09 November, 2020

Housing Market Update - Balmy now, a cool change coming

  • House prices have held up much better than almost everyone expected, including us. The main positive drivers of accelerating house price inflation have been record-low mortgage interest rates, the removal of loan-to-value ratio (LVR) restrictions, and undersupply of housing.
  • The Reserve Bank of New Zealand (RBNZ) is in a tricky situation with house prices currently booming, but economic hardship likely down the track. We consider the RBNZ will undertake further easing, including a cut in the Official Cash Rate (OCR) to -0.25% and introducing a Funding for Lending Programme (FLP), but commit to reinstating LVR restrictions to take the top off housing market froth.
  • House price rises may further accelerate in the last few months of this year as buyers anticipate the reinstatement of LVR restrictions next year. However, even as interest rates fall further, we expect house prices to fall moderately next year as LVR restrictions are put in place, government support rolls off, unemployment rises, and net migration turns negative as we reopen our border with Australia.

Housing Market Oomph

House prices have continued to defy the gloomy predictions of many that hard times caused by COVID-19 lockdowns and closed New Zealand borders would stunt the housing market. In fact, the opposite has occurred – housing market activity has lifted, and house price rises have accelerated. Housing market strength has been broad-based across the country (although house prices have been hit in Queenstown and Rotorua due to the dramatic downturn in visiting overseas tourists).

There are several reasons why the New Zealand housing market has confounded gloomy expectations, which we outline below.

Go Hard, Go Early Policy

Since March, the Reserve Bank of New Zealand (RBNZ) has embarked on a “least regrets” approach to combating the economic fallout or COVID-19. This approach has led to the RBNZ cutting the Official Cash Rate (OCR) 0.75% to a record low of 0.25% and successively ramping up Large Scale Asset Purchases (LSAPs) to $100 billion. It has strongly hinted that that it will undertake further easing over coming months, including later this year implementing a Funding for Lending Programme (FLP) to supply banks with cheap funding for the purposes of expanding its customer lending, and further cutting the OCR into negative territory next year. This is illustrated in the diagram below. The goal of the RBNZ is to lower banks’ funding costs further so that retail deposit and lending interest rates fall to levels comparable to overseas, particularly Australia where retail interest rates have remained consistently lower than in New Zealand.

Lowering Bank Funding Costs

Source: RBNZ

As part of its role in supporting workers and businesses in the current crisis, the RBNZ also removed LVR restrictions, which restricted the proportion of bank mortgages for homes purchased with deposits under 80% of their value. LVR restrictions were primarily removed so that they do not interfere with the operation of the mortgage deferral scheme, which will automatically result in a greater proportion of banks’ total mortgages slipping into the high loan to value category. If LVR restrictions are removed it will make it easier for first home buyers and investors to access borrowing for house purchases, thus contributing to housing demand pressures.

The Government has also played a major role in supporting workers and businesses in the current crisis, with the wage subsidy being front and centre. This has been complemented by the mortgage deferral scheme, which according to credit reporting bureau Centrix, resulted in a peak of 7% all home loans (54,000 borrowers) being on deferred or reduced payment plans. The key effect of the wage subsidy and mortgage deferral schemes together for the housing market has been to minimise the mortgage defaults and forced house sales that might have occurred due to lockdowns and border closures. With the possible negative consequences on housing neutralised to a large extent, the positive impacts of lower mortgage interest rates and the removal of LVR restrictions have dominated.

Record Low Mortgage Interest Rates

Since April, average new floating mortgage interest rates have declined around 1.4% to 4.42%. In anticipation of the RBNZ’s intentions to achieve even lower retail interest rates, interest rates on fixed term mortgages have fallen significantly below floating interest rates, with the large banks now offering mortgage interest rates in the range of 2.4%-2.5% on terms of around 12-18 months. Heartland Bank currently offers the lowest interest rate of 1.99% for fixed term mortgages of one-year and with at least 20% deposit. It is possible that floating mortgage interest rates could also fall to significantly under 2% over the next 12 to 18 months.

Booming Borrowing

Record low mortgage interest rates and the removal of LVRs have spurred a rush to the bank for aspiring homeowners and housing investors, with the volume of mortgage lending rising 32.8% in September from September 2019. This is the fastest annual growth rate in mortgage lending since 2015, as the chart below shows. Mortgage lending to investors grew at a steep 54.7% annual rate, while lending to homeowners, which accounts for the bulk of total mortgage lending, leapt 27.9%. The burst in investor borrowing suggests that an element of exuberance is entering the housing market. The implications of this are discussed below.

Shortage of Housing Supply Relative to Demand

Housing supply has been increasing at a consistent pace in recent years fueled by robust building activity, as indicated by the growth in consents for new dwelling units, shown in the chart below. However, the pace of new building has been insufficient to meet red hot demand stimulated initially by high net inward migration and, latterly, by lower mortgage interest rates and the removal of LVRs. Following a relatively brief period last year when supply and demand appeared to be reaching balance, housing demand has again galloped ahead of housing supply, as the chart below shows. This relative dearth of housing is starkly demonstrated by the number of houses available for sale, which Real Estate Institute of New Zealand (REINZ) statistics show declined 17% in September from September 2019, reaching its lowest level on record. The relative shortage of housing combined with current demand pressures is putting significant upward pressure on house prices.

New Zealand Housing Market Not Unique

The rebound in New Zealand’s housing market amidst a global pandemic is not unique to this country. Housing activity has been robust in many other developed countries, including the US, Canada, UK, and Australia. Similar factors are in play in driving up house prices in those places – rock-bottom mortgage interest rates and government support to combat the economic fallout from the pandemic. Many analysts have also pointed to the increased desire for living in larger suburban homes due to the trend of working from home, which has been accelerated by the pandemic. However, New Zealand’s housing market pressures have been accentuated by the relative lack of housing supply, which is not as apparent in other countries.

Financial Stability Concerns

The RBNZ Governor, Adrian Orr, has recently expressed his discomfort with frothy elements emerging in the housing market as indicated by the leap in housing investor activity and the upward trend in the proportion of high LVR loans, as the chart below shows. It is likely that the RBNZ will reinstate LVR restrictions to keep a lid on the riskier parts of house lending, although this might have to wait until the Government’s mortgage deferral scheme runs its course on 31 March 2021.

Housing Becoming Less Affordable

A consequence of New Zealand’s rapid house price growth over an extended period is that house values have climbed relative to peoples’ incomes making them less affordable to people wanting to enter the market. New Zealand’s house price to income ratio trended up from 2011 and has flattened off above the OECD average since 2016, as shown in the chart below. Recent house price rises will likely see the house price to income ratio again trend higher, diverging further above the OECD average.

Although house prices are historically high compared to household incomes, which is making it harder for lower income people to afford, debt servicing cost as a share of household incomes is historically low. This underpins the current demand pressures in the economy as debt servicing is not currently a major barrier to further increases in lending for housing purposes. A low aggregate debt service ratio also implies that borrowers are likely to have a buffer after debt repayment to meet unexpected expenses, even if debt servicing costs go up a significant amount in percentage terms. Therefore, a decline in incomes or rise in interest rates is less likely to lead to a large rise in defaults as debt servicing costs go up. This suggests that the soundness of the New Zealand financial system is currently not unduly threatened by high house prices.

The RBNZ’s Tricky Course Ahead

Despite low interest rates and a sound banking system, the heated housing market currently presents a tricky challenge for the RBNZ as it balances the need to stimulate the economy with its responsibility to ensure riskier lending does not cause problems down the track. The RBNZ’s main policy tools to combat the economic effects of the COVID-19 crisis – cutting the OCR and LSAPs – are clearly having a positive impact on mortgage lending and housing market activity. This will be welcomed by the RBNZ to a certain degree as higher house prices help lift consumer demand and residential housing investment. From a financial stability perspective, keeping interest rates low and supporting household incomes through minimising job losses will also be beneficial as this supports the ability of borrowers to meet their debt repayments. However, to the extent that higher house prices induce riskier lending, such as increased lending to high LVR borrowers (which we are starting to see), vulnerabilities in the banking system will rise in the future.

For this latter reason, it is likely that the RBNZ will reinstate LVR restrictions in March next year. This will likely take the top off housing frothiness at a time when rising unemployment and low migrant numbers are also starting to have a negative impact on housing activity. In the short-term, however, low mortgage interest rates and the prospect of reinstated LVR restrictions may induce some buyers into the market before the LVR restrictions are in place. Therefore, it is possible that house prices accelerate further in the last few months of this year.

The RBNZ also has a public communication challenge with house prices currently accelerating. Under Governor Orr, the RBNZ has stressed the importance of getting the public onside for the RBNZ’s mandate and the measures it takes to achieve its objectives. However, there is increasing public debate on the negative effects of rising house prices on housing affordability and wealth inequality. We continue to expect the RBNZ to implement a FLP and cut the OCR 0.5% to -0.25% in April or May next year as it follows through with its least regrets approach to monetary policy in the interests of boosting inflation and sustainable employment. However, the RBNZ may have a tough task to convince the public that they should look through near-term housing market strength and that its ultra-easy policies are the best for the economy in the current situation.

Housing Market Still Likely to Cool Next Year

We continue to expect the housing market to fall moderately next year. The main reason for this is because we see unemployment rising sharply as the wage subsidy scheme ends, New Zealand’s border closure cuts off the supply of foreign tourists and students causing some businesses depending on these areas to close shop. House prices have at times been very sensitive to rises in the unemployment rate, such as in the early-1990s and late-1990s when the unemployment rate spiked up and house prices fell substantially. Prospective house buyers are wary of committing to house purchases when their incomes are stagnating and when they fear for their jobs.

The drying up of net migrant inflows will also likely be another critical factor constraining the housing market going forward as it has been a key support for house prices in recent years. For most countries, the border with New Zealand will likely remain closed until at least 2022. This is likely to be the case even if an effective COVID-19 vaccine emerges because of the time it will take to manufacture, distribute, and vaccinate populations. This will, therefore, not provide the support to the housing market that it has in recent years.

It is possible that the border between New Zealand and Australia is reopened by the end of this year or early in 2021 (provided community transmission of COVID-19 remains under control in both countries). Traditionally, the direction of net migration flows between the two countries has been heavily influenced by the relative strengths of the respective countries’ labour markets, as shown in the chart below. We expect New Zealand’s unemployment rate to increase more than Australia’s unemployment rate over the next 12-18 months as our economy is more affected by the shutdown of its border due to the higher reliance on tourism. This could, therefore, have an additional negative effect on the New Zealand housing market over that period.

Note that the Australia-New Zealand net migration series in the chart above ends in October 2018 as that is when Statistics New Zealand changed its methodology for recording departures from New Zealand.

Although house prices are now unlikely to fall to the degree that we and other economists were predicting several months ago we still see house prices coming off significantly from current levels, with annual house price inflation of between -5% and 0% over the next year.

This advice is general or “class” in nature, not specific or personalised to you. It does not take into account your financial situation or goals and, accordingly, does not constitute personalised financial advice under the Financial Advisers Act 2008. If you require personalised financial advice, there is a process to go through before that can be provided to you.


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