A profound inflection point?

[ari]

Exactly...my timing could not have been better, more luck than anything else after waiting 5 mths for Building Consent I am due to start building any day. Golden rule is no money up front for any subbie......and as you say, should be easier to find!

[Enumerate]

House price bubbles are a regional phenomenon in the anglo-economies. Not all markets are the same, is the first key observation.

The past 20 years, up to about 2005, has seen the world's central banks slowly throttle inflation out of the world's economies. This has changed, recently, with inflation pressures growning, from 2005 to the present. The prospect of recession in the US should cap some inflationary pressures but the Fed increasing the liquidity in the capital markets by lowering interest rates and accepting lower quality debt for capital adequacy reporting will keep inflation at current levels. Higher inflation, as the second key observation, seems to be here to stay. With inflation high, it is difficult to house prices collapse.

The third observation is that we are building and buying bigger, more elaborate houses built to higher insulation and facility standards by an industry incapable of demonstrating productivity increases with materials that are inflating in price. The commodities boom makes us feel richer so we want better housing stock which costs us more due to the commodities boom ...

NZ lenders are still in the market. The money is horrendously expensive <- this is the single biggest factor in the housing affordability stakes - the cost of a mortgage and NOT the price of the asset is the fourth key observation.

My view is that due to the above factors the housing market, in NZ, will not crash. There will be an orderly unwind as highly leveraged players take a bath due to increasing mortgage rates and as market uncertainty slows sales. Hence there might be patches of price weakness but it has to be remembered that constant house prices means declining asset value as high inflation chips away ...

New Zealanders may slow down the property churn to match Australia and the rest of the anglo-economies. Even the "investors" will find a way to cope with the high mortgage rates.

Just as the price run up in NZ (Queenstown excepted) was not a bubble; there will be no anti-bubble price run down.

Now might actually be a great time to buy property ...

[Steve]

At least then it might be possible to get a chippie or sparkie to do some jobs on the place without having to wait for 6 weeks and take out a mortgage to pay for it.... :mad:

YOTT

Totally agree there! I can't wait for someone to have the time to undertake some 'smaller' jobs. Of course, I just may not be pushy enough?

I don't mind having to wait, but when they spend weeks telling you that they will be there in two days time, it does piss you off a bit...

[Dimebag]

Enumerate,

Thanks for your thoughts, but I must respectfully disagree. After a long boom, people will proffer every conceivable rationalisation for why current prices are not too high and will not fall. The same thing happened during the dot-com bubble. The fact that stocks were trading at ridiculous multiples to earnings, if indeed there were any earnings, was not considered relevant at the time. Likewise, the fact that property prices are unbelievably expensive relative to rents and incomes continues to be similarly dismissed as unimportant.

Clearly things have not been taken to the same extreme as in the dot-com bubble, but still, some figures are telling. The median house price in NZ is $340,000 while the median household income is $56,000, which is say $45,000 after tax. So the median NZ house price is 7.5x the average take home pay! This is unbelievable. The median household cannot remotely afford to pay for the median house.

Consider the median household trying to buy the median house with a 10&#37; deposit, and a 30-year mortgage with 9.5% interest. The annual payments on this mortgage would amount to about $31,000, which is 70% of household after tax income!! Even if 20% was put down, payments would still amount to 60% of after tax income. I don't have figures on average rents, but I understand that they are only generating rental yields of ~3-4% compared to interest rates of closer to 10%. This is surely not sustainable.

So if prices are so unaffordable how did they get this high in the first place? The key point to consider is who the marginal buyer of property has been in recent years. The marginal buyer is the one who sets the price. I would argue that the marginal buyer has been (1) property speculators drawing on existing equity in other properties to leverage themselves into a new property in the expectation of large capital gains, or (2) wealthy immigrants using savings to buy properties, combined with constraints on new housing supply, or (3) irresponsible lending by banks to first home buyers who simply cannot afford the properties they are acquiring.

There has also been some "trading up" activity by people using existing home equity to buy into a more expensive house with the aid of additional debt, but this trading up behaviour requires somebody to buy their old house so in aggregate this should not push up median prices.

These are the only potential explanations. However, net permanent and long term immigration has fallen off a cliff recently and is now at close to break even levels, and the other sources of demand rely on aggressive lending by banks and a continuation of speculative demand. With prices having flattened off and begun to fall, as well as the significant developments emerging internationally, banks are tightening lending standares and speculators are becoming more cautious (or simply cannot obtain financing to pay previous prices).

Consequently, house prices must fall simply because with tighter lending standards there is now an absence of buyers who can afford to pay current prices. They will not collapse overnight. What we will see is a widening of the bid/offer spread, as buyers can only bid to the level they can afford while sellers will continue to hold out for yesterday's prices which they erroneously perceive their houses to be worth. Consequently, the inventory of unsold homes and days it takes to sell should be expected to skyrocket at the market turning point, which is exactly what we are seeing. Prices must now undergo an extended period of correction.

The abolute most new home buyers can realisticlly afford is 50% of household income (particularly with the rising fuel and food prices, and the cost of living generally). This suggests the median price should be closer to $220,000 (35% below current prices). Even 50% of household income is a stretch. House prices have received a boost from both an expansion in household income through the increasing prevalence of double-income households and by a willingness of households to commit an ever-growing portion of income to mortgage service. The ability of households to pay even more towards a mortgage has now come to an end.

On top of this, this is while the economy remains strong, with record-low unemployment and income growth. There is an absence of any margin of safety in current house prices. What if the economy goes into recession and unemployment jumps and incomes fall? The correction could be severe. Indeed, if house prices start to fall we will likely see a sudden slowdown in discretionary consumption as the wealth effect reverses and the punters stop borrowing and spending up large and start saving money and paying off debt. This should trigger a broad slowdown in the economy.

Yes, the migration tap can potentially be turned on. But it relies on NZ being able to attract high-income/net worth people to live in NZ despite our low incomes. Some will come and this could provide some support in major centres such as Auckland where supply constraints are real, but not in small provincial centres. Furthermore, there is a real risk NZ experiences emmigration which would further compound the bear case.

As for the inflation argument, our reserve bank is much more focused on controlling inflation than the fed and will aggressively hike interest rates if inflationary pressures continue to build. Yes, house prices will go up with inflation but so will interest rates, and the punters' monthly payments will go through the roof!! Stretched consumers will simply not be able to afford to pay the morgage and default activity will be high. Prices will fall in real terms (they fell 40% in the 1970s in NZ) and this is what really matters, as any inflationary gains will ultimately be paid for by homeowners in higher interest rates in any case.

Dimebag

[patsy]

Dimebag – thank you for your thoughtful comments. Very much welcomed.

Needless to say, the issue of property has as much social and emotional connotations as anything else. However, what happens to property as an investment class will have much less to do with how government addresses such social connotations (increase land supply, affordable pricing, etc.) than what investment fundamentals may dictate. The bottom line is that property values will revert to the mean, i.e., to their long term trend – either as a shock or as a gradual trend.

Beyond all the nonsensical catchphrases (e.g., “property never falls in price because they ain’t making any more land”, and other halfwit justifications), property prices (or the return from it), will respond to a simple formula:

Total Return = growth in economy + rental yield + growth in speculative expectations

The growth in the economy may be around 2%, rental yield 5%. For 2008 and beyond, one may be forgiven to think that the “growth in speculative expectations” will be pretty much negative or zero at best. However, given the simple fact that the law of return to the mean will catch up sooner than later, it implies that the speculative returns will be negative. Therefore, unquestionably, “total return” from property will be negative.

Nevertheless, this does not necessarily mean that the price of property will become affordable again, where affordability is measured as repayments no greater than 30% of BEFORE tax income. Whether in NZ, in Australia, in USA, or anywhere else, owning a property is not a right but a privilege. This, unfortunately, is not fully understood or acknowledged for the simple reason that property is a highly emotional issue. Again, if we look at property as simply another asset class, nothing guarantees that such an asset class will ever be (in average) commensurate with 30% of before tax income.

Salary growth will never catch up with property growth for one simple reason: NZ has not increased productivity at the same rate as the increase in credit. This is the same as saying, property values have increased at a rate comparable to the rate of increase in credit but salaries have kept behind because NZ has not increased productivity at the same rate. Again, in other words, the amount of money/credit in circulation has increased in NZ (and the US as well) to such an extent that NZ’s asset backing (including property) has increased in price to equate to the amount of money in circulation.

Who has been responsible for such an increase in liquidity? The answer squarely points to the massive amount of liquidity injected by the Reserve Bank from 2002 to mid 2007, when Bollard resisted increasing the OCR. But Bollard is only half responsible for this. He has been given the mandate of ensure the implementation of Keynessian economics in the false belief that it is possible to stimulate growth by increasing liquidity. The RBNZ modified by Cullen clearly points at increasing liquidity in order to decrease the real value of the NZ dollar and foster employment while increasing the target range for inflation. This simple change is one of the key factors in the increase in property prices – huge liquidity and huge credit expansion leading to huge price increase to equalise credit to asset backing.

Some things can be done to avoid a property crash and pain in the unsophisticated property investor:

1) Opening the immigration tap is NOT an option. The reason is that because of NZ’s quasi 3rd world features, it is not attractive to top immigrants (world demographer Harry Dent confirms this views). NZ has to compete in the global marketplace for top labour – and NZ cannot compete. NZ is the default choice to those that cannot access a better country. Therefore, we get the second/third tier of immigrants – those who would end up opening a convenience store in the city centre and a $2 Shop in a suburban mall. This is not the group that will rescue NZ property.

2) What NZ can (and will possibly do) is to generate inflation. High inflation will be the panacea of the home owner because inflation will liquefy debt and will push property prices up or cushion a steeper fall. This is what NZ government has been gearing up for through the ballooning public service. There is no better way of generating inflation than increasing the size of the welfare state. With inflation, home owners will see their debt decrease in real terms but the proles will be oblivious to the fact that inflation is an additional tax on them – a tax used to rescue a property market collapse.

RBNZ is not that concern with inflation, despite the rhetoric. The real reason for high interest rates is NZ’s need for overseas funding to support individual borrowing. A low OCR will leave NZ without overseas funding. Arguably, the OCR is low in relative terms to NZ’s country risk – NZ’s risk is much greater than that implied by just 1% difference in OCR versus Australia’s.

Overall, I believe that property prices will revert to the mean (will decrease) but the pain of borrowers will be cushioned by a perverse mechanism of increasing liquidity and fostering inflation, which is a covert way of taxing everyone.

[AJ]

Dimebag:

I agree you calculations make it nigh on impossible for first home buyers. But I don't think it's correct to calculate the corrected median house price based on what the first home buyer can afford.

Instead of a 90% mortgage I guess the figure used should reflect the median amount people own of their houses. Given that steepness in increase in prices recently it's probably closer to 55-65% i'm guessing.

Irresponbile lending or not, ultimately the current house prices must be close to affordable to the "median" otherwise there would be alot more panic than we see.

[skinny]

Goodness me, an intelligent thread on sharetrader! I was beginning to despair. I'm actually trying to sell my place at the moment due to a shift from Wgtn to, sigh, Akl. We've had a few reasonable OK offers but have turned them down as I tend to agree with Enumerate more than Dimebag on this one.

To clarify, I think prices here on average are over valued, maybe by as much as 30% as suggested by a simple discounted rents model, but the average will likely mask all sorts of regional and intra-regional variations. In Sydney and Melbourne, the pattern has been that weakness in property markets has mostly been seen in apartment markets and outer suburban areas (in real terms I believe prices in Western Sydney have now been falling for over 6 years). In contrast, prices for fee simple homes in relatively upmarket areas have held up fairly well whilst rents have boomed. House prices in the resource rich states have continued to boom.

IMO the dynamics in the NZ market will likely play out similarly to the Oz experience. House prices in most of the provinces will likely remain robust as long as the agricultural boom continues (I've seen some analysis that suggests it may have more legs than the hard commodities). Prices in outer suburban areas in Wellington, Chch and especially Auckland will likely to a huge hit. The holiday home market, especially for houses not actually right on the waterfront also look very vulnerable. But prices for fee simple homes in desirable inner city locations and internationally desirable spots around NZ could hold up quite well.

Reasons:

1) IMO inner city homes remain cheap as chips in NZ. My wife and I earned an enormous (by NZ standards) income while living in Europe but could not hope to afford a decent home in an inner city location without working for +10 years; let alone one that has a seaview or a great backyard which is easily affordable here. Over the ditch in Sydney or Perth likewise we would be struggling (even given higher salary levels there) to buy something of comparable quality. This is a major factor why we decided to settle back in NZ and I'm certainly not alone in this regard!
2) Relatedly, when we are looking at inner city and lifestyle location you probably really do need to take into account global prices and incomes. I've already spent 4/10's of my working life offshore and will likely spend a few years more at some point. Like a lot of kiwis my lifetime income is significantly higher because of offshore earnings and its my lifetime income that factors into decisions like buying a house.
3) There are a couple of 'shock absorbers' out there that should especially cushion the higher end. The most important is the exchange rate. It is exceptional and unjustifiably high according to the RBNZ and if history repeats it will tank when they do ease policy. This will be huge boon to those with substantive offshore wealth looking to enter into NZ property (be it kiwis abroad looking to return, kiwis here with offshore wealth or potential new immigrants). Second, NZ's after tax incomes for upper income earners are actually quite high (from memory around 5th in the OECD). They're going to get higher still going forward with the tax cuts. Another absorber which will benefit all property holders of course is that interest rates are likely at a cyclical peak. We could easily see the OCR come down under 500 basis points over the next few years. If the down cycle in property finally kills kiwi's love affair with property as an asset class it might actually stay there ;-)

[patsy]

Compare my previous post a couple of days ago with what Brian Gaynor published today in the Herald:

"New Zealand is in a particularly precarious position because we have taken full advantage of the global liquidity explosion to borrow heavily for consumption purposes and to invest in residential housing.

With the contraction in global liquidity expected to continue, the next big issue for the domestic economy is the Tokyo housewives and their New Zealand dollar deposits.

If these investors take their money home there will be a reduction in New Zealand liquidity, we may then have to offer higher interest rates to attract alternative liquidity and the kiwi dollar could come under pressure at the same time.

This is not a particularly attractive proposition for highly leveraged domestic companies and individuals."

http://www.nzherald.co.nz/section/3/...ectid=10499497


As mentioned, the fact that RBNZ is keeping rates at a so-called "high" level (whichis low given our country risk) has more to do with borrowing needs (mainly for unproductive purposes) than inflation.

[Tok3n]

Property is NZ's favorite investment class. So many 20s/30s years olds come back from the O/Es flushed with enough cash to buy 2-3 properties in a pretty desirable country, so how could there be crash with such constant demand.

For the property market to tank in NZ, you'll real a real economic shock especially to the to the rural sector. All these media reports are rubbish and over-hyped about a property correction or crash, it hasn't happen, prices are still high.

[corran]

Property is NZ's favorite investment class. So many 20s/30s years olds come back from the O/Es flushed with enough cash to buy 2-3 properties in a pretty desirable country, so how could there be crash with such constant demand.

For the property market to tank in NZ, you'll real a real economic shock especially to the to the rural sector. All these media reports are rubbish and over-hyped about a property correction or crash, it hasn't happen, prices are still high.

Re the O/E's flushed with cash... I've been working in Europe for 8 years now and, at least anecdotally, it's starting to get much harder for O/E people to get the big money jobs. 3 of my friends in the UK are losing their IT contracts next month (with no new contracts lined up at this stage), the bank I work for has got rid of about 80% of our contracters over the last year.

If the lay-offs and hiring freezes become more ingrained, the days of NZ O/E'ers raking in the big bucks may be over (for most) for the time being. Also the NZ'ers I've talked to who were buying houses 5 / 6 years ago are more inclined to be selling, rather than buying, houses in NZ at the moment. The general consensus is that the property market in NZ has peaked, so cash up while you can and switch to another asset class for a few years.

We're clearly in the midst of a global economic shock at the moment. At least in the UK it's much, much harder to get credit than it was a few months ago. Because of this (and general sentiment) the pool of willing & able buyers has shrunk dramatically.

The supply of houses on the market is increasing -- some homeowners can't remortgage when they need to, many others are toiling with higher interest rates and big increases in food & energy bills. Many of these people have to sell urgently and are being forced to accept offers far below what they would have got 12 months ago.

As you say, prices in NZ are still high. Way too high when compared to what they should be based on affordability. The next couple of years is shaping up to be a difficult time for many of the world economies.... the possibility of stagflation is growing ever larger. I wouldn't be surprised to see median house prices in NZ and the UK dropping 30-40% from their peak over the next 5 years...