Why worry about the Auckland housing bubble?

Cropped houses-503Every day, our newspapers and TVs have an article about the Auckland housing issue and why someone needs to be doing something about it. Most New Zealanders glance at these articles and pity those trying to buy their first home, then shrug and move on - secretly thinking that long may this housing boom continue as it is good for their net worth. There is also a commonly held view that the rapid rise in Auckland house prices is an Auckland first home buyer problem and it doesn’t really affect anyone else.
However, the Auckland house boom is now a New Zealand issue. It will have a future impact on many New Zealanders and we should all be starting to think about how we will handle the inevitable fallout from it.

What is driving the Auckland housing bubble?

This part of the equation has been well documented by the media and a plethora of experts. In the last 10 years Auckland’s median house price has risen by 213 per cent, averaging over 20 per cent per year. This is clearly not sustainable. This massive price growth has been driven by:

•    Migration: Auckland’s position as New Zealand’s number one city of choice has resulted in faster population growth than the rest of New Zealand. This puts the housing stock under increasing pressure. On an annual basis, net migration has risen to 68,000 people (in the year to March 2016) helping to underpin the economy and boost the property market. Much of this growth has come from international students and fewer Kiwis leaving for Australia, given the downturn in their mining sector and weaker employment market.

•    Town planning and infrastructure restrictions: Auckland Council has been reluctant to relax its zoning requirements and enable Auckland to expand out and also up. This pushes up the price of what land is available for development under the plans approved by the council. In a number of instances, large potential subdivisions have been shelved due to inadequate infrastructure such as power, water and sewage being available.

•    Low interest rates: We now have historically low interest rates and until early 2016, a huge appetite by the banks to lend money for property purchase or speculation. When interest rates are low, people feel more comfortable borrowing money to buy a rental property as they believe it is a one-way road to riches - most of these investors/speculators have never experienced a significant downturn in property prices.

•    Tax inequalities and a positive property psyche: There have been significant tax advantages associated with borrowing to buy a rental property. When people see massive house price increases occurring year after year and there is an ability to borrow cheap and offset costs against one’s personal income, then it is natural that they want to be a part of it. This property psyche feeds upon itself and reaches a stage (as in 2016) where the fundamentals of the property as an investment are not being seriously considered and instead, the purchaser becomes a speculator- they are buying on the assumption that the property will rapidly increase in value and they can easily sell it for a substantial gain. We are now in a situation where New Zealand must have one of the highest rental property ownership rates in the world amongst ‘mum and dad’ type investors.

What impact is this having around New Zealand?

•    Auckland halo effect: This is where Aucklanders have been selling up and moving to cheaper towns and cities - fuelling a rapid growth in house prices in those areas most favoured by Aucklanders. In recent times, growth rates in excess of 20% have been seen in the provinces.

    Provincial speculation: Aucklanders, recent immigrants and in some cases locals, have snapped up rental properties in provincial towns believing that lower purchase prices, low interest rates and higher yields will continue into the future.
•    Rising stridency of warnings: Investment commentators, economists, the Reserve Bank, the government, and even mainstream bankers, are warning that this rapid rise in house prices is unsustainable and the inevitable end could be ‘messy’- a trendy term for losing money from housing investments.

•    Increasing LVRs: The Reserve Bank has pressured the banks to raise the loan to value ratio (LVR) in an effort to restrict the rampant lending on rental property. There is also a restriction on how soon an investor can sell a home without triggering a tax liability (the bright line test).

•    Government intervention: The government is pulling out all the stops it possibly can to slow the house price rise. This includes restricting lending, increasing supply, and threatening to change tax laws.

•    Massive increase in building: There are now more houses being built in Auckland each year than ever before. The house shortage in Christchurch is now over and many Christchurch builders will turn to Auckland and the Bay of Plenty and help to further speed up construction rates in the areas of most demand.

When might the housing boom end?

Unfortunately, we do not have a crystal ball so we need to look to events elsewhere in the world and bow to the collective wisdom of some pretty smart experts in New Zealand.

Building supply is a blunt instrument. It takes years to gear up to start to meet demand and then it takes years to slow down. Because of the inability to exactly meet demand, there will inevitably be a house oversupply situation once migration has slowed, interest rates have nudged up, access to mortgages has tightened, and house supply has expanded and the confidence level of the public has fallen. All these factors lead to falling house prices.

Gordon Edington, a director in property consultancy firm Prendos, believes things will unravel in 2018/19. He believes the stimulus for a fall will be a combination of increased house supply, rising interest rates, reduced migration and a cyclical 10-year down turn (10 years coincides with the 2008 start of the Global Financial Crisis).

The government will want to see bold steps made to meet housing demand before the 2017 election and see a flattening of house prices and if possible a small decline. The government is keen to manage the situation as well as something like this can be managed so that house affordability does not become the number one election issue in 2017.

Why might this be ‘messy' for many New Zealanders?

Auckland is undoubtedly the economic powerhouse of New Zealand. It is fuelled by massive levels of household debt. When house prices rise, owners feel good and will consume more - believing they can add the new debt to their house mortgage and rising house prices will pay it off one day. When house prices fall, the credit cards stop coming out and a down turn occurs. This spending reduction affects all of New Zealand.  If this spending reduction coincides with a global cyclical downturn, then it becomes a double whammy and many parts of our economy slow - overtime is reduced, people may be laid off, tenants struggle to pay rents, migration slows, and young people return home to live with parents. All this leads to falling house prices and also falling rents.

However, things don’t stop there. The banks will want increased equity in the houses they are financing, they may want borrowers to start paying off capital rather than just sitting on ‘interest only loans’, and interest rates might rise.

About this time, any changes to tax rules made by the government in 2017 to slow house price appreciation will start to kick in and those who borrowed heavily to buy rental properties could be hit badly.

It is difficult to predict how much house prices in Auckland and elsewhere could possibly fall. We have seen property values decline in parts of Asia, the USA, Canada, UK and Europe by 50-60% during the GFC. A number of economists believe Auckland house prices are 40% or more overvalued, but that does not necessarily translate into a fall of that size in Auckland. Statistics produced by First New Zealand Capital in early 2016 indicate that a price fall of 13-17%, based upon historical falls in New Zealand, would be more likely.

Those who are not heavily indebted or are debt free, need not excessively worry. Your house price may drop, but provided you have a well-diversified investment portfolio and your house is not part of your retirement planning, then you just ride it out knowing that you will be worth a little less on paper than what you were during the boom.

For those who have massive mortgages or who have recently purchased, then things could be very messy. It is important that debt levels be reduced while interest rates are low and you focus on building up liquidity in a diversified investment portfolio so that if the banks demand a sudden debt reduction, you have money available in your non-KiwiSaver scheme investment portfolio to make this payment.

If you own a rental property and the yield on it is 3% or less (based on current market value and assuming it is debt free) then talk to us about whether now is a good time to consider selling it and diversifying your overall investment portfolio. If you are planning to sell a property, it is always better to do it in a buoyant market rather than a declining one.