Tony Alexander Update December 2021
A mini credit crunch Last month I wrote that a number of factors are coming into play which will cause a slowing in the pace of house price growth around the country. I wrote that the biggest would be rising interest rates. Eventually this will likely be the case. But right now something else is dominant. The evidence in hand so far suggests that the residential real estate market has already abruptly changed and that the main culprit is a rapid tightening of bank lending standards. In essence, a credit crunch is underway.
In the words of one mortgage broker, whereas in the past 5% of his applications for clients would be rejected, now the proportion is 25%. Banks have reduced credit availability in recent weeks for three reasons.
First, changes to the Credit Contracts and Consumer Finance Act commenced on December 1 and they essentially require that a lender prove it has assessed all expenses and all income sources along with their stability before extending credit. This is leading to banks counting many things as permanent expenses which used to be ignored.
Even borrowers who promise to cut back on discretionary spending such as daily takeaway coffees and online services in order to meet debt servicing criteria are being denied credit. Banks want to see such altered behaviour in place for three months before removing such expenses from their spreadsheets.
The CCCFA changes are also causing reduced lending to the self-employed and those in their 50s for whom retirement within the timeframe of a standard mortgage would disturb income flows.
Second, the Reserve Bank recently instructed banks to have no more than 10% of their new lending to customers with less than a 20% deposit, effective from November 1. The surge in lending recently has been so strong that banks have estimated they will be in breach of that requirement or too close to the 10% limit for comfort. So, for an unspecified period of time, banks have stopped lending at low deposit to buyers of other than new dwellings.
Third, banks expect that from sometime next year the Reserve Bank will introduce debt to income lending restrictions – DTIs. These will limit lending to a multiple of the borrower’s income. Banks have been experimenting with DTIs in order to get their systems ready for when the rules have to be applied. These restrictions have also affected some borrowers.
It is perhaps worthy of note that over the past six months 35% of mortgage lending has involved a DTI above 6. That is, debt has exceeded 6 times income. 19% has involved a DTI of 7.
These sudden changes in lending criteria have denied funding to many potential property buyers and this has led to some sharp changes in responses to the monthly survey I run each month with REINZ. In particular, the gross proportion of real estate agents around the country saying that they are seeing FOMO has fallen to 39% from 70% in October.
This is the lowest proportion since the 35% of April 2020 when we entered into the first nationwide lockdown and house prices were widely expected to fall. This time, a net 18% of agents still feel that prices are rising in their location whereas back in April 2020 a net 17% felt that they were falling.
So, conditions are not the same as back then. But the speed with which market sentiment and the presence of buyers has changed has been sharp.
How will things progress from here? For investors it will be good news if the market now progresses with minimal upward price movement. This will remove pressure on the government to try and improve affordability for young buyers by repeating their tax announcement of March 23 this year. There has been a risk that if house prices are rising at above a 10% annualised pace early next year the government could double-down on its changes, perhaps removing deductibility of other expenses – or all of them.
For first home buyers the news is good in that once the banks ease up their shock tightening of lending criteria, we will see more listings to choose from. Already listing numbers are rising and through summer as vendors lose their optimistic expectations of sky-high prices, they will set more realistic price floors. Importantly as listings rise, those potential vendors who have held off selling for fear of not being able to buy again will lose that fear and list their properties.
At the same time we are likely to see more investors taking profits from the 39% surge in house prices since March 2020, and some selling as they factor in decreasing ability over time to deduct interest expenses from taxable rental streams.
Is it likely that house prices will fall on average? Not really when we factor in the strong labour market, rising construction costs, and backlog of buyers who have stood back from the market frustrated at the costs they keep incurring for failed bids and frenzies in the auction rooms. In some regions decreases may occur as thin markets have amplified price changes.
But in Christchurch the long-overdue price catch-up which started in winter is likely to continue. In Auckland prices are below their trend relative to the rest of the country and this will act as a natural price cushion. Wellington prices on average are well above trend but lack of readily developable land for now will provide some price support.
Will the Reserve Bank react to a flattening market by not raising interest rates as they have predicted? No. Their target is overall inflation, not house prices. They will remain focussed on consumer spending strength, measures of inflation expectations, availability of capacity in the labour and materials markets, and offshore price trends.
Fixed mortgage rates are likely to rise beyond current levels. But further moves might not amount to much for a few months as the recent increases have been the fastest on record and a lot of the expected tightening of monetary policy has already been factored into the 3–5-year fixed borrowing costs which banks face and therefore the fixed rates at which they lend out.
From here the biggest rate movements through 2022 will be for floating, one, and two-year rates. Most borrowers for the moment are fixing for three years. But these remain the most uncertain times which any of us economists have ever seen (Omicron for instance) and having one’s mortgage spread over a number of fixed rates would be a good idea from a pure risk management point of view.
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By Tony Alexander