Four reasons higher interest rates mean pain in Asian property but no crisis

The impact of higher borrowing costs on Asia’s housing markets must be put in context given key factors that make a full-blown crash unlikely
Asia’s largest markets face manageable inflation with strong capital positions, high home ownership and worry less about serviceability than affordability

Nicholas Spiro

Published: 4:30pm, 14 Nov, 2022

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In a speech last month, Bank of Korea governor Rhee Chang-yong said there was a subtle but important difference between increases in interest rates in South Korea and the United States. “Considering the high proportion of floating rate mortgage loans in Korea, over 60 per cent compared with less than 10 per cent in the US, you can think of our 50 basis-point increase as having the equivalent impact of a 75 basis-point increase by the Fed,” Rhee said.

The central banker put his finger on a key vulnerability in Asia’s residential mortgage markets: the high share of variable-rate loans which fluctuate with changes in rates, as opposed to fixed-term lending, which shields borrowers from the impact of higher rates for some time.

In a report published in May, Fitch Ratings singled out Australia as one of the markets most at risk from tighter monetary policy, in part because of the high share of variable-rate mortgages.

Fitch’s methodology – which classifies fixed-rate loans that expire or reset in the next 24 months as variable-rate mortgages – shows that even fixed-rate borrowers whose loans have a relatively short maturity are vulnerable.

While many Australian borrowers on variable rates switched to cheaper fixed-rate loans during the pandemic-induced recession, a large portion of these mortgages need to be renewed next year. With the Reserve Bank of Australia having raised its policy rate seven times since May, a “mortgage cliff” looms as the average rate on fixed deals of up to three years exceeds 5 per cent, up from 2 per cent in mid-2021.

In Hong Kong, practically all borrowers are on floating rates, with 96 per cent of new mortgages tied to Hibor, the city’s benchmark interbank rate.

People walk through Exchange Square in Hong Kong on October 28. With the HKMA moving in lockstep with the Fed, the one-month Hibor has shot up to 3 per cent, its highest level since the 2008 financial crash. Photo: AFP

As the Hong Kong Monetary Authority moves in lockstep with the Federal Reserve to maintain the city’s currency peg to the US dollar, the one-month Hibor has shot up to 3 per cent, its highest level since the 2008 financial crash.

This has forced commercial banks to raise their prime rates for the first time since 2018 just as secondary home values drop deeper into correction territory, having fallen 14 per cent from their peak in August last year.

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Ben McCarthy, head of Asia-Pacific Structured Finance & Covered Bonds at Fitch Ratings, noted that in the US, where most mortgages are fixed for three decades, “it is the lender that takes the risk”. In Asia, by contrast, where variable-rate loans are much more prevalent, “it is the consumer, which is good for banks”.

Dangerously high levels of household debt in South Korea and Australia increase borrowers’ sensitivity to rises in mortgage rates. According to the International Monetary Fund, half of South Korea’s household debt is tied to floating-rate loans and structured as “bullet payments”, which involve large lump sum payments at the end of a loan term. In Australia, household debt has surged to a staggering 180 per cent of gross disposable incomes.

A man waits for a residential home auction to start in Sydney, Australia, on November 12. Australia’s home loan values plunged 8.2 per cent from a month earlier to A$25.1 billion (US$16.1 billion), the lowest level since November 2020. Photo: Bloomberg

However, the impact of higher borrowing costs on Asia’s housing markets needs to be put in context, particularly given key mitigating factors that make a full-blown property crash unlikely. For starters, Japan and China do not suffer from soaring inflation and continue to diverge sharply from other leading economies by maintaining loose monetary policy.

While China faces a debilitating downturn in the housing market, which encouraged some mortgage holders to band together and halt payments on unfinished homes, the turmoil has forced Beijing to do more to support the sector. A banking crisis is less of a concern than whether China can come up with a new growth model.

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Second, the pressure on Asia’s housing markets is less acute because of banks’ stronger capital positions and prudent loan underwriting standards. In South Korea and Australia, macroprudential policies were tightened to increase the resilience of the banking sector and assess borrowers’ ability to cope with financial shocks.

Louis Kuijs, chief economist Asia-Pacific at S&P Global Ratings, said it was important to differentiate between economic stress and financial instability, with the former posing more of a risk. “We’re starting from a position of a pretty well-taken-care-of financial system,” Kuijs said.

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Third, it is common in Asia for people to own their properties outright, blunting the impact of higher rates. Furthermore, many owners with mortgages accumulated a large amount of equity when prices were rising sharply. Although first-time buyers and borrowers who took out mortgages only recently are at risk, declines in home values this year need to be put into perspective.

In Australia, prices last month were only 0.9 per cent down in annualised terms and still rising sharply in Adelaide and Brisbane. In Singapore, private and public residential prices continue to grow.

Fourth, and most importantly, serviceability is far less of a concern than affordability. Hong Kong, Sydney, Melbourne and Auckland accounted for four of the top eight least affordable housing markets among 92 cities surveyed by Demographia in its latest international housing affordability study published in March.

Given chronic supply shortages and policies that favour homeowners at the expense of first-time buyers, the real problem is the lack of decent and affordable housing. Higher rates will put Asia’s housing markets under increasing strain, but not enough to cause a crisis and not nearly enough to improve affordability.

Nicholas Spiro is a partner at Lauressa Advisory