Property: A house of cards?
The Kiwi housing market has a close link to the economy, writes Shamubeel Eaqub.
House sales have slumped over the past year. House sales lead the economic cycle in New Zealand and the odds of a recession in the next couple of years is better than even.
Price increases are slowing and sellers are getting cold feet, preferring not to list.
This seems to be the main experience of housing downturns in New Zealand – when the market slows, sellers disappear. There is little turnover and price falls are limited.
But house price falls are possible, although not common. New Zealand has a rare history here, in that prices have never really fallen sharply or for a sustained period – we have never had a crash in that sense. But house price falls have happened in New Zealand, especially in many regions in the post-2008 global recession, and especially once prices are adjusted for inflation.
In addition, major house price falls have certainly happened internationally – and we should not be complacent about such a thing happening here.
The Canadian city of Toronto had a huge rise in house prices in the late 1980s, followed by a 50 per cent slump in central city prices in a housing bust that lasted seven years. In recent months, there appears to be another significant housing downturn starting in Canada.
In the past 50 years, nominal (that is, not inflation-adjusted) New Zealand house prices have fallen in just four years, generally in exceptional circumstances: the tail-end of a long recession in 1992, for instance, or the deep and long recession that lowered prices in 2009.
But relative to the cost of living, prices have fallen far more often.
This is because New Zealand has been through periods when inflation was high, and the cost of living rose sharply, but house prices did not rise in tandem.
Once inflation is removed from the figures, we can see that in the past half-century, house prices fell in 19 of those years – nearly 40 per cent of the time.
A little care is needed with these figures, as they include an exceptional period in the late 1970s when both the economy and house prices performed poorly, due to oil price shocks and economic mismanagement.
More recently, house prices fell from their 2007 pre-recession peak in many places. QVNZ tracks the house prices in some 68 local areas, and its figures show that in 2015, house prices were lower in 62 per cent of the regions in nominal terms, than they were in 2007.
Once we take into account increases in the cost of living, house prices are lower in 82 per cent of the regions. So even in New Zealand, we have evidence that house prices are not a oneway bet – they can fall in many areas, and sometimes severely.
However, house prices have risen since that downturn, even in the regions outside of Auckland.
There are similar examples internationally. Compared to their 2007 level, house prices in 2015 are down sharply in Ireland, Spain, Netherlands, Denmark and the US. In each instance prior to 2007, house prices rose sharply relative to incomes, and lots of houses were built and traded; when the momentum ran out or an external shock hit, house prices fell sharply.
The impact of house price declines has not been even across countries, but their combined experiences nonetheless provide some insights into the possible implications for financial and economic stability, should a similar crash occur in New Zealand.
A major fall in house prices can create chaos across an economy, as we saw in the global financial crisis. A house price crash caused widespread business failures, job losses and a broader economic recession.
The key channel was the banking and finance sectors. They loaned aggressively through the upturn in the housing market and the economy in general, but reduced lending and called back loans when the cycle turned down. This amplified the economic cycle, over-egging it on the upturn and driving it into the ground in the downturn.
Here is how the ripple spread. As house prices fell, many property developers and their financiers went bust, causing layoffs in construction, real estate, finance and other sectors that supported house building, such as forestry and building materials firms.
There is a familiar pattern in such crises. Initially, households become more cautious; they reduce their spending on discretionary and luxury goods, and reduce their borrowing – not just in mortgages, but also in credit card use and other consumer finance.
They tend to spend only what they earn, rather than borrowing to spend more. This hits retailers, non-mortgage financiers and those who support these sectors. But as the downturn broadens, job losses mean households spend even less, business stops investing and hiring, and a recession is in train. The more debt people had previously taken on, the worse the impact.
There is not always a clear sequence of events – the economy is a complex international web of millions of individual decisions. But the end result is inevitably a recession.
A major fall in house prices can create chaos across an economy.