QV data showed a 5.7 per cent rise in New Zealand house prices in 2012, with the Auckland weighting of course a major factor. While Auckland prices rose between 8 and 11 per cent, most other areas were relatively flat, and sales volumes overall were generally well below the peaks of 2003-2007. New Zealand prices generally, and Auckland prices specifically, are very high by international standards on a household income basis. With that background, how do you see the year ahead?
Zollner: New Zealand housing affordability is indeed stretched by comparison with both other countries and our own history. But history also shows that if the housing market gets a head of steam up, "fundamentals" can get overlooked for a surprisingly long period of time. That's the Reserve Bank's fear at present, but for now we agree with them that already-high debt levels and only modest income growth will cap the housing market upturn before it gets out of hand. If it doesn't, the Reserve Bank will step in one way or another. We predict annual nationwide house price inflation to top out around 8.5 per cent over 2013.
Dickens: National house prices are set to rise a bit more than incomes, but with some major regional differences continuing.
Murphy: The post-2007 drop in sales volumes acted to modify house price declines during the global financial crisis (GFC). More recently, the relatively subdued volume of house sales in the Auckland region, in combination with increasing demand, has created the conditions for rising house prices. Housing markets have strong regional and local characteristics. In the absence of any major economic or environmental shocks, there is likely to be continued upward pressure on house prices in Auckland, whereas other regional markets (depending on their economic conditions) may have lower rates of change.
What is your view, this far out, for 2014 when mortgage rates start to move?
Zollner: We would see house price inflation of around 3.6 per cent in 2014.
Dickens: Low mortgage interest rates have disguised the underlying housing affordability problem while Reserve Bank data shows that borrowers have flocked to floating and short-term fixed mortgage interest rates that have been the lowest in the last few years. This means the housing market remains vulnerable to rising mortgage interest rates, with the risk that the national average house prices could fall when mortgage interest rates eventually return to more normal levels. However, whether interest rates will increase enough to result in the national house prices falling in 2014, as distinct from stalling, is open to debate. Lack of exposure to longer-term fixed mortgage interest rates also means disposable incomes of people with mortgages are vulnerable when interest rates do eventually increase to more normal levels, with implications for consumer spending and economic growth more generally.
Murphy: Mortgage rates represent just one element in a complex array of factors that affect housing markets. It should be remembered that during the 2003-2007 boom mortgage rates were significantly higher than current rates yet we had rapid house price inflation. The boom conditions were supported by a strong economy with low unemployment, a liberalised mortgage market characterised by new products and generous lending conditions, and strong consumer and investor sentiment. In the context of continued global economic uncertainty, any mortgage rate increases are likely to place downward pressure on the housing market. However, local economic issues and regional housing supply and demand imbalances could result in continued upward price pressures in places such as Auckland.
Many New Zealanders have a confidence that house prices will continue to rise steadily, with perhaps a flat year or two from time to time. In a country where wages are unlikely to charge ahead - and coming from a position of low interest rates - how sustainable is that view in the next 10 years or so?
Zollner: House prices have generally tended to rise in line with nominal incomes but, of late, rises in house prices have been more extensive. Housing affordability is currently very stretched, and investors have to be realistic about further, gains from here. Our own Property Investors Survey suggests they currently are. If house prices rise much further there is a risk of correction further down the track, but the increases seen so far can be partly justified by factors such as low mortgage interest rates, population growth and housing shortages.
Dickens: As I've mentioned, there's a downside risk to national average house prices when interest rates increase to more normal levels. With national average house prices currently rising more than average incomes, the underlying affordability problem is getting somewhat worse, which increases the vulnerability when interest rates rise.
Murphy: If future population growth exceeds housing supply it is reasonable to assume, in the absence of an economic recession, that there will be upward pressures on house prices over the next 10 years. However this general trend does not translate into a guarantee that all house prices will increase. Housing markets are characterised by distinct regional and local trends. Certain regions, and sub-markets within regions, will experience upward price pressures whereas others might experience price declines. In addition, different house types have different price dynamics. Marginal homeowners (those who just scrape into low-cost housing and struggle with servicing a mortgage) and marginal investors are usually the ones who benefit least from capital gains and are often the first to make losses.
House prices in some first-world countries have been hammered in the past five years (Ireland, for example, down by 50 per cent and the United States, down by 30 per cent). Dire predictions were made that New Zealand prices could fall by similar amounts during the GFC. Yet prices here were resilient. What "perfect storm" could bring such results to NZ?
Zollner: The main reason we do not see a large house price collapse as a serious threat in New Zealand at present is that we have a shortage of housing some 30,000 units in Auckland alone, by our reckoning. House-price collapses tend to occur in nations that simply build too many houses during the boom times. The "perfect storm" that would precipitate a house price collapse would include a building boom, a strong net migration outflow, a deep recession, but higher mortgage interest rates on account of a steep rise in bank funding costs, and lower credit availability. That ought to do it.
Dickens: New Zealand is unlikely to see the situation where there are enough forced/mortgagee sales of the scale needed to drive a major fall in house prices. However, the risk remains that real or inflation-adjusted house prices will fall over the next decade or so (i.e. house prices rise less than incomes and rents, with rising interest rates likely to play a significant part in driving this outcome, while moves by the Government to get local government to improve section and new housing affordability may also bear fruit and play a part.) Murphy: Housing markets are nationally constituted and are characterised by distinct legal, financial and building industry structures and systems. Our housing boom coincided with a "global" liberalisation of mortgage markets but our banking practices, building processes and demand and supply conditions differed from other countries. The lack of a banking/financial crisis (as in the US and Ireland) or a sovereign debt crisis (Ireland) meant that New Zealand did not experience a significant housing market downturn. External shocks, such as a global sovereign debt or financial crisis, which resulted in an economic recession and increased unemployment in New Zealand, would be the "perfect storm" that would adversely affect our housing market.
As the world economy starts to recover and the country continues to welcome new citizens, New Zealand may see a return to the migration patterns of 2002-2004, which helped to drive house prices. Is there a danger those pressures, exacerbated by a lack of new developments, could contribute to a deeper bubble with an unhappy conclusion for some property-owners?
Zollner: We do expect net migration to turn more positive over the years ahead but are not predicting boom times. That said, migration flows tend to be regionally concentrated and can be difficult to predict. Price rises in response to inward migration are, at least initially, a necessary signal that more houses are required. It's if the housing market develops its own momentum beyond the fundamentals that a bubble could occur. The Reserve Bank will respond to such a scenario unfolding to try to head it off. Historically the Reserve Bank has tended to belatedly respond with interest rate rises when the horse has already bolted, but this time round it is talking about some new measures targeted at the housing market specifically, which might help
Dickens: Super-high net migration experienced in 2002- 2004 is unlikely to be repeated because it was the product of low emigration coinciding with high immigration. Immigration policy has been much more stable since the mid-2000s, which means such a mega boom in net migration is extremely unlikely. However, emigration could remain as cyclical as it has been in the past and there is the potential over the next two to three years for a major cyclical fall in emigration driven largely by job opportunities in the Australian resources sector drying up. So increased net migration and higher population growth will play a part in boosting housing demand over the next few years, subject to uncertainty over the timing. But this increases the upside risk to interest rates, which means the boost to housing demand from higher net migration could be relatively short-lived, and with a lag, could be offset by the negative impact of higher mortgage interest rates.
Murphy: If the economy is growing and in-migration increases, then these economic fundamentals are likely to drive house price inflation. Bubble conditions would develop if speculative pressures meant that transaction and investment decisions were increasingly driven by a desire for capital gains rather than accessing housing as somewhere to live. Property booms are usually arrested by tightened credit conditions. Households that purchase at the peak of a bubble will most likely experience negative equity and if they suffer loss of income (unemployment) they could default on their mortgages. Non-core or peripheral housing submarkets that experienced rapid house price inflation as a consequence of the bubble are most likely to be the first to experience a downturn. Putting aside the special conditions in Christchurch, we are seeing a widening gap between house prices in Auckland and the other cities and towns. Until the last year or two, that gap has been fairly constant as price rises in Auckland have flowed through. Will the "new" gap continue to expand as the opportunity offered by Auckland becomes more compelling?
Vollner: In our view, part of the recent rise in Auckland house prices is that the construction of new dwellings has failed to keep pace with the growth in population. Auckland remains a magnet for both overseas and internal migration. The most recent housing market data suggests the upswing is broadening into the regions, but it is quite conceivable that the relative price of living in Auckland will simply continue to increase as the New Zealand population grows. Demographic projections suggest that about half of the growth in nationwide population over the next 20 years will come from Auckland.
Dickens: The Auckland outperformance will probably continue for another year or two. One factor behind it appears to be greater job opportunities in Auckland compared to many provincial centres. When I look at the new companies setting up, especially new tech-related companies, Auckland dominates. This is probably playing a part in driving the Auckland outperformance. However, there is a long history of Auckland outperforming for periods (as in the present and the 1990s), with this followed by it underperforming for periods (as in the 2000s). Provincial New Zealand will eventually have a renaissance, but it may not be for a few years.
Murphy: The current widening reflects regional differences in housing demand and supply dynamics. Increasing population pressures, in combination with a downturn in new housing starts, and reduced listings in the second hand market (the dominant component of the market) has pushed Auckland house prices up. Housing booms usually begin in areas of highest demand (large national centres such as Auckland, Sydney and London) and, as boom conditions develop, other markets rise. In a downturn, centres located down the urban hierarchy are likely to suffer more significant and prolonged housing downturns. In the context of ongoing demand pressures I would expect that that Auckland would continue to experience house price increases that are higher than the rest of the country.
The Reserve Bank is plainly concerned about rising values, and the high dollar is limiting its ability to restrain prices. How soon will it be before the bank starts to show more muscle (with higher deposit/loan ratios, for example, or tighter lending rules for banks)? What sort of impact would such measures have?
Zollner: Signs suggest the Reserve Bank is well advanced with regard to macroprudential tools, and signs of a broadening in the housing market upswing will certainly be adding some urgency to their talks with Treasury about how such measures can be implemented. In practice, we suspect such measures are some way away, but the very threat of them could affect investor enthusiasm. The Reserve Bank will be hoping so.
Dickens: The focus is on rising house prices as a result of the new clause in the Policy Targets Agreement that means the governor has to focus more on asset prices, including prices, with this relevant from both monetary policy and prudential supervision perspectives. I struggle to see house prices increasing enough this year for the Reserve Bank to take significant action; while if it does take significant action, the market will ultimately move to undermine the regulations. New Zealand experienced major banking regulations in the Muldoon era and the market ultimately defeated those associated with housing lending. In the 1980s we endedup with around 40 per cent of mortgage lending being conducted via solicitors' trust accounts that were outside the regulatory net. So while the Reserve Bank might have some initial success in moderating housing boom using such interventions, history here and overseas is full of examples of the market sidestepping banking regulations.
Murphy: The Reserve Bank's capacity and willingness to move will depend on both internal and international developments. If the global economy picks up this year I would expect the Reserve Bank to push for a tightening in the housing market going forward. Traditionally the Reserve Bank has relied on the OCR to deal with house price inflation but this has not always been successful. If the Reserve Bank imposed loan-to-value (LTV) rules for mortgages, such rules would have their biggest impact on first-time buyers and could exacerbate housing affordability issues. Existing owners, trading up in the market, are less likely to be affected as they have access to equity and usually take on lower LTV loans. First-time buyers, who usually struggle to generate a deposit will be placed under more pressure if LTV ratios are reduced.
