The Official Cash Rate (OCR) has been cut 75 basis points over the past six months and mortgage rates have fallen. But because household deposits are an important source of bank funding (eg for home loans), banks have had to strike a balance, meaning both mortgage and deposit rates have fallen by less than the OCR has. And as the OCR goes lower (we're forecasting a further 50 basis point reduction by August 2020), we think the pass-through to mortgage (and deposit) rates will diminish. Indeed, there's a real risk that if deposit rates go lower, household deposit growth could slow markedly as depositors seek higher returns elsewhere. This would mean banks have a lower deposit base from which to provide new loans, reducing the positive impact to the housing market and broader economy. So even if the price of credit (ie the interest rate) is low, supply constraints (credit availability) can be a significant headwind.
Loan to Value Ratio (LVR) restrictions were never intended to be a permanent feature of the housing market. But, six years after their implementation in 2013, they remain a key element, contributing to less risky lending and putting downward pressure on house price inflation. Numerous tweaks to the LVR restrictions have been made in recent years, but is it time to loosen them a little more? Recent housing market outturns have been modest, particularly on the sales activity side. But there are lots of moving parts, and significant regional divergence. While household debt levels are certainly high, growth in household disposable income does looks to be running at around the same pace as housing credit growth - and above house price inflation. Both we and the RBNZ expect house price inflation to remain modest relative to previous cycles over the next few years, but frankly, a wide range of outcomes is plausible given the recent drop in mortgage rates, possible developments in credit availability, the softening economy, and policy changes. All up, we think a small loosening in LVR restrictions is likely at the upcoming November 27 Financial Stability Report.
With the Government having announced a KiwiBuild ‘reset’, we go back to basics; thinking about demand and supply in the housing market. The New Zealand housing market is prone to boom and bust cycles, and subject to large swings in demand, often coming from swings in migration. But constrained housing supply means that increases in housing demand tends to lead to higher house prices, while housing construction reacts more slowly. A focus on easing supply constraints is what is really needed, so we review what is being done on that front. The KiwiBuild reset this month offered some goodies for first home buyers, but the newly announced ‘reset’ policies are likely to just add to housing demand. That said, elements of the KiwiBuild programme may still be able to add some value by addressing supply constraints. Other policies are also in train in the background – the Government is building a record number of state homes and the National Policy Statement on Urban Development has the opportunity to transform local land-use planning and infrastructure. But this is all coming against a backdrop of downside risks to the construction sector outlook.
Land makes up a pretty hefty chunk of the price of housing, and has made some significant contributions to house price inflation over the years. After taking a drive though the New Zealand countryside, you could be forgiven for thinking that New Zealand has an abundance of land and that a simple way to address housing affordability is simply to extend a few urban boundaries, pop in some roads and get building. But alas, land appropriate for housing might not be as abundant as you think and the stuff we do have, particularly around key urban boundaries, is currently being put to good use. Given the numerous downsides of urban sprawl, increased housing density is definitely going to have to be part of the solution to addressing housing affordability in New Zealand. While the data suggest construction activity is shifting towards multi-unit dwellings, there's still a decent way to go. And with cost pressures eroding profitability in the sector, and construction firms recently becoming increasingly pessimistic about their own outlook, activity risks are skewed to the downside.
The rules and regulations governing the New Zealand rental property market have undergone a number of changes over the past few years, and it looks like more are on the way. Law changes have generally focused on improving the lot of renters and first home buyers. And while some, such as the Healthy Homes Standards, have broader economic benefits (eg fewer sick days), there's no such thing as a free lunch. Higher-than-otherwise rents and a lower-than-otherwise stock of rental properties are costs that from a social perspective are just as difficult to quantify as the benefits. But for now, let's look at the coal face; at how some of the rules have changed for residential property investors, and how they might change further. Given some of the costs of non-compliance, it is pretty important stuff of which to be aware. Regarding their impact on the housing market (and the economy more broadly), we think policy changes have been - and will remain - a key headwind. But the fundamentals (a shortage of houses and downward pressure on mortgage rates), suggest there are enough supports out there to keep things from rolling over.
This month we take a closer look at housing market performance across different regions in New Zealand. Weakness in the Auckland and Canterbury markets have weighed on the nationwide picture, with these regions comprising 42% of house sales combined. But a number of other regions have experienced strong price gains recently. Based on a number of metrics, we identify Gisborne, Manawatu-Whanganui, Tasman-Nelson-Marlborough and Otago as hotspots, while exceptional heat is being seen in Southland and Hawke's Bay. In addition, Bay of Plenty, Waikato and Wellington markets are also running hot, just not as hot as they have been. Conditions can change quickly and the outlook is uncertain, but all else equal, strong demand in these markets appears conducive to further regional price increases. This delayed cycle relative to Auckland is not unusual for the New Zealand housing market. On the whole, we expect that the nationwide market will remain contained. But regional divergence is expected, with hotspots expected to continue to outperform while headwinds blow strongest in Auckland and Canterbury.
The OCR has been cut to an all-time low of 1.50%, and mortgage interest rates have fallen. In addition, the Government has taken the possibility of a capital gains tax taken off the table. Given these developments, now seems like an appropriate time to reassess our outlook for house price inflation. After adjusting for supply and demand imbalances, we estimate that a 1%pt fall in the mortgage interest rate would typically bump up annual house price inflation up by around 2.5%pts after 6-12 months, all else equal. However, the lengthy list of policy changes this cycle means all else most certainly isn’t equal. Indeed, we find evidence that the recent moderation in house price inflation is owing to factors other than the typical “macro drivers” of population growth and interest rates. This supports our view that the policy landscape and affordability constraints have had a significant role to play, and will continue to do so. All up, we’ve baked in a small bump into the house price inflation outlook, but don’t expect it to shoot for the moon.
For a number of years, construction demand has been strong; activity has ramped up to a high level and firms have been run off their feet. But recently, firms have started reporting that growth in new building work has started to drop off and the outlook is looking less assured. Pent-up demand for housing and KiwiBuild will provide a floor for activity, but that may not be enough to sustain today’s very elevated levels. Construction firms’ costs continue to escalate, but in the context of wariness about the demand outlook, they are finding it more difficult to increase prices, causing profitability stresses. And this comes against the backdrop of an industry already grappling with broader financial, productivity and staffing challenges. So far this cycle, such challenges have been manageable in the context of strong growth in building work, but they will be difficult to bear should demand start to wane, even if activity remains elevated as we expect. And with construction a bellwether of the economic cycle more broadly, this adds to the picture that has formed of an economy past its best.
Credit availability is a significant determinant of housing market developments and the economic cycle. Lending has generally been conservative this cycle, but from 2016, reduced credit availability contributed to cooling in the housing market and loss of economic momentum. Credit has been less of a constraint recently; the housing market and GDP growth are being held back by other headwinds. And banks’ funding positions have been favourable, conducive to continued prudent lending supportive of the housing market and ongoing economic growth, albeit below trend. Nonetheless, some businesses and farms are facing challenges on this front, and waning deposit growth poses the risk that credit becomes a more significant constraint once more. Adding to that, proposed (and probable) changes to bank capital requirements, if implemented, would impact both the price and availability of credit, with potentially quite significant implications for the economy, including for the housing market.
Rental inflation has been trending higher recently, with policy changes aimed at making property investment less attractive playing a role. Rental affordability has not worsened in aggregate, but some households will nonetheless be feeling the pinch. Going forward, waning population growth is likely to see pressure on rents subside somewhat. Yet with the pipeline of policy changes continuing, including possible extension of capital income taxation, rental inflation is likely to remain solid as investors attempt to maintain returns. Overall, we expect the recent trend of rental inflation outpacing house price inflation to continue for a while yet. Headwinds are expected to continue to act on the market for existing housing, while property investors attempt to recoup some yield by increasing rents.
In our August 2018 Property Focus we took a look at how property markets globally relate to the New Zealand market. We concluded that the New Zealand housing market was probably not being dragged down by global developments, but that it could be in the future, with global housing markets having become increasingly synchronised over time. This month, in that context, we take a look at recent developments in housing markets abroad. In summary, housing markets are certainly cooling in synch with each other, but outside of Australia there is no sign that the cooldowns are anything unusual.
The planet is warming, presenting a challenge for policymakers on a global scale that needs to be addressed. Among other issues, for New Zealand the price and availability of insurance (and thereby credit) is likely to be affected over the long term by the threat of physical damage, particularly in coastal regions. This could weigh on property values in these areas and put balance sheets under strain, with financial stability implications. The overall economic impacts of climate change are difficult to estimate, though New Zealand appears better placed than many. But the costs of reducing emissions are significant. As the economy transitions to meet emissions targets, prices of emission-intensive goods and services are expected to increase considerably, and significant structural change in the economy is expected to take place. This is likely to dampen household incomes and consumption, with lower-income households most affected, which could also weigh on property values.
This month we take a closer look at housing market performance across different regions in New Zealand. Weakness in the Auckland and Canterbury markets have weighed on the nationwide picture, with these regions comprising 42% of house sales combined. But a number of other regions have experienced strong price gains recently. Based on a number of metrics, we identify Gisborne, Manawatu-Whanganui, Tasman-Nelson-Marlborough and Otago as hotspots, while exceptional heat is being seen in Southland and Hawke’s Bay. In addition, Bay of Plenty, Waikato and Wellington markets are also running hot, just not as hot as they have been. Conditions can change quickly and the outlook is uncertain, but all else equal, strong demand in these markets appears conducive to further regional price increases. This delayed cycle relative to Auckland is not unusual for the New Zealand housing market. On the whole, we expect that the nationwide market will remain contained. But regional divergence is expected, with hotspots expected to continue to outperform while headwinds blow strongest in Auckland and Canterbury.
This month we update our views on the outlook for the housing market. A number of offsetting forces are buffeting the market, but the balance of those forces may be changing. Our central view is that the market will see some volatility in coming months, especially in light of policy changes, but that an overarching theme of softness will prevail – with house price inflation expected to be modest. However, we’d emphasise that the outlook is very uncertain at present, and is subject to a number of important risks on both sides. Recent falls in mortgage rates could lend further support to the market, particularly given market tightness in certain regions. But on the other hand, policy changes could see a significant departure of investors from the market, recent softness could see expectations reassessed, and/or the migration outlook could be weaker than expected. On balance, we see risks as tilted to the downside. And in that environment, we expect that the RBNZ will ease loan-to-value restrictions a little at the November FSR. This will provide a boost to the market, but the effect is not expected to be large.
Since late 2017 households have been building their housing equity. In part this reflects reduced turnover as the housing market has cooled; high turnover tends to be associated with increased debt because buyers typically have less equity than sellers. Recent lower turnover partly reflects government policy changes, uncertainty and affordability constraints. But credit conditions have played an important role in reducing turnover and building housing equity too. In addition, households are perhaps more constrained or more cautious towards debt in the post-crisis period. Nonetheless, debt levels remain high, meaning that households will be vulnerable should house prices fall or interest rates rise. The fact that those entering the market now have bigger buffers does help mitigate the risk and the potential fallout of a disorderly housing market downturn, with macro-prudential policy having played an important role here. But in light of financial stability risks, we expect that the RBNZ will take a cautious (and gradual) approach to easing loan-to-value ratio restrictions. An easing in November is possible, but settings are expected to remain “tight” for some time.
New Zealand’s housing market has slowed at the same time as a number of other markets, particularly Australia. So is the New Zealand housing market being dragged down by global developments? Our analysis suggests probably not. But it could be in the future. The recent slowing in the local market appears to reflect primarily domestic factors, including investor wariness and policy changes. Affordability constraints also appear to be weighing in Auckland – and some international markets like Sydney. But other domestic factors are offsetting; credit is generally available, population growth continues and interest rates remain low. Moreover, the RBNZ has monetary and macro-prudential policy ammo if required. Nonetheless, in the event of a global shock, there is a risk that the New Zealand housing market could be significantly affected. Global housing markets have become increasingly synchronised over time, particularly in downturns. This ups the stakes, particularly given that household debt is close to record highs.
It is widely known that housing is expensive in New Zealand. But we think the effects of unaffordable housing might be much more pervasive than generally appreciated. Not only does the high hurdle to purchasing homes have important implications for wealth equality, generational equity and financial stability, but it also impacts the economy’s productive potential. High house prices make it more difficult for younger households to invest in businesses, limiting the entrepreneurial endeavours of younger people. They also create barriers to labour mobility and social mobility, both of which matter for achieving our productive potential. And to the degree that high house prices are a symptom of excess domestic demand pressure, they will be associated with upward pressure on the real exchange rate, stifling exporting and import-competing activity. The challenges of low productivity growth and housing unaffordability are both complex and difficult to solve, but in our view these issues are inextricably linked.
The Government has implemented or proposed a number of policies that will affect investment in residential property. Outcomes are uncertain, but the policies being proposed are no magic bullet to fix New Zealand’s housing affordability issue, though they will likely have a temporary dampening effect on house price inflation. The most important factors underpinning housing demand have been strong immigration and low interest rates, and these factors are expected to persist. There are also crucial issues for affordability related to the supply side: high construction costs, construction industry productivity, restricted supply of land, and provision of infrastructure – and it is important that focus remains on addressing these issues, although quick fixes are in short supply here too. As with all policies, there may be unintended consequences, including potential upward pressure on rents, or negative impacts on housing supply at the margin – particularly for apartments. On the other hand, the proposed policies could have other benefits, like encouraging households to diversify their assets.
The conventional economic wisdom in New Zealand is that a strong housing market supports consumption. But recently, this relationship has weakened, with households in aggregate seemingly no longer feeling good about rising house prices. Houses are unaffordable for many, servicing a large mortgage is a stretch, even at low interest rates, and the home ownership rate has declined. We suspect that the relationship between house price inflation and consumer confidence has changed as a result of these affordability concerns, in combination with the policy-driven slowdown in the housing market. Going forward, the relationship between the housing market and spending is expected to be more nuanced, with housing affordability concerns unlikely to recede any time soon.
New home building is at a high level. While rebuild activity in Canterbury has waned, overall housing demand is being driven by strong population growth, a shortfall of housing, and low interest rates. And despite rising construction and land costs, high existing house prices have made building attractive relative to buying. With demand expected to remain solid, we expect residential building activity will remain at high levels. But capacity in the construction industry is constrained and labour shortages are acute. Government initiatives intended to improve housing affordability will also contribute to demand, but we expect impacts on both the rate of home building and house prices will be relatively small. We have reached a more difficult phase in the construction cycle and rising costs and delays could put pressure on firms in the industry. Pockets of pressure could emerge, particularly around cash flow.
The housing market has entered 2018 on a firmer footing after cooling through 2017. From here, we expect the housing market to remain stable, with prices rising at a moderate pace. A key headwind is affordability – particularly in Auckland, where eye watering prices are holding the market back from resurgence. But this is not true everywhere. And now that the Auckland market has cooled, the rest of the country is playing ‘catch up’. While there are reasons to expect Auckland house prices to rise faster than elsewhere on average over time, a large and unsustainable divide was created by Auckland’s recent astronomical rise. Going forward, this catch-up dynamic is expected to support the rate of house price inflation outside Auckland. And with steam taken out of the Auckland market and affordability at its limits, we expect price pressures there to remain subdued.
Over recent months we have outlined our thoughts on where we believe the housing market goes from here. Although activity has shown more signs of life of late, and the risk profile does appear less negatively skewed than it did, we have not changed our overall views. We see prices effectively staying ‘on ice’ for the foreseeable future, with modest growth overall. But what does that imply for the broader economic outlook? History has taught us that the housing market has a critical bearing on the economic cycle. All else being equal, we expect softer house price growth to be a headwind for consumption growth going forward, although perhaps to a lesser extent than history would suggest, given that the softer housing market has not been driven by a turn in the interest rate cycle, but rather by a more restrictive credit landscape, including macro-prudential policy. Nevertheless, with the household saving rate having deteriorated over recent years (to an unsustainable level in our view), weaker house price performance is expected to see households look to rebuild precautionary saving, and this will be a headwind for overall activity growth.
The housing market has had a great run in recent years, but times are changing. The market cooled over 2017, but staged a small comeback late in the year. What could be in store for 2018? In November last year we discussed the possible impact of the new Government’s policies, concluding that they are likely to keep house prices ‘on ice’ for the foreseeable future. This month, we focus on some other key drivers – the outlook for migration, mortgage rates, and the Reserve Bank’s LVR restrictions – and come to a similar conclusion. We are not anticipating anything untoward; there are certainly still factors that will keep the market supported. However, there are offsetting forces too that make a marked rebound in house price inflation unlikely.
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