House prices: the burning questions

Lending restrictions and rising mortgage  rates should result in house prices cooling in 2017, but there is also the perception of a bubble about to burst. ODT senior business reporter Simon Hartley examines the influences Westpac acting chief economist Michael Gordon sees affecting the housing sector during 2017.

While runaway Auckland prices cooled towards the end of 2016, regional prices had a boost in late 2016, as especially evidenced in the Queenstown area, where average values broke the $1 million mark for the first time.

Westpac acting chief economist Michael Gordon says he has more than halved the amount he expects house prices to grow in 2017, and puts forward three competing arguments for a softer housing market during the year.

"There’s been growing discussion recently about whether the housing market has reached a turning point," he said in Westpac’s last monthly housing roundup.

In Westpac’s last quarterly economic overview Mr Gordon revised downward  forecast  house price growth, which over the past few months has  declined from 11% to 8% to just 5%,  after two years of double-digit gains.

The volume trend for residential building work had doubled over the five years since the low point in the September 2011 quarter, Statistics New Zealand (SNZ) said.

For the quarter to September, the volume of residential building work rose 2.4%, after 5.7% and 5.6% respectively in the June and March quarters. The actual value of building work topped $5billion for the first time in the latest quarter, made up of $3.3billion of residential work and $1.9million of non-residential work.

"Compared with the same quarter in 2015, all regional groupings except Canterbury had large increases," SNZ business indicators senior manager Neil Kelly said.

Mr Gordon said while there were three arguments pointing to a softer housing market, it was important to distinguish between them, not just to come up with a sensible forecast, but to guide any policy decisions about housing during 2017. 

"One is that the latest round of loan-to-value ratio [LVR] restrictions has finally broken the back of the housing market. "Another is that mortgage rates are now rising instead of falling. Lastly, some have argued that the housing market is simply a bubble ready to burst," he said.

On lending restrictions, he said the third round of LVR restrictions, announced in July, had clearly had an impact on activity in the housing market. He noted that while the  LVR restrictions limited the number of potential house buyers, they had little impact on the maximum price  bidders were willing to pay.  That was being driven by  factors such as rental yields, borrowing costs and the tax treatment of investment property, none of which were affected by LVR restrictions.

He also suspected that the Reserve Bank-mooted debt-to-income restrictions, should they to be added to its macroprudential "toolkit", would suffer from the same drawback. Real Estate Institute of New Zealand figures up to November showed house sales were down more than 16% from their peak in April 2016. Separately, reported the number of homes available for sale had been edging up in recent months, but largely as a consequence of the slowdown in sales.

"The number of new listings remains near its lows, indicating that homeowners are under no pressure to sell into a softening market," Mr Gordon said.  "However, it’s less clear whether the restrictions have been effective in cooling house prices," 

At a national level, prices had continued to rise since July, albeit at a slower pace.

While the rate of increase had clearly slowed in some previous hot spots, such as Auckland and Hamilton, in an even greater number of regions, prices had accelerated since July.

"What’s more, this doesn’t seem to accord with the regions that are more affordable ... For instance, one of the hottest regions is Queenstown, where the average house price now tops the $1million mark," Mr Gordon said.  On interest rates, Mr Gordon said during the past two years, mortgage rates had declined steadily, following cuts to the official cash rate (OCR) and  anticipation of such cuts.

"This has steadily underpinned the price that investors are willing to pay for properties," Mr Gordon said.  However, that scenario was changing,  global interest rates having turned higher in the past few months, and New Zealand was being "taken along for the ride".

While rising rates began before the US election, Donald Trump’s surprise election and speculation of a US surge in infrastructure spending had accelerated the trend. In addition,  a slowdown in deposit growth  meant local lenders were now having to turn to more expensive sources of funding.

"Consequently, mortgage rates have risen by around 20 basis points from their lows for a two-year fixed term, and around 40 basis points for a five-year term," Mr Gordon said.

He expected the OCR to remain unchanged in 2017 but suspected longer-term interest rates would face further upward pressure during the  year, he said.

"That will mark a clear break from what the housing market has experienced over the last couple of years, and it’s the key reason why we’re forecasting a much more subdued pace of house price growth [in 2017]," Mr Gordon said.  Westpac’s view was that higher mortgage rates would have a more meaningful, and sustained, impact on house prices than lending restrictions alone ever could.

Lastly, Mr Gordon tackled the bubble issue, describing it in terms of the degree of  "stretch" that existed in the housing market. Metrics such as house prices compared with disposable income, and house prices to rents, had risen strongly in recent years, and were very high by world standards.

"Some argue that house prices must eventually fall back to levels that are more ‘affordable’," he said.  When considering house prices,  the market was  really talking about the price of land, the value of the land plus dwellings. "And the value of land will reflect not just its current use, but its potential for future development." 

There was a speculative element to property prices, in the sense today’s land prices reflected the value of houses not yet built, and also that there was some uncertainty around the future value of those houses. New Zealand’s burgeoning population, especially in Auckland, had created a demand for new homes which the market was struggling to deliver.

"Ultimately, the solution will include more intensive use of existing land, particularly in the main centres," he said.

Two main elements could trigger a collapse in land prices, Mr Gordon said.  The first was in failing to realise the full value of the land, either through renewed restrictions on building or by building the wrong kind of homes.

Secondly, demand for housing could fall short of expectations if, for example, the current high level of immigration to New Zealand turned to a net outflow of people.

"Even so, those [two] forces are unlikely to come to bear quickly," he said.

The accumulated shortage of housing, estimated at 35,000 dwellings and mainly in Auckland, and the building industry’s limited capacity suggested there was little risk of an oversupply of homes any time soon, he said.