Tony Alexander update March 2022
The pullback from unsustainable pricing heights.
Last month I wrote about the boom being over in the residential real estate market around New Zealand and the past month has brought further evidence of this. Specifically, after falling 1.5% in December average NZ house prices fell by another 1.1% in January.
In Auckland the falls over the past two months respectively have been 2.4% and 2.6%, Wellington +0.2% then -2.9%, and Canterbury -0.8% then +0.8%. We shouldn’t read too much into monthly price changes because they can be quite volatile. But I have done so here because the usual measure I use smoothed over three months would not capture the suddenness of the change in housing conditions through our summer.
From just before the middle of last year my main housing comment had been that we had entered the “endgame” for the housing boom whether one was referring to the Covid-boom, the surge in prices since shortly after the Global Financial Crisis ended, or the three decades since 1992. My expectation had been that we would see prices flattening out and activity levels falling firmly away from the June quarter of this year.
Instead, these things have happened almost six months earlier than expected. This is not because interest rates have increased more rapidly than anticipated. The Reserve Bank is still well behind the curve with its rate rises which so far amount to only 0.75%. At the 1.0% level which the official cash rate was taken to on February 23 monetary conditions are still highly stimulatory.
The sharp market turning has also not occurred because of a labour market shock. We have learnt that the unemployment rate has fallen to a record low of 3.2% and all measures of labour market strength show worsening shortages of employees. One from the NZIER shows that a record net 73% of businesses are struggling to source skilled staff and a record net 61% are struggling even to get unskilled people. Far more businesses are constrained now by a lack of employees than by a lack of customers.
The sudden turning of housing market strength reflects a credit crunch induced by three big changes. First, the Reserve Bank has made it clear that after a period of investigating the functioning and effectiveness of debt to income limits on how much banks can lend people, they are likely to formally introduce such limits from late this year. In anticipation of this happening some (not all) banks have introduced DTIs already, usually at a ratio of 6.
Second, after reintroducing loan to value ratio restrictions (LVRs) in February 2021 the Reserve Bank required investors to have a 40% deposit from May. Then from November 1 they began restricting banks to having a maximum of 10% of their new loans with deposits below the minimum required rather than 20%.
As November advanced some banks realised that if they let pre-approvals for mortgages be used as promised to young buyers, they would risk breaching the 10% limit. So, through the month they pulled authorisation for many of these loans and young first home buyers around the country found themselves unable to bid at auctions and tenders as they had been planning.
Such sudden removal of pre-approvals has ended, but mainly because banks have pulled back from offering the volume of lending to people with low deposits which they were doing previously.
Third, and most important of all the credit crunch elements, changes to the Credit Contracts and Consumer Finance Act came into force on December 1. These changes essentially mean banks need to base their lending decisions on the specific sending patterns of loan applicants rather than using standard numbers from statistical tables. They also feel they cannot risk taking an applicant’s word that they will alter spending levels once they have to service a mortgage.
This has resulted in thousands of potential borrowers either being denied finance or simply no longer even contacting a bank or mortgage adviser to submit an application because of the publicity given to banks cutting back their credit availability.
This sudden cessation of credit flows at levels of the past has left many people unable to bid at auctions and the result has been sellers having to pull back from their expectations of receiving extremely high prices for their properties. And that is probably the best way to think about the declines in prices which are underway – a reality check.
Average house prices last year soared to levels well away from the fundamentals of economic and labour market strength, housing supply, and financing cost and availability. The strength of FOMO fear of missing out – on the part of buyers was so great that sellers found they could post higher and higher asking prices and people would continue to pay them.
When willing demand exceeds willing supply prices can soar, especially in a market where new supply can be slow in responding to pricing signals.
But now, sellers are losing their belief that the silly prices of late-2021 can be achieved and more realistic pricing conditions and levels are returning. We cannot know how long this pullback from the fantasy ether will last or by how far prices will fall. But as an economist I am still left focussing on the fundamentals when it comes to assessing where things are likely to go and what those fundamentals look like is this. The negatives now dominate. These include rising interest rates which will eventually see mortgage rates near 6.5%. Opening of the borders is likely to see a net outflow of Kiwis seeking higher incomes offshore. New house supply is booming, and people are now diverting their spending back towards offshore travel.
But there are also some firm positive elements in play. These include the strong labour market, rising construction costs, granting of residency visas to up to 165,000 migrants, and some support from a few returning Kiwis.
The upshot is that from where we all stand at the moment, it seems reasonable to believe that average NZ house prices will fall by maybe 10% from levels of late-2021. That process may take a lot of this year. After that a potentially extended period of directionless prices is possible.
Then again, keep in mind that two years ago we economists had exactly the same outlook for a fall in prices. And look what actually happened! So treat all price forecasts with a bag of salt and keepfocussed on the long-term fundamentals which still argue for prices increasing over the coming decades.
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By Tony Alexander