Tony Alexander: Brace for higher interest rates
Thirty five years of falling interest rates in New Zealand have now ended.
Last week I took a look at how the risk and return characteristics of residential property investment have changed and investors need to take those changes into account when considering how they manage their housing assets.
The changes largely mean new investors should be prepared to pay less for a property than before March 23’s announcements, and those with mortgages will look to reduce their debt levels while seeking compensation for higher costs by raising their rents.
For investors these changes are important.
But from my point of view as a macroeconomist interested in the big picture, the changes just announced by the government pale into insignificance against two other key factors which have encouraged me to say this next sentence repeatedly in recent years.
Since 1992, on average NZ house prices have risen by 6.8% per annum but going forward that rate of increase is likely to ease to 5% or lower.
Why do I believe this? There are a few reasons but here are the two main ones.
First, since the late 1980s interest rates facing borrowers and being offered to savers in New Zealand and the world over have been falling. These declines have been factored into higher prices for assets like shares, residential and commercial property, even precious metals.
But the period of falling interest rates has now ended. From here on out interest rates will tend to be at higher levels than where they are now. That means not only an absence of fresh reason to invest in other assets for yield and in doing so pushing their prices up. But it also delivers a small incentive to shift out of those assets. The three and a half decades of falling interest rates boosting house prices in New Zealand have ended. Now we get to the second main reason why I see slower house growth, and it has nothing to do with government or Reserve Bank policy settings. Between 1996 and 2018, New Zealand’s population grew by 31% or nearly 1.2 million people. To house those people, we needed an extra 420,000 houses. Over those 22 years, consents were issued for the construction of 515,000 houses, apartments etc. Allowing for a net addition to the housing stock of about 80% of those dwellings (older houses demolished, left vacant, consents not acted on etc.) we saw about 412,000 extra houses made available for us to live in. Why did prices rise so much if house supply growth actually matched housing needs?
Because few affordable houses were built, and construction was insufficient in areas of greatest population growth such as Auckland. Now let’s look forward. Statistics New Zealand have just projected that between 2018 and 2048, New Zealand’s population will grow by another 27% or 1.3 million people. Housing those people will require an extra 465,000 houses, equivalent to 580,000 consents. Already, just over 100,000 dwelling consents have been issued, and again allowing for just 80% of construction consents actually adding to the housing stock this means we need some 470,000 extra consents to be issued.
Will it take all the next 27 years for these extra houses to be built? No. At the current rate of consent issuance near 39,000 over the past year, we will be able to build all the extra houses needed in the next 12 years.
In other words, we already have the capacity to build twice the number of houses that we will actually need over the next
27 years. More than that, because there has been a shift in construction towards townhouses and away from expensive apartments and standalone houses, there will be a far higher proportion of new houses deemed affordable than before.
On the basis of the projected supply growth, I have no trouble predicting that average house price growth here on out will be well below the old 6.8% nationwide and 7.8% in Auckland. Frankly, when one adds in the incentives for investors to finance new house supply, the extra training of apprentices, moves to free up land and fund infrastructure,
5% starts to look too high a price rise assumption for the coming three decades.
I would suggest using 4% in long range projections.
Why did prices rise so much if house supply growth actually matched housing needs? Because few affordable houses were built . .