KEY POINTS:
New Zealand's housing market is so overvalued and wages are growing so slowly that we at interest.co.nz expect median house prices will not rise back above their November 2007 peaks until 2018 at the earliest.
The size of the bubble is so large it may take until 2028 before prices recover and people who invested in 2006 and early 2007 start seeing capital gains again.
We realise this is a controversial view. Most property investors and real estate agents are predicting a housing slowdown lasting a couple of years before prices get back on their inexorable climb higher, delivering capital gains for property investors as it has done for most of the last decade. They point out there has never been a significant fall in house prices for very long and that prices will bounce higher within a year or two, as they have done after previous slowdowns.
We say it's different this time because the scale of the boom in the last seven years is unlike anything in New Zealand's modern economic history. House prices simply exploded in 2002 off the trend line we have been on since the 1970s.
A perfect storm of factors drove this unprecedented boom, including:
* Interest rates fell as low as 6 per cent,
* Aggressive lending by banks, who saw mortgages as a low risk assets that required less capital backing under new Basle II capital adequacy rules,
* High migration post 9/11 as a wave of Asian immigrants arrived and New Zealand expatriates returned,
* A slowdown in new home building after the introduction of complex and costly new leaky building laws in 2004, and,
* A rash of tax avoidance-driven property investing via family trusts and LAQCs after Labour imposed the new 39 cent tax bracket.
These all combined to push prices into a stratosphere where there was so little affordability oxygen that a steep fall was the only result. And now we are seeing that steep fall.The median house price, as measured by the Real Estate Institute of New Zealand (REINZ), has already fallen 4.2 per cent from its November 2007 peak of NZ$352,000. Remember that number. It will be seen as a high water mark we don't reach again until 2018 at the earliest, we say.
House prices are likely to fall 30 per cent over the next 2 to 3 years or so if the market is allowed to return to affordable levels.
Housing was last affordable at the beginning of 2003. Back then it took around 40 per cent of the after tax pay of a median salary to service the mortgage on the median house. That 40 per cent threshold is the one many bankers use to say whether a home loan can be afforded. Since 2003 house prices rose by two thirds and the 2 year fixed mortgage rate rose from 6 per cent to 9.6 per cent. That blew out that affordability ratio to over 80 per cent by early 2008.
Prices have already fallen sharply in some areas. The first quartile house price in Northland fell 25 per cent to NZ$187,500 in February alone. The sample size on this is small, but even the median price in Northland has fallen 15.3 per cent to NZ$284,000 from its peak of NZ$335,000 in December. The Auckland median is down 7.2 per cent to NZ$427,000 from its December peak of NZ$460,000. So some areas have already gone a long way towards that 30 per cent fall.
The Reserve Bank is forecasting a 5 per cent fall in house prices this year, but has acknowledged that prices are 20-30 per cent over valued by independent measures and could fall much more sharply this year and next year.
So assuming prices fall 30 per cent to a low of NZ$246,000 by 2011, how long would it take for prices to rise back to that NZ$352,000 peak again? That answers the question of how long will property investors who bought in 2006 and 2007 have to wait for capital gains.
We've approached the question of how long will it take for prices to rebound in three ways.
Firstly, it's worth looking at the long term trend for house prices. If house prices were to follow the trend they were on before the bubble blew up in 2003 then it would take until around 2027 before prices ground there way up again to that NZ$352,000 level again. That trend is the blue line in the chart above. We've projected that house prices will fall back to that trend line in 2011 and then follow it back up again to NZ$352,000 by 2027.
Secondly, it's worth looking at the underlying affordability trends. If interest rates were to remain unchanged and take home pay was to keep rising at its current rate of 3 per cent then it would take until 2032 before a median house price of NZ$352,000 was affordable again. By then the mortgage on that house would again cost 40 per cent of a single take home pay to service. Even taking into account that household income is higher than single median salaries, then it would still take until 2021 for affordability on household income reached that 40 per cent threshold.
Under this scenario we're assuming a household income was equal to 1.27 times a single median income plus NZ$4,000 a year of other income.
Finally, you can use another method of measuring the underlying value of houses. This was suggested by a poster on this blog back in February. He assumed that the housing market would return the same as the six month term deposit rate invested at the bank over the long term and allowed to compound. He has produced a chart showing a close correlation using that method from 1992 until 2003 when house prices exploded.
If prices were to return to that trend and we assumed a 7 per cent rate for bank deposits over that time then you'd expect house prices to return to that NZ$352,000 peak in 2018. That is the blue line in the chart above.
So we have a range from 2018 to 2021 to 2027 to 2032 before prices get back to their level of November 2007. That assumes that the median price falls 30 per cent to start with and that we don't see massive changes in migration, interest rates or house building activity.
Here's the caveats:
* The government could boost migration to bolster the housing market and take pressure off wages. That is seen as unlikely in the next year or two around an election.
* Interest rates could dive because the economy is in recession and we no longer have an inflation problem. That would also bolster house prices as home loans become more affordable.
* House building could dry up completely, meaning the little extra supply of new housing coming on to the market now is further reduced. This would increase pressure on supply and keep prices high.
Without any of these acts of parliament or god, then property investors are staring down the barrel of a decade or two of little or no gains.
* Bernard Hickey is the managing editor of finance and investment website interest.co.nz
