NEW ZEALAND HOUSING – Prices to Fall?
New Zealand is experiencing a housing market boom. House prices are increasing at 13 percent per annum nationally, and at 15-20 percent in Auckland and close-by regions. Auckland house price inflation in excess of income growth has seen the median house price to income ratio grow to 9.7 times, making Auckland the fourth most expensive city relative to income out of 367 cities worldwide.
The situation is extending what most ‘experts’ would consider reasonable and as a consequence both the
housing market and the banking system are at risk of material correction in prices. Evidence from housing
cycles in several advanced economies suggests that the longer this continues, the more likely there will be
a severe correction.
New Zealand banks are heavily exposed to housing with mortgages making up around 55 percent of total
assets. Meanwhile household debt stands at a staggering 163 percent of household income, leaving the
majority of the country susceptible to a sharp correction.
The Reserve Bank is concerned about the risks to financial and economic stability inherent in the housing
market. As a consequence, it has a number of tools at its disposal that it can use to attempt to curtail
investment in housing. A patchy domestic outlook combined with an overvalued currency and low global
inflation is restricting the banks’ ability to use monetary policy to address their concerns (i.e. raising the
cash rate). Consequently, macro-prudential policy must instead be used.
New Zealand Housing – Preventing the Bubble
RBNZ’s Goal
The Reserve Bank’s primary role is to maintain price stability in the wider economy in
conjunction with maintaining the soundness and efficiency of the financial system.
In the Reserve Banks opinion, the housing risk is now starting to impose a systemic risk
to the financial system and wider New Zealand economy. Because housing is such a
pinnacle part of New Zealand economy, there would be significant and material
implications if a full blown housing market collapse was to eventuate. Consequently,
both the Reserve Bank and New Zealand government are attempting to take steps now
to prevent such an outcome.
In the past, increases to the cash rate (OCR) have been an effective method to curtailing
housing demand. Increases in mortgage rates and therefore credit growth helped to
moderate demand and consequently prices. However, because of general weakness in
both the domestic and global economy, the cash rate is at its historical lows and is likely
to remain low for some time. Consequently, macro-prudential policy (ie changes to
regulations/policy) are needed.
Why are House Prices so High?
Net migration
New Zealand’s stronger economic performance relative to many other advanced
economies as seen a large influx in both returning New Zealand’s and a pick-up in
foreigners moving to New Zealand.
Net migration flows continue to hit new records, with annual net migration now
approaching 70,000 people.
With a corresponding increase in population demand for housing also increases. This
causes price pressure and drives house prices higher. Migration flows had been heavily
focused on Auckland, but are now becoming more dispersed helping to push national
prices higher.
Credit Growth & Low Interest Rates
Given the low level of interest rates and strong performance of house prices, both
investors and first home buyers have been attracted to the housing market. This has
seen credit growth grow materially and as a consequence household debt-to-income
ratio now stands at 163 percent and now exceeds the previous peak reached during
the GFC.
Lax credit conditions make it easier for home buyers to access the market and
therefore leads to higher demand pressure. It also allows buyers to extend beyond
their means and purchase properties previously outside their investment set. It also
allows existing home owners to purchase additional properties and unlock existing
equity in their house to buy ‘investment’ properties. This results in increased demand
and a lower available supply to the wider market.
Mortgage rates declined over 2015 as the Reserve Bank eased interest rates in light of
on-going low CPI inflation. One and two year rates are now in the low 4 percent range,
which New Zealand has not seen since the 1950s.
High and rising debt levels leave households very vulnerable to any future increases in
interest rates or deterioration in economic conditions. While a large increase in
mortgage rates is unlikely in the current global environment, at today’s high debt-to-
income ratios, a relatively small increase in interest rates could put significant pressure
on some borrowers.
Supply Constraints
The housing supply response has been constrained by planning and consenting
processes, community preferences in respect of housing density, inefficiencies in the
building industry, and infrastructure development constraints. Consequently, despite
the large increase in demand and price, the housing industry has not been able to
respond quickly enough to meet these changes.
Although Auckland annual housing consents recently reached an 11 year high and are
some 20 percent above last year in value, the number of residential building consents
per capita in Auckland is currently around 40 percent of the peak level achieved in the
mid-2000s. We estimate the shortage of houses in Auckland has increased over the
past year and may now be in the order of 20,000-30,000 houses.
Auckland house price inflation in excess of income growth has seen the median house
price to income ratio grow to 9.7 times, making Auckland the fourth most expensive
city relative to income out of 367 cities worldwide. Outside Auckland, house price to
income ratios in most centres are around 4 to 6 Overall, New Zealand house prices relative to incomes are 32 percent above their long run average, and the second highest in the OECD. The IMF estimates that New Zealand house prices are around 20-40 percent overvalued based on long run affordability
metrics.
Furthermore, the overall housing shortfall is expected to increase further as supply is
growing more slowly than demand. More encouraging is the higher-intensity building
development that is now contributing a greater share of new dwelling consents.
Apartments, townhouses and other attached dwelling types accounted for 42 percent
of new residential building consents in Auckland over the past two years, compared to
28 percent nationally.
Possible Solutions
Initial loan-to-value (LVR) restrictions
The Reserve Bank first introduced a broad 80 percent LVR restriction in October 2013,
in response to growing housing market pressures and an increasing proportion of high
LVR lending from 2011. Then, in November 2015, a resurgence of pressures in Auckland
led the Reserve Bank to tighten the LVR restriction to 70 percent for Auckland
investors.
The Reserve Bank also established a new residential property investor class for banks.
Loans in that class now attract a higher risk weight than for owner-occupier mortgages,
requiring banks to fund such loans with a higher proportion of equity. The LVR
restrictions have strengthened bank balance sheets against housing market shocks.
The share of banks’ exposures to riskier mortgages has fallen across a variety of
borrower types.
It is now largely impossible to borrow more than 70 percent against an Auckland rental
property.
More broadly, the share of high LVR (+80 percent) mortgages on bank balance sheets
has continued to trend downwards. High LVR loans now account for 12 percent of
banks’ residential mortgage exposures, compared to around 21 percent just prior to
the initial introduction of LVR restrictions in 2013 Over time, these balance sheet trends will help to reduce banks’ losses on riskier loans in the event of a downturn in the New Zealand housing market.
%’age of total bank mortgage lending
The proposed change would see the RBNZ broaden its LVR restrictions from Auckland
to the rest of the country. However, at this stage it is unclear what the LVR ratio would
be set at. LVRs also tighten up banks’ lending conditions, potentially leading to a slow-
down in credit growth and house price inflation for a period.
Debt-to-income ratios (DTIs) restrictions
An alternative measure but on that could be used in conjunction with the LVR restrictions is a debt-to-income ratio restriction. DTIs aim to improve the safety of borrowers’ balance sheets, thereby reducing the likelihood of mortgage defaults in a downturn. In particular, debt-to-income limits are intended to better equip borrowers to continue servicing mortgages in the face of income losses and/or increases in
interest rates. DTIs, like LVRs, tighten credit conditions, resulting in some brake on
credit and house price inflation.
Debt-to-income ratios have been used internationally but not yet in New Zealand.
Capital overlays, like LVRs, improve the capacity of banks to absorb losses from mortgage defaults in a downturn. Additional capital requirements might also slow credit growth as banks adjust to higher equity funding.
A DTI would be a new instrument that would need to be agreed with the Minister of
Finance under the Memorandum of Understanding on Macro-prudential Policy.
Adoption would require more analysis and systems preparation than required under
the introduction of a nationwide LVR requirement.
Alternative Measures
Two areas for on-going consideration outside the influence of the RBNZ include tax and
migration policy. These are instead government focused issues but could equally be
effective in curtailing house price inflation albeit much more controversial.
On the tax front, the implementation of a capital gains tax on housing could help curb
short-term speculative activity in the housing market. In addition, consideration might
be given to further reducing the tax advantage of investing in residential housing and
making it less appealing to for investors to make use of negative gearing.
A change in the migration policy is a complex and controversial issue. However, there
has been 160,000 net inflow of permanent and long-term migrants over the last 3 years
which has generated an unprecedented increase in the population and a significant
boost to housing demand.
Given the strong influence of departing and returning New Zealanders in the total
numbers, it will never be possible smooth out the migration cycle. But, it may be
possible to assess the reviewing migration policy in relation to the required skills New
Zealand is appealing to. Higher restrictions are likely to lead to lower net migration.
Over time, this could over time help to moderate the housing market imbalance.
Implications
The RBNZ intend to roll out the nationwide LVR restriction before the end of the year.
We believe that this is likely to be done in conjunction with the DTI ratio restrictions.
However, the DTI restrictions still appear to be some time away and more
consultation is needed.
When the 2015 LVR Auckland policy changes were brought in, they corresponded to
a 2-4 percentage point reduction in Auckland house price inflation over a six-month
period. This price impact is similar to that assessed for the initial LVR restrictions in
2013.
Hence a fair assumption is that a reduction somewhere in the region of 5-10% in
house price inflation over the space of a year is likely. The changes are unlikely to
cause a shock to the housing market, rather a gentle slowing as it becomes more
difficult for investors to borrow to purchase houses. Over time this should see house
prices moderate and thereby an increase in house price affordability.
As time progresses, new housing supply should come on to the market and further
alleviate the supply demand imbalances that currently exist.
We may observe alternative investment such as shares become relatively more
attractive for investors and therefore perform better than property over the medium
to long term. Investors will be able to avoid the uncertainty surrounding the
regulation changes and impact on house prices while still enjoying the economic
benefits for a growing country. With New Zealand stocks offering one of the highest
dividend pay-outs in the developed world, shares appear to be an attractive
alternative.