House prices to fall next year

House prices are likely to fall next year and in 2023, Westpac economists say, as rising interest rates put pressure on the market.

In their latest economic overview, the bank’s economists said they had revised their house price forecast as a result of the Government’s recent moves on the housing market.

The extension of the brightline test on capital gains, and the removal of investors’ ability to deduct interest costs to reduce their taxable income, would remove the 10 per cent growth they had expected over the rest of this year, they said.

‘‘The proposed reforms signal the biggest changes in the residential housing market in over 30 years. Leveraged investors currently account for around onethird of sales in markets like Auckland and Wellington, and their search for yield has been a major factor underpinning house price increases in recent years.

‘‘Removing the deductibility of interest costs will dramatically lower the yield on rental properties and reduce the prices that investors will be willing to pay for houses. That downwards pressure will be reinforced by the extension to the bright-line test.’’

Acting chief economist Michael Gordon said the changes were unlikely to lead to price falls in themselves. But he said interest rates would push prices down 3 per cent to 4 per cent a year over 2022 and 2023.

Longer-term interest rates were already creeping up around the world, he said. The previous settings were based on a world without a Covid-19 vaccine, with ‘‘not a lot of hope on the horizon’’. But as that changed, rates lifted.

Short-term rates would eventually follow as the prospect of central banks increasing official cash rates became closer. Westpac expects the official cash rate to remain on hold until early 2024. It had earlier predicted 2025 but revised that after the Government housing announcements.

‘‘While that may seem like a long time to wait in the face of a rebounding economy, there are other factors that are likely to drive a tightening in financial conditions between now and then.’’ He said Westpac’s predicted easing in house prices was modest compared to the 20 per cent rise experienced over the past year.

Price falls could be more pronounced if interest rates moved more quickly than expected. ‘‘Even so, this signals a starkly weaker outlook than we had anticipated before the recent policy announcements.

‘That’s important as the housing market plays a key role in shaping demand conditions in the economy more generally. Now with a policy-related cooling in house prices on the cards, we also expect that household spending will recover more gradually.’’ The rates of residential property building were well above what was needed to keep up with population growth, the economists wrote.

‘‘Shortages that developed over the past decade are being rapidly eroded. And even when the borders eventually reopen, slower population growth means that we’ll need to build fewer houses than would otherwise have been the case.

‘‘The weaker outlook for house prices will also have a dampening impact on residential construction. New builds remain exempt from the extension to the brightline test and may have other tax advantages over purchasing an existing property.’’