Brian Fallow: Don't expect surge in home prices

Despite a stagnant market, houses in New Zealand are still seen as expensive. Photo / Richard Robinson

There was good news from the housing market this week: it went sideways. Indeed over the past year the Real Estate Institute's house price index has risen just 0.9 per cent.

It is 5.3 per cent below its peak in late 2007. At that point house prices had doubled since 2002, accompanied inevitably by a rapid rise in household debt both in absolute terms and relative to incomes, which of course did not double but out of which mortgages and rents have to be paid.

Household debt is now 160 per cent of disposable incomes, up from 100 per cent 10 years ago and 50 per cent 20 years ago.

Net equity in housing has grown almost as fast, at least over the past decade, from 240 per cent of incomes to 375 per cent. It represents 70 per cent of households' net wealth.

Home loans make up 56 per cent of banks' lending as well.

So from the standpoint both of households and the banking system it is just as well that we have not seen a major correction in house prices.

But as any businessman knows, a decent balance sheet is all well and good but you need income to pay the bills.

And there the present position, and the outlook, are not particularly flash.

Real per capita gross domestic product peaked in December 2007 and by March this year (the most recent data available, such are the lags in preparing the national accounts) was still 4 per cent below that.

Looking forward, the labour market has probably turned the corner but remains soft, with an unemployment rate of 6.8 per cent, when it was at 4 per cent or lower over the four years before the global financial crisis. Wage growth is in the nil to feeble range.

The average mortgage rate, meanwhile, is at cyclical lows. It is going to rise - the only question is at what pace - pushing up debt servicing costs as a share of income from the current five-year low.

So while from the standpoint of household and bank balance sheets it is good that house prices have not dropped much, from the standpoint of housing affordability and households' capacity to spend money on other things it would be unfortunate, to say the least, to see the housing market take off with a hiss and a roar again.

What are the chances of that? Bank of New Zealand economist Craig Ebert says house prices are "still very much on the high side" relative to household disposable income and rents.

Between the mid-1990s and early 2000s house prices were in a range of three to four times disposable (that is, after-tax) income. From present levels they would have to fall 40 per cent to get back in that range.

Meanwhile the ratio of house prices to rents, which had been quite steady from the mid-1980s to the early years of the last decade, doubled during the boom. Put another way, rental yields halved. And the ratio is still about 90 per cent higher than it was for all those years.

All of these metrics - household debt to income, debt servicing costs, house prices to income and rental yields - suggest that anyone looking for quick capital gains from the housing market is trying to set fire to pretty wet wood.

Perhaps the most important change is in households' attitudes towards debt and saving.

Household debt increased 2.3 per cent in the year ended July, and 2.4 per cent in the year before that. In real terms it hardly increased at all.

This is a far cry from the double-digit annual growth we saw during the housing boom years, 2003 to 2007 inclusive.

That period saw a net withdrawal of housing equity, which by 2007 was running at over $7 billion a year or 7 per cent of household disposable incomes, the Treasury estimates.

That has flipped to a net equity injection of 3 per cent of GDP.

A swing of 10 per cent in households' spending power is not good news for businesses competing for the consumer's discretionary dollar.

But it represents a necessary correction to, and payback of, the excesses of the boom.

The drawdown of housing equity during the boom turbocharged consumption and inflamed inflation to the point that the Reserve Bank pushed the official cash rate to 8.25 per cent.

We don't want to go there again.

The associated increase in household debt was to a large extent financed by foreigners. New Zealand households, after all, were collectively "dis-saving", spending around $1.12 for every $1 of income.

That run-up in overseas debt has pushed the country's international liabilities, net of New Zealand assets offshore, to $167 billion or 89 per cent of GDP - a level similar to the "pigs", Portugal, Ireland, Greece and Spain.

That does not mean that the markets are necessarily about to dump a monsoon bucketful of grief on us as they have on them. Government debt levels are much lower than in those countries and we have our own currency to act as a shock absorber.

But in a world which has become much more risk-averse and where burgeoning Government deficits mean much more competition for savings, it is a distinctly uncomfortable, if not downright perilous, position to be in.

It highlights the importance of the task the savings working group, chaired by Kerry McDonald, have been given and the subsequent decisions the Government has to make.

Above all New Zealanders need to dump the idea that the best way to provide for their old age is not to save money but to borrow money and engage in highly leveraged punts in the housing market.

As we can't have our cake and eat it, we need to be ready to sacrifice more consumption today, for the sake of greater consumer ability later.

This would be a fundamental turnaround from the pattern of improvidence, profligacy and myopia evident over recent years.

But the alternative is to have that change forced upon us, in a brutal and abrupt way, when the world's savers, through their agents in the financial markets, decide they no longer want to fund the gap between the standard of living we want to have and the one we have actually earned.