Large percentage of property loans may be a problem if recession hits

THE surge in property prices has created a fresh avenue for investors wanting to make big bucks, but it is also creating a huge future problem that if left unchecked, can spell trouble for households, banks and the overall economy.

The robust property market has seen the percentage of property loans to total loans in the banking system rising well beyond the levels seen during the 1997/98 Asian financial crisis.

The growth in house purchases is said to be among the largest contributors to the tremendous build-up in household debt over the past 10 years.

Those concerns, for now, are being overlooked as the sector has not yet showed signs of strain.

For those investing in property as a means of investments, it has yielded huge gains.

“I have made more money from property than from stocks,’’ says one retired analyst, who has been investing his nest egg over the past few years.

It’s not hard to see why that has been the case. Stock markets have been volatile over the past few years.

Although a bet on the right stock can lead to generous returns, the effort and thought that goes into picking a winning stock is far more tedious than buying a house.

In property, the general rule is that you cannot go wrong if you buy a house at the right location. And there are always a few hot areas where huge returns can be made.

However, the pressure for overall prices in the country to appreciate is growing beyond those so-called hot locations.

The Real Estate and Housing Developers’ Association Malaysia earlier in the week said prices of residential properties, notwithstanding the earlier big gains, was expected to rise 10% to 20% over the next six months.

Another boost to property investment is that money is plentiful right now.

Look at the banks’ advertisements and you can see how innovative loan schemes have become.

Housing loan repayment periods have gone from 30 years to up to 40 years, and home buyers can now take loans up to the age of 70, way past their retirement age.

This works on the premise that their retirement benefits, prior investments or their children’s incomes should be sufficient to pay the mortgages taken out on their homes.

Also, the innovative loan schemes that require smaller downpayments – 5% or even zero payment – has allowed buyers to make huge returns.

A 20% appreciation in property values between the time the house is bought on, say, a 5% downpayment, to the time the house is completed (which is normally a couple of years or so), would see speculators raking in a four-bagger from their small downpayment, even after paying real property gain tax.

The extension of loan periods, the low interest rate environment and the smaller margins banks are willing to take just to grow their market share of property loans, have also helped fuel demand for properties.

“The fate of the banking sector is tied to the property sector,’’ says ECM Libra head of research Bernard Ching.

With half of the loans growth for the banking sector to June (which is 13.3% on an annualised basis) coming from properties, the portion of residential loans on the banks’ books is estimated to be 27%.

The percentage just prior to the Asian Financial Crisis was said to be around 17%.

The low interest rate environment really began after that crisis and it has been maintained by the subsequent recessions that have hit the country.

This has contributed greatly to a rise in total household debt as a percentage of the economy.

Household debt as a percentage of GDP was 40% in 2000 and today, that figure is around 64%.

“It’s rising and that has been the trend,’’ says Maybank Investment Bank analyst Wong Chew Hann.

Although property loans form a big part of the financial system, analysts say such loans are not in danger of default as the non-performing loan (NPL) ratio is low, particularly for higher-end properties.

But the danger will come should Malaysia suffer a severe recession. Analysts say transport and consumption loans would be the first to signal a default, rather than property loans.

However, with the nature of each new recession different from the ones before, and with recessions becoming more frequent, some analysts point out that if left unchecked, the current situation may become a problem.

To address this, maybe Bank Negara, taking a cue from what China has done, will need to look at instituting more stringent requirements for housing loans.

One suggestion is to impose higher downpayments, based on percentages on a rising scale, for people buying second, third or more houses.

That way, the profit from their initial investments on the homes will shrink after paying off the real property gains tax, thus making it less attractive to punt on house values.

Maybe prudent limits on banks should to be considered, given the banks’ exposure to residential properties.

Whatever the case, its better to err on the side of caution.

A property market collapse always spells trouble for the economy.