VAP shares are down 23% this year. Where to from here?

After 11 years of interest rates going in one direction, it’s been a shock to the real estate market and construction industry to see interest rates going up.

But that’s just one factor affecting the property sector: banks are tightening their loan requirements, builders can’t source materials, and inflation is chewing away at family savings which were being earmarked for mortgages.

This confluence of factors could drive the property sector far lower, and Vanguard Australian Property Securities Index ETF (ASX:VAN) shares could tank as a result.

Banks are tightening mortgage requirements and raising rates at the same time

When interest rates rise, banks raise mortgage lending rates as well, and the impact on the property market is well understood. Right now, though, banks are also tightening lending requirements.

This is a double whammy for borrowers. Not only will their mortgage budget fit a smaller loan, but banks are insisting on even smaller loan sizes. For example, ANZ cut its maximum loan to income ratio from 9 to 8 – an 11% reduction in maximum loan size.
This tightening of loan requirements could act as a multiplier effect on the rising interest rates, causing far more chaos than the market is expecting.

Building companies can’t deliver on their promises due to the breakdown of the supply chain

One of the risks of buying off plan from a builder is that the house may never actually get built and the buyer loses out. This is relatively rare in a bull market where flipping properties generates enormous amounts of cash and housing materials seamlessly arrive from local producers and from China.

After two years of lockdowns, however, the supply chains in Australia are extremely rusty and stiff, but not broken. The same cannot be said for China.

Much of China remains in lockdown as it pursues its zero-Covid policy, and nobody knows how long it will take for Chinese exports to normalise.

Nearly everything has Chinese components, so there are shortages everywhere.

If you want to buy a car in Australia, for example, you’ll have to sit on a waiting list for up to a year.

This is no big deal for a car dealership, because the car is imported and sold as a single unit.

Housing, however, sits under construction losing money for the builder. Unsellable and unbuildable.

In the first quarter of 2022, 270 construction companies closed down or went bankrupt, according to credit reporting agency Equifax.

Soaring inflation is eating away at family budgets and savings, putting property purchases even further out of reach

Australia’s official consumer price inflation (CPI) rate was 5.1% for the first quarter 2022. This is mild compared to the US. However, certain figures are of particular concern to the property market.

First, the non-discretionary CPI – including fuel, electricity, food etc – increased by 6.6% compared to the previous year. This is an important component, because families can’t reduce this segment of spending to maintain their savings rate. This pushes the next housing purchase further down the road.

Secondly, rising electricity prices are not yet reflected in CPI numbers.

Over the past two years, the electricity spot price in the eastern states has risen by between 500% and 1100%. However, long term contracts and subsidies by the Australian Energy Market Operator have shielded consumers from these price rises. They are still in the pipeline and will flow through over the next year.

Building approvals are down by a quarter and tanking

Last week the Australian Bureau of Statistics (ABS) announced that building approvals for May fell by 23.4% from a year ago – almost a quarter.

Keeping in mind that this was before interest rates began to rise, the outlook for the property sector appears to be grim.

The combination of tightening mortgage loan requirements, supply chain woes, rising inflation, and rising interest rates could drive the entire property sector far lower before a bottom is in sight.

If the above assumptions are correct, as [AR1] VAP captures the entire property sector, betting on VAP shares falling could reap significant rewards.

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