Pieces of a housing bubble jigsaw puzzle
Laura Walters looks at the warning signs in property.
You don’t have to go far to find someone who believes New Zealand’s in the midst of a housing bubble, but it’s harder to find someone willing to put their money where their mouth is.
By definition, bubbles burst – so when will this one go?
We spoke to economists and housing experts from New Zealand, Australia and the United States – including a senior economist and forecaster who helped predict the US housing bubble crash in 2007. But no-one could put a date to it.
HSBC chief economist for Australia and New Zealand Paul Bloxham says there’s the potential for prices to fall but a combination of factors would have to come into play. He doesn’t see that happening in the next couple of years, and that’s as far as the HSBC forecasting stretches.
Bloxham’s the man behind the ‘‘rockstar economy’’ claim, and now he says New Zealand’s having a ‘‘rockstar revival’’, supported by strong fundamentals underpinning hot property prices.
Meanwhile, Kiwi housing activist Hugh Pavletich says there’s a bubble and it will pop.
‘‘It is not ‘if’ it is going to burst … the only question is ‘when’.’’
Pavletich authors the annual Demographia Report – a survey that measures housing affordability by comparing prices to annual, median household incomes. Spoiler: Our houses are unaffordable.
When ‘‘greed turns to fear’’, leading to a loss of confidence in the market, a burst is imminent, he says.
Others, including Robert King, senior economist and managing director of the Jerome Levy Forecasting Centre in New York, say many factors can cause a housing bubble burst.
The closest we’ve come to putting an actual date on an end to the crazy price rises is a Westpac quarterly report, where chief economist Dominick Stephens picks the start of 2018 for the first decline in house prices in real terms. He’s not predicting a crash but it could be the start of a downturn.
No two bubbles are the same but based on past crashes it’s possible to put together a number of puzzle pieces that could click together to create a bubble bursting moment.
‘Severely unaffordable’ housing
This puzzle piece is already in place.
Pavletich’s Demographia Report defines house prices as ‘‘severely unaffordable’’ once they exceed 5.1 times the median annual household income.
Auckland houses are currently at 10.2 times the annual income, with the rest of the country averaging 5.5 times.
Pavletich says Auckland’s median multiple will hit 12 by next year’s election.
US economist and forecaster King says one of New Zealand’s housing bubble warning signs is the rapid increase in house prices relative to income.
Since the first quarter of 2012 real household income in New Zealand has risen by 2.7 per cent but real home prices have risen by 38.6 per cent.
King says one of the most clearcut signs of the US housing bubble was not the changes in house prices but the ‘‘rapid and reckless trends’’ in household borrowing.
The more house prices rise relative to income, the greater the necessity for low interest rates or easy lending standards to allow households to afford a home. But of course, this makes the housing market only sustainable while interest rates are low and banks are willing to lend (more on this soon).
Household debt rises
Household debt hit $169 billion in June 2016, with housing loans accounting for $139b (82 per cent) of that debt. This is more debt than before the GFC.
It’s also worth keeping an eye on interest-based borrowing by banks. In the US, the increased prevalence of non-traditional mortgages, or speculative borrowing, was a strong warning sign of a bubble.
These borrowers generally lack capital and are vulnerable to interest rate rises. They are also the first ones to sell up when things take a turn.
In May, about 55 per cent of new lending to investors was on interest-only terms. And a third of owner-occupiers were borrowing money just to cover interest repayments.
Meanwhile, we’re at a 30-year high for residential investment as a percentage of GDP.
This again indicates the Kiwi economy has grown increasingly dependent on housing to drive growth and profits.
Tightened lending restrictions
The Reserve Bank (RBNZ) introduced loan-to-value ratios in October 2013 in response to rapid house price growth and an increase in the use of low-deposit loans. As of October, 90 per cent of banks’ residential mortgage lending must go to owneroccupiers with 20 per cent deposit, or more. And no more than 5 per cent of residential mortgage lending can go to investors with less than 40 per cent deposit.
Meanwhile, the RBNZ has also introduced debt-to-income ratios. This is to make sure borrowers will be able to service their loan.
If the central bank deems it necessary to intervene, it’s usually a bubble warning sign. And this puzzle piece is already in place.
Black swan event
Carmen Vicelich, head of property valuation service Valocity, says past housing market crashes have usually come off the back of a ‘‘black swan event’’ - a (usually) unforeseeable, large-scale, macroeconomic event. They send shockwaves through the world’s financial markets and among other things, lead to interest rate rises, a loss of confidence and eventually sell-offs and debt defaulting – all the pieces you need to burst a housing bubble.
Interest rates rise
Interest rates are at historic lows and aren’t set to rise any time soon but a black swan event could force banks to lift rates quickly, leading to debt defaulting, asset selling and less borrowing. RBNZ sets the Official Cash Rate but in a financial crisis, it can’t stop banks raising their mortgage rates.
If interest rates rise, many who’ve borrowed large amounts to finance won’t be able to service their debt.
HSBC’S Bloxham says the way things are tracking at the moment, interest rates are unlikely to rise anytime in at least the next two years.
Offshore investment declines
The supply and demand story is largely being driven by migration – New Zealand has welcomed almost 70,000 people this year.
A drop in money coming in from overseas could come about from a significant drop in migration or a policy change that would see residents locked out of the market, in favour of citizens.
This would drive demand and house prices downwards.
It’s unlikely politicians will be willing to turn off the offshore money tap but it’s not impossible.
And while migration is eventually expected to slow down, it’s unlikely to be enough to significantly impact the demand size of the equation.
Sell-off
Those who are at risk of not being able to service their debt, especially speculative investors will start selling, driving up supply and pulling prices down, fast.
US economist Hyman Minsky, who came up with the Financial Instability Hypothesis, identified three types of investors:
1. Hedge borrowers: those whose incomes allow them to service the interest payments on their debt and to pay down some of the principal.
2. Speculative borrowers: those whose incomes allow them merely to service the interest payments on their debt.
3. Ponzi borrowers: those whose incomes are insufficient to cover the interest on their debt.
A market characterised by a large number of Ponzi borrowers can only be sustainable while asset prices continue to increase and while lenders continue to be willing to lend into the market. Speculative and ponzi borrowers are the first to sell when the market takes a turn, for fear of not being able to service their debt and losing out on their investment.
If the downturn is severe enough, other homeowners who are unable to keep up with interest and principal repayments will follow suit. This will lead to further supply in the market and drive prices down due to vendors wanting to sell quickly, before prices drop further.
Loss of confidence
Talk of ‘‘market sentiment’’ might not hold the weight of conviction of percentages and figures but a widespread loss of confidence can count for a lot.
Downturns in the global market, interest rate rises, shudders in the domestic housing market or worrying global events such as the unpredictability of a Donald Trump presidency - can all lead to a drop in market sentiment.
A widespread loss of confidence in the market can lead to selling and a pull-back in investment, driving prices down as supply goes up and demand falls away.
There goes the bubble
If we get to this point, and all or some of these pieces fit into place, it’s likely the bubble will burst and house prices will plummet. But at the moment, no one’s predicting when a burst could happen.
The experts we spoke to talked of a slowdown (mortgage activity is down 21 per cent nationwide compared to a year ago), possibly a plateau, and maybe even a slight downturn at some point (Westpac’s 2018 prediction), but not a crash.
While houses are unaffordable for many at the moment, the fundamental economics are there to back up the hot property market. So until some or all of the above puzzle pieces start slotting into place, million dollar bungalows are likely here to stay.