Housing policy has moved very fast in recent months, and for good reason – the market has gone bonkers. Affordability and credit constraints mean the recent pace of house price inflation was never going to be sustainable, but now, with the policy headwind about to start biting harder, we think the slowdown is looming. This month we take stock of recent policy changes and discuss some of their expected impacts. House price inflation is expected to slow a little faster than otherwise, and the risk that house prices actually fall is now higher. But while these policies may take the heat out of the market, the impact on rents could be less helpful from a broader housing affordability perspective. Further, most of the recent policy changes won’t help to deliver the additional houses NZ needs to address its structural problem – they buy time. The supply side is where policy now needs to focus.
The housing market has had a spectacular run over the past year, fuelled by easy financing conditions, with interest rates low and credit readily available. But this environment is not expected to last forever. Interest rates are expected to rise, albeit gradually, with longer-end interest rates expected to lift first. This is expected to pass through only very slowly to costs faced by borrowers, but eventually, debt-servicing is expected to become more expensive. Meanwhile, abundant bank funding has ensured that credit has been readily available to meet demand, but slowing deposit growth, bank caution and policy changes are expected to see credit conditions become more of a constraint. Eventually, these factors, alongside affordability limits and other headwinds, are expected to see a slowing in the housing market, though the timing is uncertain, and conditions are expected to tighten only gradually. To the extent that some in the market are assuming current very easy financing conditions will continue, expectations may be disappointed, potentially weighing on the market more than we currently expect.
Globally, housing markets have generally beaten expectations through the COVID-19 crisis, in part due to a policy response that has been large and synchronised. But the New Zealand housing market has been an outlier, supported by – and contributing to – our strong economic recovery to date, which has been underpinned by our successful health response and effective fiscal and monetary policy. Relative to history, the recent episode has been different too. Although the current housing upturn shares some similarities with the 2000s, maintaining momentum for such an extended period appears unlikely this time around. While momentum can be self-propelling to some extent, acute housing unaffordability, very high debt levels, macro-prudential policy tightening and credit constraints look set to weigh in time, with a slowing in the rate of housing price inflation expected. However, it may take time for the market to turn and, until that happens, affordability and debt levels could become even more stretched. See Feature Article: Off the beaten track for more.
A number of ongoing themes will shape the way forward in the year ahead. The COVID-19 pandemic continues to run rampant globally, and our national fortunes will remain crucially tied to our continued success in keeping the virus out. The path to inoculation will take time, and bumps are possible along the way. Domestically, housing is likely to remain high-profile, with the market ending the year on an unsustainable footing. A degree of cooling seems likely, and credit conditions may become less permissive, though it is also possible that unaffordability continues to worsen, exacerbating longer-term risks. Meanwhile, new challenges look set to come to the fore, like the impact of our lost summer of tourism. Businesses have been remarkably resilient, setting us up well to weather this test. But even so, we need to brace for some impact. Inflation risks have increased too, especially with supply disruptions an ongoing problem, and volatility may return as markets digest the unfolding outlook. For policymakers, trade-offs are becoming trickier to manage and longer-term issues will rear their heads, along with questions about when policy settings might return to “normal”. And of course, we will be faced with unknown unknowns in the time ahead – those inevitable uncertainties that will shape the path forward, for better or worse. See Feature Article: On the horizon – Key themes for 2021 for more.
Housing unaffordability is an enormous problem in New Zealand, with especially significant consequences for our young and most vulnerable – and trends continue to move in the wrong direction. Making meaningful progress is urgent, and change needs to be bold to reverse the tide. Broadly, we need to release land, build more houses and better align supply and demand settings. Even sustained stabilisation in house prices would require a monumental shift in the market, and would be a vast improvement from the rapid house price inflation we are seeing currently. But it’s not just policy that needs to change – we need to change our expectations too. Policymakers and the public both need to be willing to accept house price stabilisation or even gradual real house price declines. Not only would this help affordability, but a managed supply-induced decline in house prices is a much better outcome than a painful correction, which is a risk under the current market structure. Although policy change can take time, engineering this sort of response in an orderly way is certainly possible, as shown in Canterbury post-earthquakes. See Feature Article: Unlocking the solution for more.
With the OCR near zero, the RBNZ has had to work with a new bag of tricks since the COVID-19 crisis hit. This month we provide a simple explainer of how these tools work and affect the economy. The latest tool to be introduced is the bank Funding for Lending Programme (FLP), which is aimed at lowering interest rates on mortgages and other bank loans. It's hard to know what impact it will have, but it might lower interest rates by another 20-40bps. Looking forward, a test for the economy lies ahead. The outlook for policy is finely balanced though, and developments in the housing market are one of many possible factors that could tip the balance towards erring away from a negative OCR. A negative OCR is a mind-bending idea, and could have some negative consequences, but for most people on the street the implications would be the same as for a regular cut in the OCR. See Feature Article: Bag of tricks for more.
The housing market is riding high, with income support having provided a significant cushion, alongside a boost from lower mortgage rates. The removal of loan to value ratio (LVR) restrictions has added to demand but has not been a significant driver of the market – and yet financial stability risks are increasing. A “frothy” speculative element appears to be emerging, with FOMO (fear of missing out) part of the equation. Buyers are of the view that it is a good time to buy despite being in the midst of an enormous economic downturn, and house prices appear to be moving against the tide of fundamentals from already very elevated levels. That could contribute to a more volatile cycle if a turn in the market comes – particularly if buyers entering the market have high debt to income, making them more vulnerable to income strains. Macro-prudential policy is likely to be increasingly in the spotlight if current trends continue. The fact is, the housing market does undergo downturns from time to time and homeowners need to be able to ride the wave knowing that sometimes it does get choppy. See Feature Article: Riding high for more.
The housing market and new mortgage lending are bright spots in an economy otherwise facing an enormous amount of uncertainty. Low mortgage rates are lending a hand, and monetary policy is expected to provide even more stimulus, with the OCR expected to go negative next year alongside a bank Funding for Lending Programme (FLP). We expect the OCR will be lowered by 50bps to -0.25% in April, and that the FLP will strengthen the pass-through to retail rates. The impact of the combined policies is uncertain, but short-term fixed mortgage rates could dip below 2% next year. Further declines in mortgage rates will help to shore up the housing market, spending and confidence. But that’s set to go up against a range of dampening factors that are likely to become more evident by year end. Because of this, we expect that lower mortgage rates will provide a cushion, but won’t propel the housing market significantly. That said, there are offsetting forces and a ‘muddle through’ is possible. More broadly, risks to the economic outlook are tilted to the downside and it is possible that the OCR moves even lower than we currently expect. See Feature Article: Lend me a hand for more.
The long-term benefits of home ownership are significant, but buying a new home is expensive. Housing affordability has worsened in recent decades; it now costs more to purchase a house and longer to save for a deposit, putting home ownership further out of reach for many. This is true across most New Zealand regions. Recently, lower mortgage rates have made home ownership costs cheaper, benefiting existing homeowners and those who can enter the market. But those who are locked out of the market cannot reap the same benefits, and rising unemployment and income strains are eventually expected to put pressure on the debt-servicing capability of some households. The RBNZ is providing an important cushion to the economy through lower mortgage rates (and other channels), reducing the blow to both house prices and incomes. But it won't solve New Zealand's housing affordability problem; that requires a hard look at structural factors. See Feature Article: Locked out for more.
The COVID-19 crisis has seen trends in the housing market shift. There are offsetting forces, and the crosscurrents are highly uncertain. Currently, the market is supported – but this support may start to wane, particularly later this year. We are wary that a number of factors could weigh in time: a tip in the balance between demand and supply, rising unemployment, caution towards debt, and tighter credit conditions. We see house prices falling 5-10%, but the outlook is highly uncertain. It will hinge on the global COVID-19 situation, economic conditions, migration flows, policy choices, and household attitudes. See Feature Article: Turn of the tide for more.
The reopening of the New Zealand economy has made the outlook a little bit brighter. Recently, there has been a bounce in spending and positive anecdotes about the housing market - but we do not expect this positivity to last. The period ahead is when people on the street will feel the recession in lasting ways. Unemployment is rising and businesses are cautious. It will be a slow economic recovery, which means mortgage rates will be low for a long time. For some households, this will make home buying and spending more attractive, while for others it presents an opportunity to improve their financial positions. Although low interest rates will cushion the economic blow to some extent, weaker incomes and reduced job security will weigh on the housing market. The shortage of housing will likely erode, particularly in tourist regions. We have nudged up our house price forecasts, but only a little. We see house prices down 12%, which will weigh on household spending, with risks now more balanced. See our heatmap for vulnerability to house price falls by region.
The outlook for the property market has shifted abruptly. This has raised many questions and we could arguably write an ANZ Property Focus on each. This month we give short answers to some of those big questions.
With the country under Level 4 lockdown, the property market is eerily quiet. It's a highly uncertain time. We can't predict exactly what will happen for the property market from here; it will depend crucially on how the COVID-19 outbreak evolves. But at this stage we expect the following: the economic impact will be enormous; property market data will be all over the place in the period ahead; financial pressures will increase with many people in limbo; construction firms and the like will incur significant delay costs; credit is likely to be constrained; reduced income prospects and a fundamental shift in the supply-demand balance will see rents under downward pressure; house prices will fall significantly; and commercial property could be even more affected than residential, given its clear links to business activity.
A recession is now underway that may be quite deep. The global and domestic slowdown on the back of the COVID-19 outbreak will see new challenges emerge for the construction industry. Demand will moderate on weaker sentiment and incomes, particularly on the residential side. Projects could be delayed and costs increase, intensifying financial pressures that already exist for some as a result of squeezed profitability, credit constraints and low cash buffers. The lower OCR will ease financial pressure for construction-related firms by lowering debt-servicing costs, although the availability of credit will remain a constraint for some. Firms will need to actively manage risks in the difficult and uncertain period ahead that may be prolonged.
Rising house prices are a mixed blessing. It tends to encourage increased spending in aggregate, with some households benefiting from wealth gains and easing collateral constraints. This boosts GDP, though usually debt as well. But for other households, higher house prices mean home ownership slips further out of reach. And the low interest rates than can be the driver of higher house prices can adversely affect older households, even if they own their own homes - they are typically savers rather than borrowers, so lose when rates fall. Currently, households are feeling pretty good on the back of the strong labour market and better economic news (at least up until recently). However, risks are looming. Deposit growth has not kept pace with strong credit demand, meaning banks' balance sheets are under pressure, and credit availability may become a headwind. And emerging global risks are in the spotlight. We expect economic impacts associated with the tragic COVID-19 outbreak to be sharp but short at this stage. However, a larger impact cannot be ruled out. Such risks could see household optimism slide. But for now, momentum is on the up
House prices have rebounded a bit more rapidly than we - or the RBNZ - expected. Monetary policy is working, though rising house prices are most definitely a mixed blessing for the economy. We have upgraded our forecast, with house price inflation now expected to reach 8% y/y, supporting our revised call for the OCR to remain at 1% this year. There is some upside risk to that 8% number - the market is tight and house price expectations have increased - but we think a number of headwinds will keep the market in check. Given the current low interest rate environment, house prices could prove volatile. The RBNZ will be watching financial stability risks closely when setting macro-prudential policy to ensure a growth-positive pick-up in housing does not come with a risky speculative dynamic.
The state of the New Zealand economy can both reflect and determine the fate of the housing market. Some of this simply reflects that population growth swings are a huge driver of both the New Zealand economic cycle and the housing market. But it is also true that the housing cycle – both construction and prices – has a big impact in and of itself. The construction sector provides 9% of jobs. And the state of the housing market has a big say in consumers’ willingness to spend. So to round out 2019, let’s take a look at the state of the broader New Zealand economy, and put the housing market in context.
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.