Home Truths: Will rising interest rates deflate NZs housing bubble?

The jury is still out on whether Government attempts to target investors will stop soaring house prices. Liam Dann examines what else is left in the toolbox.

The Covid-19 pandemic has caused one of the biggest housing booms the world has ever seen.

Initial expectations that lockdowns and travel restrictions would stall property markets proved very wrong.

Instead the cheap money and easy credit deployed by central banks to stabilise economies has collided with a surge in investor appetite for the perceived safety and security of property.

Globally, house prices are now rising at the fastest pace since 2006, according to property market research group Knight Frank.

US house prices hit global headlines this month as new data showed they’d risen at the fastest pace in 30 years and by the largest annual percentage since 2005.

But at around 13 per cent annual growth, the US is still a long way behind New Zealand, where the average annual growth rate was nearly 20 per cent in the year to June.

We’re world champions when it comes to overheated housing markets.

Bloomberg Economics runs an Index of countries most at risk of a housing market bubble. Somewhat inevitably, New Zealand leads the pack on nearly all the metrics.

“Gauges of risk are flashing warnings at an intensity not seen since the run-up to
the 2008 financial crisis,” writes Bloomberg economist Niraj Shah.

New Zealand, Canada and Sweden rank – at one, two and three -as the world’s
“frothiest” housing markets, he says.

The index uses annual house price growth as well as metrics like price-to-rent ratio and price-to-income. We lead the field on all three.

So are we really due for a 2008-style crash?

After years of dire warnings about housing bubbles, nobody in this country seems to think so.

And frankly, if we look at what happened to the New Zealand market in 2008, the threat is unlikely to offer much hope to those seeking a return to affordability for first home buyers.

Despite dire predictions, the New Zealand housing market didn’t really crash in 2008.

It stalled and, by some measures, prices drifted off by about 10 per cent before resuming a steady upward trajectory.

The reality is that we need to engineer a much deeper structural change in the market dynamic if we want to return to a more affordable housing market.

Thankfully, New Zealand is also leading the world with policy moves to cool the market.
And, perhaps more importantly, it looks set to lead the world in lifting interest rates back to pre-Covid levels.

Independent economist Tony Alexander believes the New Zealand housing market has been running 2-3 months in advance of other international markets, because of our successful Covid eradication strategy.

“That success meant we began focusing on the low interest rate and absent foreign travel impact on our personal housing ambitions before the same factors started sweeping through offshore,” he wrote this month.

In other words, we were at the front end of the Covid boom.

Could it be that we’ll be the first to emerge out the other side?

For the record, Alexander is wary of putting too much store in international comparisons, believing New Zealand’s market is unique.

“Anyone extrapolating developments offshore strongly into the NZ housing market got
their predictions terribly wrong in the GFC,” he says.

“Our housing market can be uniquely affected by sharp changes in net migration flows
which are rarely relevant overseas.”

He’s also sceptical that we’ll be able to achieve the kind of market slowdown being forecast by Treasury and the Reserve Bank.

Both Treasury and the Reserve Bank grabbed attention in May with forecasts that see house price growth moderating dramatically in the next year or two.

Treasury sees the growth rate falling to 0.9 per cent by the middle of next year.
The RBNZ sees annual average house price growth decreasing from 21.5 per cent growth in 2021 to just 2.6 per cent in 2023.

Few economists have been prepared to pick outright price falls.

Westpac economists have been out on a limb in forecasting “modest falls of around 3 to 4 per cent over 2022 and 2023.”

Reserve Bank Governor Adrian Orr has been vocal in his view price growth will slow and he won’t rule out the possibility of falls.

“Why are our growth rates slowing?” he says of the RBNZ forecasts. “Because most of the factors that driving house prices are either waning or disappearing.

“We’ve seen significant tax changes for housing investment, we are seeing significant increase in housing supply with the construction activity that’s going on. We ourselves have added and put in loan-to-value ratio lending restrictions.”

That puts downward pressure on what he calls the sustainable or “fair value” level of house prices.

Which is to say, the Reserve Bank isn’t predicting that prices in the real world will fall in an orderly manner to a perfect sweet spot just above zero growth.

Their forecasts look through short-term volatility to draw a smooth curve.

These sort of forecasts always come with a caveat: ” … these are asset price projections which are wildly uncertain,” Orr says.

Regardless, the RBNZ view is that one-by-one the solutions to New Zealand’s housing affordability puzzle are falling into place.

This year the Government has introduced new policy measures targeting investors.

The brightline period (within which people who sell a residential property need to pay income tax on any profit) has been extended to 10 years.

And more controversially, interest deductions on loans for residential investment property acquired on or after March 27 will not be allowed from October 1.

But regardless of whether these policies will work (and the jury is very much still out on that), the basic economic principle of supply and demand suggests a slowdown is due.

With borders closed and immigration stalled, demand from a rising population is no longer an issue.

Meanwhile new building – particularly in Auckland – is running at an all-time high.

Of course, one last piece of this complex puzzle remains.

Many economists believe the cost of borrowing is the most powerful driver of housing markets.

Orr acknowledged that in May.

The RBNZ’s monetary policy, for now at least, has been set to stimulate demand in the economy, with a record low interest rate.

“We are putting upward pressure on the housing market, we are encouraging investment, we are encouraging spending. Low interest rates mean mortgages are affordable and so forth … but what we’re also observing is all these other factors that are putting downward pressure through time,” he says.

If interest rates rise – as the RBNZ now projects them to – then: “yes that would be taking some of that stimulus out of the housing market and we would be putting downward pressure on spending and all those things”.

In its May Monetary Policy Statement, the RBNZ surprised the market by reintroducing interest rate projections.

These suggested that interest rates – which had previously been described as on hold for the foreseeable future – would start rising from the middle of next year.

Since then things have moved quickly. The economy has continued to strengthen.
Businesses increasingly report rising costs and labour shortages.

All the signs point to inflation moving up above the Reserve Bank’s mandated target band of 1-3 per cent.

That has seen economists and markets shift their rate hike bets further forward – with the odds now favouring the first official cash rate rise in November this year.

What kind of impact will that have on the economy?

ASB economist Mike Jones crunched the numbers.

“On our calculations, a scenario in which mortgage rates lift around one percentage point to 4 per cent would see an extra approximately $3.1 billion sucked out of mortgage-holders’ pockets annually,” he says.

“For reference, that’s equivalent to about 1.6 per cent of total annual disposable income, or 3 per cent of annual retail spending in NZ.”

That’s a lot of money, although he cautions that we need to consider the flip side of the equation “as higher interest rates will obviously put cash back into the pockets of savers, who might feel inclined to spend more”.

Falling interest rates have been one of the key drivers of the house price boom we’ve seen over the past 18 months, Jones says.

“We expect this tailwind to soon flip into a light headwind, joining the likes of rising housing supply, tighter credit conditions, and reduced investor enthusiasm for housing.”

The “slow upward grind” in mortgage rates over the next few years should at least slow the rate of house price inflation, he says.

ASB has 15 per cent price growth pencilled in for 2021 and just 2 per cent for 2022 “based on our mortgage rate forecasts alone”.

If anything that is a conservative estimate, Jones says.

“A scenario in which mortgage rates rise faster than we’re expecting – to 4 per cent, say, by the end of 2022 – would be consistent with some small quarterly falls in house prices.”

Orr and the Reserve Bank get to revise their views this Wednesday when they deliver the latest Monetary Policy Review.

The RBNZ is likely to keep its options open on timing but will be increasingly explicit about the direction of travel.

Even in May Orr was (in his words) “shouting from the pulpit” that house buyers have to be ready for higher rates.

“When you’re considering buying, don’t get excited by the current mortgage rate. Think about what mortgage rates might look like on average through time and how does that feel for you as a buyer or investor,” he said.

“Globally interest rates are very low and certainly below what we would consider a neutral interest rate … so be wary around your ability to service a mortgage.”

There’s no doubt great scepticism exists, within the property sector and wider public, about the ability of economists – including those Treasury and the Reserve Bank – to forecast the housing market.

In the 12 years since the GFC there have been numerous false starts on interest rate hikes, and countless warnings about the property market crashing.

New Zealanders seem convinced the property market is a one-way bet.
That collective attitude becomes self-fulfilling.

It ensures that market confidence holds even when economic fundamentals suggest it should be stalling.

The next year looks set to provide the biggest ever test of those beliefs. If prices do fall there is a risk that public attitudes and market confidence could crumble fast.

We could see a significant sell-off as investors look to cash up before prices fall further.

But if confidence holds and prices keep rising, the Government and those seeking affordable housing solutions will be forced back to the drawing board.

A far more fundamental problem will have been revealed – something that runs deeper than traditional economic drivers, into the social fabric of this country and the psyche of New Zealanders.

House hunters respond

On Saturday we shared the stories of first-time house hunters. Here’s what they have to say about the ideas in today’s Home Truths coverage.


A lot of focus is on what people are able to pay, the market rate.

But this barely comments on how only some people can pay that, usually people who already own a property or 10, or have come back from overseas with piles of cash.

It ignores the fact many people who desire to own are priced out and not even in the calculations.

KiwiBuild was meant to cap prices for some homes, but only in some locations.

A cap on all house prices, and on how many people are allowed to own, might actually slow things down.


I think house prices will continue to grow, as this depends on supply and demand.

Auctions also drive up prices. Some places like Christchurch still have the majority of houses selling via auction.

However, I’ve seen demand for houses drop in Waikato, where houses in the first home/ investor category will drop in price if there’s been less interest.

Lend-to-income ratios would further limit first home buyers unless it was only restricted to investors.

There should be a limit to how many properties investors can buy or at least restrictions on lending to investors until we see more of a balance. However, I know this is hard to implement.

I find it hard to believe economists as recently they’ve been wrong in their predictions so many times.

It can also drive the buying frenzy and create panic like we’ve seen this year.

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