Property Report: The further the stretch, the greater the snap

File Photo / Herald on Sunday

The housing market is surging ahead, fuelled by low interest rates, lifting net migration, and a shortage of houses in Auckland and Christchurch. House sales are up about 25 per cent year-on-year, and house price inflation is rapidly approaching double digits. But while homeowners in Auckland may be celebrating, the Reserve Bank is wagging its finger in disapproval, stating in their Financial Stability Report that "housing pressures are an increasing risk in the financial system".

Their fear is a nasty boom-and-bust housing cycle. The bigger the boom, the greater the potential bust, and the experience of the Global Financial Crisis is that housing busts can be both problematic and expensive to clean up.

New Zealand housing is already expensive by any measure, and household debt relative to incomes has barely fallen from its unprecedented 2008 peak. These indicators don't necessarily imply a looming correction, but the further the rubber band stretches, the greater the pressure for a snap-back.

Previous dips in house prices have tended to be pretty shallow. The mild and short housing downturn in 2009 prevented the recession being worse. But it may have helped entrench the perception that house prices never fall. They most certainly can. In the United States, nominal house prices fell by nearly a third in the three years from mid-2006. In Spain, house prices are 27 per cent down from their 2008 peak, and still falling. The wave of defaults there has been so large that it has caused enormous damage to the banking system.

So what can be done to cool the housing sector before it becomes destabilising? The obvious answer is to raise interest rates. The Reserve Bank's forecasts do show interest rates gradually normalising. But more rapid action would be problematic. The currency is already very high, damaging exporters and import-competing firms, and the Reserve Bank has no desire to put a rocket under it by moving interest rates in the opposite direction to the rest of the world. And the economy remains patchy across regions and sectors and inflation benign.

The Reserve Bank can't set interest rates specifically for the housing market, but they are developing tools that lean that way. The first step is to permanently increase the amount of capital that the "Big Four" banks must hold against high loan-to-value ratio (LVR) lending - around 30 per cent of new lending currently. The official aim is simply to make the banks more robust to a housing downturn. But were this measure to make such borrowing more expensive, or decrease its availability, the Reserve Bank would not complain. Why, in that context, it is aimed solely at the big banks is something of a mystery.

The Reserve Bank is also looking at making required levels of bank capital adjustable, not just for high-LVR lending but for other sectors too, or across the board. They will also be able to demand banks alter their mix of capital towards less flighty - and more expensive - forms at times of higher risk, and are giving themselves the power to restrict high-LVR lending directly.

Similar measures have had some success in cooling housing cycles overseas. But they aren't costless. Any type of intervention will have unintended consequences, as money is mobile. Restrictions on high LVR lending also make it harder to get on the property ladder.

In addition, such measures are only a partial solution. With Auckland recognised as having 30,000 houses too few, choking off demand might reduce activity temporarily, but it will not suddenly make more houses magically appear. Indeed, it might well discourage necessary investment. Encouragingly, we're seeing a multi-pronged attack. An aggressive programme to build 39,000 houses in Auckland over three years has been announced in partnership with Auckland City Council. The Government has announced an enquiry into construction costs, and legal changes to allow them to overrule city planners' restrictions on greenfields development.

Part of housing's recalibration must also be changing society's tastes and perceptions. The average new-build house size has grown inexorably over recent decades at the same time as the average number of inhabitants has shrunk. At some point, we have to get realistic as a nation about what is really affordable and necessary.

Although recent developments are encouraging, playing catch-up with years of under-building is a big ask. Even if Auckland manages to construct 13,000 units per year (no mean feat while rebuilding Christchurch at the same time), it will be 2026 before the shortage of houses is eliminated. That's the reality of chasing a moving target, with Auckland projected to account for more than half of New Zealand's total population growth over that time.

* Sharon Zöllner is senior economist at ANZ Bank.

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