7 May 2018
Originally featured in the Real Estate Institute of British Columbia's INPUT Magazine
 
Australia weathered the Global Financial Crisis (GFC) reason- ably well thanks largely to international demand for natural resources, especially from China. While some industries felt the impact of the GFC, the mining boom shielded the Australian economy from widespread recession and drove interstate migration and economic growth to the mining-centric states of Western Australia and Queensland.
 
At the same time, China’s economy was growing at over 10.0% per year, overtaking Japan in 2010 to be the second-largest economy in the world behind the US.1 This rapid economic growth drove urbanization at an unprecedented pace. In 1978, there were no Chinese cities with more than 10 million people and only two with 5 to 10 million. By 2010, there were six cities with populations of more than 10 million and a further 10 cities with 5 to 10 million people. China’s urbanization rate increased from 17.4% to 56.1% between 1978 and 2015,2 resulting in the Chinese economy being the largest contributor to global growth since 2008.3


In 1999, the Chinese government introduced the Go-Out Policy: a program designed to leverage its massive foreign exchange reserves to support and accelerate overseas expansion and acquisitions by Chinese companies.4 However, the policy did not really gain momentum until the GFC when, in November 2008, the Chinese government provided a RMB 4 trillion5 stimulus package.
 
Urbanization and a reformed economic system in China created a strong middle class and a substantial high-net- worth (HNW) population. Many had been in wealth creation mode for the past two decades. However, after the GFC, signs emerged of a growing preference of Chinese investors to pursue wealth preservation strategies.

Like the UK, US, and Canada, Australia has been a popular destination for Chinese investment. Underpinning demand is a safe, stable economy with strong rule of law, a high-quality education system, a freehold real estate title system, and added lifestyle benefits such as food safety, a clean and safe living environment, and similar time zones.
 

Strong Population Growth 

Population growth has been fundamental to demand for Australian residential property relative to supply, particularly in the largest states of New South Wales and Victoria. Due mostly to an increase in net immigration    in line with the Australian Government’s federal immigration policy, annual population growth since mid-last decade has averaged over 370,000 people compared to 218,000 over the decade to 2005.6

The actual supply of dwellings, however, has not increased commensurately with population growth, resulting in a material shortfall, which contributed to an increase in house prices.7 Positively, the higher house prices have prompted a substantial residential construction response, which has helped to rebalance Australia’s economy following the record mining investment boom of the decade to 2013.
 
Recently the US, with a population of 325 million people, achieved one million international student enrolments across its higher education institutions. Australia, with a population of only 24 million, is predicted to surpass its one million enrolment goal by 2025. Australia’s 554,000 overseas-student cohort is anchored by Chinese students at 28% of the cohort, and Indians at 11%.
 
However, in recent years there has been substantial growth from Colombia, Brazil, Nepal, and Malaysia.8 Having diversity across student source countries will be crucial to the success of this dynamic sector going forward. At a state level, international education has been Victoria’s largest service export industry for over a decade. In 2016–17, education and related travel generated AUD 9.1 billion in export revenue.9

The quality and prestige surrounding Australia’s education institutions is a key reason for growth in international student enrolments. However, there are many other factors, including:
  • safe and secure communities
  • welcoming, culturally diverse localities
  • ready access to their country of origin’s cuisine
  • good prospects to achieve permanent residency and to migrate to Australia after graduation
Increasingly, course-related employment opportunities are also a primary enrolment motivator. Australia provides international students with the opportunity to undertake 20 hours per week of paid employment
while they are studying. If the students graduate with an undergraduate degree, they can remain in Australia and work full-time in the local economy for two years under a Temporary Graduate Visa – subclass 485 before returning home.10
 

Category of purchasers 

The increased foreign demand for Australian  property has been most pronounced in Sydney and Melbourne. Foreign residential buyers in Australia can be categorized into three groups (summarized in the table below).
 
Under Australia’s foreign investment framework, foreigners generally need to apply for foreign investment approval before purchasing residential real estate in Australia.

The Australian Government’s policy is to channel foreign investment into new dwellings as this creates additional.


 
jobs in the construction industry, helps support economic growth, and alleviates risk of a housing bubble  led by demand-supply imbalance. It can also increase government revenues, in the form of stamp duties and other taxes as well as increased economic activity generated by additional investment. Foreign investment applications are therefore generally considered in light of the overarching principle that the proposed investment should increase Australia’s housing stock.11
 
While the general policy is to channel foreign investment into new dwellings, certain categories of foreign nationals who hold visas entitling them to reside in Australia continuously for at least 12 months may be given Foreign Investment Review Board (FIRB) approval to purchase established residential property (second-hand dwellings). However, they must use the property as their principal place of residence. They must also sell the property when they leave Australia, when their visa expires, or when the property is no longer used as their principal place of residence.12
 

Introduction of the Significant Investor Visa  

On November 24, 2012, the Australian Government announced the introduction of the Significant Investor Visa (SIV) in addition to other Business Innovation and Investment visa programs. The SIV required an investment of AUD 5.0 million in complying investments and entitled the applicant to a four-year visa and, importantly, a pathway to permanent residency. SIV holders  were also eligible to purchase established residential property, subject to FIRB conditions.
 
The SIV program drew strong interest in its first two years, as it offered candidates the flexibility to invest the entirety of their AUD 5.0 million commitments into a single asset class, which, aside from government bonds, was required to be effected through a managed fund.

Exposure to real estate was popular, with complying managed fund asset classes, including commercial real estate and A-REITs, but not established residential real estate. This initial framework yielded 1,641 SIVs or AUD
8.2 billion in complying investments. Substantially more investment and economic activity is thought to have been generated by the new migrants and their families outside of their AUD 5.0 million investments.13
 
Coinciding with the introduction of the SIV program were optimal conditions for above-average price growth, 
most notably in New South Wales and Victoria, with robust population growth, record-low interest rates, and a strong lending market. Of the many SIV targeted investment products established, some appeared to incorporate spurious access to residential investment and development. While possibly compliant under the original investment framework, these products were not in the spirit of the legislation and did not engender public goodwill towards the SIV program.
 
Fears of instability in the Chinese economy, most notably reflected in material devaluation of its currency, the Renminbi (RMB), drove wealthy Chinese to pursue capital preservation strategies—including international diversification.
 
By 2014, the impact of the additional foreign demand for residential (and commercial) property was revealed in rapidly rising real estate prices across Sydney and Melbourne markets, causing housing affordability and immigration to become major political issues. The Australian Government announced a review of the SIV program as well as a review into the Foreign Investment Review Board’s monitoring process and enforcement capability.
 
In 2015, state and federal governments in Australia started introducing various surcharges and taxes to capture additional revenue from increased foreign demand. In mid-2015, changes to the SIV complying investment framework were introduced, closing loopholes  that had enabled SIV investors the access to residential property. The changes appear to have markedly reduced the demand for the program, with just 250 SIV visas granted under the new investment regime (July 1, 2015  to October 31, 2017); 8.9 per month as compared to 52.9 per month under the original program.14
 
Figures published by the federal government show that 87.3% of all SIVs granted were to applicants from China, and a further 3.1% were to applicants from Hong Kong. The vast majority of all SIVs granted have been in New South Wales and Victoria.15
 
By 2015, accelerated credit growth, historically low interest rates, high levels of household debt, and strong com- petition in the housing market prompted the Australian banking regulator, the Australian Prudential Regulation Authority (APRA), to increase the level of regulatory oversight on mortgage lending in Australia. A consequential major credit squeeze for property investors and developers, particularly those from offshore and/ or seeking interest-only loans, led to fears of a material housing price correction. Among the measures APRA implemented were lower loan-to-value ratios (LVR) and increased “serviceability floors.” For example, lenders began testing a borrower’s ability to service their loans at an assessment rate of more than 300 basis points above their current mortgage interest rate.
 
Prior to APRA’s increased activity, major Australian banks had been willing to lend to investors and foreign buyers of Australian real estate supported by overseas income at relatively high LVRs, reducing the equity required to settle transactions. Interest-only loans were also prevalent, reducing the ongoing holding costs for purchasers. In addition to various global economic drivers, the low deposit (down payment) requirements for new residential off-the-plan (OTP) property purchases (generally no more than 10%), the rising  property market, and the ability for purchasers to acquire freehold title attracted unprecedented levels of offshore demand.
 
Provided (below) is a summary table of the changes introduced in the State of Victoria between 2014 and 2018, together with federal government initiatives. New South Wales and Queensland also introduced similar taxes and duties over the same period of time.

 
 

Market Impact

 
The Australian residential property market has been  very strong post-GFC, particularly since 2012, and has remained highly resilient amid ongoing commentary of an imminent downturn. The base conditions of strong population growth (particularly in Victoria and New South Wales), low interest rates, and easy  access  to debt have continued to propel the real estate boom with median house prices rising 73% in Sydney and 51% in Melbourne between 2012 and 2017.25
 
The steep price growth prompted both state and federal governments to take action in an attempt to cool the booming market.
 
As a result, the Australian residential market has faced several domestic and offshore headwinds since 2015, notably:
  • a tightening credit environment driven by APRA
  • new foreign-purchaser property taxes
  • increased foreign-purchaser government oversight
  • a tightening of immigration controls
  • a tightening of Chinese outbound capital controls
  • a strengthening of Chinese currency


While it is difficult to accurately attribute specific weight to any particular factor, collectively these factors have lowered demand for Australian residential property, particularly in the booming markets of Sydney and Melbourne. Changes to immigration policies and the introduction of new taxes have each weakened confidence. However, the macro-prudential intervention of APRA to moderate access to debt for investors has plausibly had the most significant impact on the market.

As Australia was introducing a range of domestic regulations to address the booming housing market,  China, too, was tightening capital controls to maintain capital reserves and support its economy. Chinese currency devaluation was a concern for investors during the early part of this decade, fuelling international diversification and outbound investment. The strong appreciation of the RMB against the US dollar and resilience of the Chinese economy since late 2015 are also likely contributors to  the decline in demand for Australian property.


 
Market statistics from CoreLogic indicate that Australia’s latest residential real estate boom may have peaked in July 2017, with both Sydney and Melbourne housing markets now starting to slow. The data indicates Sydney is cooling faster than other capital cities, declining 3.1% since the peak in July last year, albeit following a 74%   rise in the past five years. Melbourne is stabilizing, following a 59.0% increase since 2012.







There is much conjecture in the Australian media and broader commentary as to whether this is the start of a soft landing for the booming residential market or something more drastic. The Australian Government believes APRA’s macro-prudential intervention is successfully slowing a booming housing market. Developers, on the other hand, have expressed increased concern about numerous government policies and tax changes in the past four years that have substantially undermined foreign confidence in Australia as an investment destination.
 
While data for the established housing market is relatively accessible and transparent, demand data for the new apartment market is far less so. Pre-sale statistics are typically maintained by developers and their financiers; larger projects tend to have lengthy sale and construction periods prior to settlement. Anecdotally, we understand that offshore demand for pre-construction or off-the-plan investment property has slowed significantly. Given the numerous tax and policy changes in the past few years, it is hard to accurately attribute the decline to one specific change, but collectively it seems that access to debt and regularly changing government regulations appear to have negatively impacted foreign purchaser confidence.
 
Investors, both domestic and foreign, typically make up a high percentage of purchasers for most apartment developments in large cities. The recent investor credit squeeze and new tax initiatives have changed the economics of residential property investment, particularly for foreign buyers.
 
Provided above is a hypothetical example of the impact of the tax and finance changes in recent years, assuming a foreign investor purchases an $800,000 apartment off-the-plan in Melbourne, Victoria, in 2014 and in 2018.
 
Debt is typically determined based on a loan-to-value ratio with the value being the value of the property (excluding duties and taxes) as determined by independent valuation at the time of settlement, which, depending on market conditions, may be lower than the original purchase price. For the purposes of this example, we have assumed valuation is at purchase price. Most financiers providing debt to foreign purchasers of new investment property have a maximum LVR criteria of 65%, but typically aim for 50–60%.
 
In addition to the increased upfront equity requirement, the cost of debt has also increased with debt providers that fund offshore investors typically requiring higher application fees, establishment fees, and annual interest rates as compared to established tier-one banks. Many cash-rich investors have chosen to settle in cash rather than pay the additional costs associated with using non-bank lenders. However, their investment returns
are impacted as the benefit of leverage is reduced and their eligibility to acquire additional investment properties is restricted, overall reducing demand for investment property.
 
For less wealthy investors and speculators, however, the large equity gap is creating unexpected problems, increasing settlement risk for developers and their financiers given that most purchasers only pay a 10% deposit with the balance due on completion. While most developers are not reporting a large increase in pre-sale contract defaults, we understand that settlement delays are building and nominations (where a purchaser on-sells their pre-sale contract) are growing. Depending on the location and project, those who purchased at the start of the boom may have enjoyed capital growth while the project has been under construction and therefore may be motivated to settle with equity or on-sell their con- tract for a profit. However, those who purchased at or near the peak of the market and are now facing a large, unexpected equity gap as a result of declining values, reduced demand, and limited financing options may be less motivated to settle.
 
The Australian residential property market is now finely balanced. The various regulatory policy responses designed to cool the booming housing market are taking effect to the satisfaction of the Australian Government and regulatory authorities.

The medium- to longer-term impact on foreign purchaser demand, particularly the impact on new apartment sales and upcoming settlements, is, however, uncertain. The 2018 year will be one where the Australian property market will be deeply scrutinized by government regulators, developers, financiers, owners, and investors alike.
 
End notes
1 World Bank, “China 2030: Building a Modern, Harmonious and Creative Society,” 3 (2013).
2 Govt report: “China’s urbanization level reached 56.1%,” The State Council – The People’s Republic of China, accessed February 23, 2018, http://english.gov.cn/news/video/ 2016/04/20/content_281475331447793.htm.
3 “The World Bank in China” last modified March 28, 2017, http://www.worldbank.org/en/country/china/overview.
4 “Chinas ‘going out’ strategy,” The Economist, accessed February 23, 2018, https://www.economist.com/blogs/freeexchange/2009/07/chinas_going_out_strategy
5 Adam McKissack and Jessica Xu,  ”Chinese  macroeconomic  management  through the crisis and beyond,” 2011-01: Chinese macroeconomic management through the crisis and beyond (2011), accessed February 23, 2018.
6 S. Oliver, “Will Australian House Prices Crash? Five reasons why it’s more complicated than you think!” AMP Capital (2017), accessed February 23, 2018.
7 Australian Bureau of Statistics. “Number of Dwelling Unit Completions by Sector,” 5752.0 Building Activity Australia, 2017.
8 “International education in Australia – soft power and solid results,” Department of Foreign Affairs and Trade, accessed February 23, 2018 http://dfat.gov.au/about-us/ publications/trade-investment/business-envoy/Pages/august-2017/international- education-in-australia-soft-power-and-solid-results.aspx.
9 “Victoria State Profile,” Department of Foreign affairs and trade, accessed February 23, 2018, https://dfat.gov.au/trade/resources/Documents/vic.pdf.
10 “International education in Australia – soft power and solid results,” Department of Foreign Affairs and Trade, accessed February 23, 2018 http://dfat.gov.au/about-us/ publications/trade-investment/business-envoy/Pages/august-2017/international- education-in-australia-soft-power-and-solid-results.aspx.
11 “Residential Real Estate” Foreign Investment Review Board, accessed February 23, 2018, http://firb.gov.au/real-estate/.
12 Ibid.
13 “Significant Investor Visa (SIV) Statistics,” Australian Government – Department of Home Affairs, accessed February 23, 2018, https://www.homeaffairs.gov.au/about/reports-publications/research-statistics/statistics/work-in-australia/significant- investor-visa-statistics.
14 Ibid.
15 Ibid.
16 “FAQs,” Australian Trade and Investment Commission, accessed February 23, 2018, https://www.austrade.gov.au/international/invest/guide-to-investing/coming-to- australia/significant-and-premium-investor-programs/faqs.
17 “Foreign purchasers of Property,” State Revenues Office Victoria, accessed February 23, 2018, https://www.sro.vic.gov.au/foreignpurchaser
18 Australian Trade and Investment Commission, accessed February 23, 2018, https://www.austrade.gov.au/international/invest/guide-to-investing/ coming-to-australia/significant-and-premium-investor-programs/faqs.
19 “2015 FIRB Reforms: A new regime for foreign investment in Australia – 1 December 2015,” HopgoodGanim, accessed February 23, 2018, http://www.hopgoodganim. com.au/page/Publications/2015_FIRB_Reforms_A_new_regime_for_foreign_ investment_in_Australia_-1December_2015/.
20 “Foreign Purchasers of Property,” State Revenues Office  Victoria,  accessed  February 23, 2018, https://www.sro.vic.gov.au/foreignpurchaser.
21 “Absentee Owner Surcharge,” State Revenues Office  Victoria,  accessed  February 23, 2018, https://www.sro.vic.gov.au/news/absentee-owner-surcharge.
22 “2017 Off-the-plan Duty Concession Changes,” State Revenues Office Victoria, accessed February 23, 2018, https://www.sro.vic.gov.au/ 2017-plan-duty-concession-changes-faqs.
23 “Absentee Owner Surcharge,” State Revenues Office  Victoria,  accessed  February 23, 2018, https://www.sro.vic.gov.au/news/absentee-owner-surcharge.
24 “Fees- residential land [GN29],” Australian Government Foreign Investment Review Board, accessed February 23, 2018, http://firb.gov.au/resources/guidance/gn29/.
25 “Residential property price Indexes: Eight Capital Cities, 2017” Australian Bureau of Statistics, accessed February 23, 2018, http://www.abs.gov.au/AUSSTATS/[email protected]/ DetailsPage/6416.0Sep%202017?OpenDocument.