How house prices can head higher
If you are a first home buyer about to walk into an open home or auction and compete against bidders who already own a home or homes, you’d best look away now.
Houses are actually very cheap to buy and own if you have owned a home for a few years, have surfed the equity without having to pay tax, and have a full-time job. All the talk about house prices being obscenely high and unable to go higher is plain wrong when you look at the actual weight of housing debt and mortgage costs.
When the prime minister and finance minister say the recent stunning rises in house prices are unsustainable, they are wrong. There is plenty of room for another 20-30 per cent rise over the next three to five years, even with Reserve Bank controls. When people walk away from auctions shaking their heads and wondering how anyone could pay that much for a house, they should realise it could actually have been higher.
Here’s a fair example of that sense of disbelief via Twitter from Keith Lynch, a Stuff editor, after he watched a house sell this week: ‘‘Auction today: House had 570k RV. Pre-auction bid of 710k accepted. Goes for 925k to a phone bidder. Most of us in the room walked out laughing in disbelief.’’
Vincent Heeringa, a former financial journalist, chipped in helpfully: ‘‘Run-down house next door on busy street has CV for $1.8m. Sells in 10 days for $2.8m.’’
It would be funny if it wasn’t so true. If the auctioneer’s audience had stopped to do some spreadsheet work afterwards, those laughs may be more like howls and moans.
Brace for these facts of life: ● The national loan to value ratio is just 20 per cent. New Zealand’s houses are now worth more than $1.5t but there is just $300b worth of mortgages against them.
● If the nation could borrow 80 per cent of the value of the housing market all at once, it would be able to pump another $900b in debt into the market and still be paying less than 20 per cent of disposable income in mortgage costs. Most renters pay more than 30 per cent of their disposable income in rent, so that would be no problem.
● Homeowners are collectively paying 6 per cent of their disposable income in mortgage interest costs, down from 14 per cent in late 2008 because of the near-trebling of house values and the fall in mortgage rates.
● Banks use a base threshold of around 6.5 per cent as their affordability measure for loans, which means they reject a loan application if the buyer could not afford an interest rate of 6 per cent. The Treasury and Reserve Bank are forecasting interest rates to be around 2-3 per cent for another decade. The banks use that affordability threshold to keep the quality of their lending high and restrict the amount of capital they have to put aside against each loan. They used to believe 6 per cent was more likely the long-run average. But if they were to decide rates were likely to stay closer to 2.5 per cent over the long run, they could lower that affordability threshold. That would unleash massive new lending and house prices.
● 12 per cent of February buyers bought the house with cash. That’s up only slightly on the long-term average and a function of many rental property investors with multiple properties and floating rate ‘‘draw-down’’ mortgages able to buy without getting bank approval by sucking equity out of their other properties at will, especially as that equity is rising.
The awful (or brilliant) truth of the housing market is prices could easily be double or treble their current levels if homeowners and banks had been allowed to borrow and buy without restrictions, as was the case before 2013 and (briefly) over the past year.
If the Reserve Bank had not intervened in 2013 to calm things down with loan-to-value ratio restrictions, average prices would have raced towards $2m in Auckland, more than $1.5m in Wellington and more than $1m in Christchurch. The unknowable is what prices would be now if the Reserve Bank had succeeded in imposing Debt to Income (DTI) multiple controls in 2017. The Reserve Bank blindsided the-then National Government in 2013 and was unable to get permission to introduce a DTI limit in 2017.
This may seem like crazy talk and is certainly out of step with the ‘‘feel’’ of prices in auction rooms. But like many, I thought prices were at ‘‘crazy’’ never to be repeated levels in 2007/8 and 2012/13. Back then, I thought the ‘‘natural’’ dynamics of demand and supply would ensure some sort of ‘‘return’’ to rationality. After all no asset market is guaranteed or invulnerable to falls, as well as rises. There are no free lunches, I thought, and surely supply would rise to match the demand and suppress prices.
But that was before the Global Financial Crisis and Covid proved that central banks and Governments will intervene to prevent financial collapse and to protect the value of assets.
Part of the response was a natural outcrop of independent central banks targeting inflation, and inflation seeming to be ‘‘unnaturally’’ and stubbornly low for a decade. A closer look at the widening spread of globalisation of manufacturing services and a weakening of the power of workers in setting wages, has seen inflation weaker than everyone expected. That meant central banks cut interest rates to zero and then started buying bonds with freshly invented money to get long-term interest rates down.
Since 2008, the world’s central banks have invented more than US$20t to force down long-term interest rates. Our own central bank joined the club last year with a plan to buy $100b or about 30 per cent of our GDP.
Part of the response was central banks and regulators, rightly, intervening to prevent the sorts of collapses that triggered the great depressions of the late 1800s and 1929/30. No-one would begrudge a central banker that stopped a cascading collapse of
Both Labour and National believe they can somehow engineer affordability without suburban homeowners ever having to see the value of their main financial asset fall, or capital gains or wealth needing to be taxed.
banks for no good reason other than a lack of liquidity.
But the pattern is becoming too obvious. Investors are seeing central banks and governments as the magic money fairy that intervenes when things go wobbly. After all, that’s what’s happened for nearly two decades. There are investors, brokers and homebuyers who have never seen anything but ever-upwards prices punctuated by desperate episodes of central bank money-printing and Government interventions.
Even our prime minister and finance minister acknowledge they would not do anything to force prices down. Both Labour and National believe they can somehow engineer affordability without suburban homeowners having to see the value of their main financial asset fall, or capital gains or wealth needing to be taxed. They believe building lots of apartments and townhouses with lower prices will reduce the average price, but not the actual price of suburban homes.
The PM has even said that four per cent per annum house price inflation was a sustainable level.
That’s great for fertility treatment centres and parents who like their 35-year-old children living at home, but it’s not great for the birth rate or the hopes of current generations for the suburban single family home lifestyle they experienced as children.
The magical thinking is based on voters being unable to understand affordability improvements are impossible without flat to falling prices, and on the idea, proven wrong over the past two decades, that housing supply will ‘‘naturally’’ respond to higher prices. Even the Reserve Bank believed in magic in 2016 and 2017 when it tried in vain to get permission to adopt DTI controls, saying it wouldn’t need to use them because supply would respond.
‘‘The Reserve Bank considers that housing demand and supply will eventually be brought into balance, partly because rising house prices will stimulate housing supply,’’ it wrote then.
‘‘Work to reduce the costs and uncertainty associated with housing construction by local and central governments should ultimately make it possible to build enough new homes to put downward pressure on house price to income ratios, particularly in Auckland.’’
Prices have risen 25 per cent since and the housing supply imbalance has widened as councils and the Government have been unable and unwilling to override nimby concerns about denser cities, and unable to override officials’ and voters determination to keep the size of Government operations and debt around the average of 30 per cent seen over the past 10 to 20 years.
But the spreadsheets don’t lie, and even the Reserve Bank and Treasury acknowledge that nothing really changes with supply restrictions and the inability to tax housing wealth. In the past three months they have both forecast further house price inflation of another 20-25 percent over the next three to five years.
The next test will be the Reserve Bank’s latest attempt to get permission to have and use a DTI tool.
Politicians want it to only apply to investors.
Magical thinking is becoming a habit.