 and must not be provided to any other person or entity without the express written consent of AMP Capital.


This article is not intended for distribution or use in any jurisdiction where it would be contrary to applicable laws, regulations or directives and does not constitute a recommendation, offer, solicitation or invitation to invest.

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