Market Update March 2018 - Bernard Hickey


Property investors and first home buyers who are fearing or hoping a surge of new housing supply should know it will be very hard for the Government to engineer.  Bernard Hickey charts the heavy headwinds buffeting Kiwibuild.
Housing and Transport Minister Phil Twyford is arguably the most important and pressured man in the new Government. 

He is responsible not just for creating the Kiwibuild programme to build 100,000 affordable houses in 10 years. He will also have to conjure up a massive transport investment programme that New Zealand’s governments (both central and local) are ill-equipped to finance. 

Actually, the house building and rail building tasks are wrapped up into one big unholy infrastructure funding mess that Twyford will have to sort out with his own party and local governments up and down the country. That means those wondering if all these extra houses might depress prices should rest a little easier or grind their teeth again (depending on who they are) because supply is nowhere near keeping up with demand, let alone eating into a 30 year backlog of under-building that some estimate at 500,000 nationally. 

Here’s the crux of the problem: the central Government in Wellington sets the migration and tax policies that drove the biggest population growth surge in the last century and a burst of debt funded buying of rental properties, but local government had to fund most of the roading and piping (drinking, storm and waste water) to cope with all these extra people and demand for housing. The trouble is all the revenue benefits of that extra population growth are captured by Wellington in the form of GST and income taxes, while all Councils have is rates on property values – very much a lagging revenue stream. Councils with strong balance sheets can use debt, but only if they haven’t borrowed much in the past and have voters willing to pay higher rates now to service the extra debt.  

The fast growth Councils have run out of borrowing runway and existing ratepayers often refuse big rate increases point blank – and councillors and Mayors know that. 

This is an almighty Catch 22. The politicians in the Beehive invited in the extra people by loosening English language rules for international students and approving hundreds of thousands of temporary work visas. The central Government’s coffers are now bulging with the GST and income revenues from these extra people. But it’s the Councils that have to deal with all the extra people and plan for them with networks or roads, pipes, parks and community facilities that can take decades to fund, plan and build. 

Auckland’s population grew by 140,000 over the last three years, which is effectively adding a city the size of Hamilton in between elections. The combined populations of Hamilton and Tauranga grew by more than 50,000 in the last five years, which is effectively the size of a Rotorua.  

The ‘golden triangle’ of Auckland-Hamilton-Tauranga is the recipient of most of the migration and natural population growth in New Zealand. It also generates most of the GDP growth.  

It’s worth delving into this funding conundrum because it shows just how difficult the task is for Twyford and the Government generally. 

To successfully build 100,000 affordable Kiwibuild houses in ten years, Twyford, the new Government and the Councils will have to find upwards of $100 billion to build roads, networks of pipes, water treatment plants, railways, parks, schools, hospitals, libraries, sports facilities and all the gear to go with them. Houses on their own are useless. 

The Councils cannot borrow much more because they’re up against their debt limits and know their ratepayers, many of whom are asset-rich but cash-poor, won’t accept the higher rates that come with higher interest costs. Auckland, for example, has already maxed out its future borrowing. Any further increase would force its credit rating to be downgraded a notch from its current AA. Each one notch downgrade increases rates by 1 percent across the board. 

But there is an added complication. An Auckland downgrade would increase the borrowing costs for all Councils because Auckland sets the baseline for all Councils that use the Local Government Funding Agency. Some also think it would trigger a sovereign credit rating downgrade, which would increase the borrowing costs for all of New Zealand’s homeowners and businesses with mortgages. 

The Government itself has also tied its own hands behind its back. Labour and the Greens both committed themselves before the election to reduce net Government debt from 23 percent of GDP now to 20 percent of GDP within five years of taking office as part of their Fiscal Responsibility Rules. It will stop the Government from simply borrowing the money to invest in long term infrastructure, which would be a sensible thing for any young growing country to do. There is also over $230 billion of household savings sitting in bank term deposits and Kiwisaver bond funds that could easily be put into Government bonds. 
It makes no sense for the Government not to borrow for long term assets that future generations will service and repay, particularly when the central Government is the beneficiary of this growth through income and consumption taxes. 

But Labour and the Greens decided they needed this artificial restriction to convince voters that they could be trusted to hold the purse strings. It ties their hands and will frustrate Twyford for years to come. 

So the central Government and local Governments are now looking at all sorts of fancy (and more expensive) funding tools that allow them to borrow to build the infrastructure, but not put the debt on their balance sheets.  

Firstly, from the Council point of view, they are looking at value capture targeted rates that tax the ‘extra’ capital gain on land triggered by rezoning of a road, for example, as a light rail route. That would mean land owners along, for example, Dominion Rd would have to pay an extra rate to the Council because the light rail route increased their land values. The councils can then use the extra revenue to service extra debt and not have to apply a broad rates increase across all other ratepayers. Auckland is also applying a regional fuel tax of 10 cents per litre, which will help it pay for extra public transport. Other councils, including Hamilton, also want the ability to levy regional fuel taxes. Eventually, Auckland and others will want to levy congestion charges to limit demand for motorways and raise extra revenues to pay for all that concrete and steel underneath motorists and train commuters. 

Twyford and the Councils also want to create a bunch of new regional development authorities with their own balance sheets to borrow to fund for big new Hobsonville-style developments. He says 10 or 15 of these massive developments will be needed to achieve the Kiwibuild targets. There also remains questions about whether the ratings agencies will allow the Councils and the Government to do this, given the assets bought with the debt will eventually come back onto their balance sheets. Off-balance sheet debt vehicles are not popular in the wake of the Global Financial Crisis. 

All of these funding contortions will take time and have their own hurdles to surmount.  

Meanwhile, Twyford has to build a massive new bureaucracy in Wellington, the Housing Commission, to run Kiwibuild, and set up all these new regional development authorities. He will also have to shepherd legislation for all these authorities and off balance sheet vehicles through Parliament and nudge and cajole and bully Councils and ratepayers to stump up with their share of the funding.
The end result is that Kiwibuild faces huge headwinds. And that’s before a single trades person is employed or a single truckload of concrete is ordered – both of which also face shortages and delays. Any house building surge will also have to happen without much or any foreign investment because the Government’s foreign buyers ban will also make it nearly impossible for foreign investors to build and own apartment blocks designed for long term rentals.
Investors and first home buyers fearing or hoping for a supply shock should hold their horses.
It ain’t happening any time soon. 
By Bernard Hickey