Welcome to the August Property Market update from Tony Alexander. In his series with us he discusses the property market, trending patterns and economic insights. Sign up to our newsletter to follow his, and Safari Group’s articles on Property Development.
Each month renowned economist, Tony Alexander will be writing a monthly update on the property market, trending patterns and economic insights. Sign up for our newsletter to follow his and Safari Groups articles on Property Development.
Tony Alexander - August Property Market Insights
Photo – Augustus Park, Parnell
Will house prices keep rising?
On average over the past year, house prices in New Zealand have risen about 30%. This is not at all what anyone remotely expected early last year, as we contemplated the depth of the recession we might shrink into, as borders were closed to staff, tourists, and students, and we entered an unknown period of lockdown.
Prices have surged for a variety of reasons with the main one being interest rates. We entered the lockdown with interest rates at record levels courtesy of the Reserve Bank cutting the cash rate 0.75% to 1.0% in 2019, in response to lower-than-expected inflation. These cuts caused the housing market to accelerate as lockdown loomed.
This upward momentum was dented for the lockdown period. But then the further 0.75% worth of cuts to the official cash rate in March saw a new wave of buyers looking to take advantage of even lower mortgage rates when lockdown ended.
We also saw a wave of investors drawn into the market as the price gain ball got rolling, and as alternatives like term deposits would see someone on a 33% tax rate lose 1.2% per annum after tax and inflation of 1.5%.
I had expected some 18 months ago that over the period from 2020 – 2024 we might see house prices on average rise maybe 7% or so a year, or some 35%-plus over the period. Now that prices have already gone up 30%, does that mean that for the remaining three and a half years prices might only gain another 5% – 10%? Not necessarily.
Prices are still likely to rise at a pace above 5% per annum for a while, but the gains will not be what they would otherwise have been, for several reasons. First, will price gains slow?
The Reserve Bank is set to raise its official cash rate to 3.3%. This is in response to inflation rising 0.5% more than expected recently. A rise to 4% late this year looks increasingly likely. In addition, the unemployment rate has now fallen more than expected and at 4.0% is back to where it was before lockdown.
At this stage it seems reasonable to assume that short-term interest rates will rise by 2% between now and the end of 2022. That means one-year fixed mortgage rates probably above 4.5%, in less than 18 months time.
Supply and demand
Population growth has slowed down because the borders are closed. Even when the borders open population growth is likely to be constrained by some Kiwis moving to Australia because of the strong growth across the Tasman, huge demand for employees, and higher remuneration on offer. Many of the Kiwis expected to flock back here are also not likely to do so as the economies they are working in overseas are already growing strongly, and job opportunities will abound.
Dwelling supply is also rising, with the annual number of consents issued for the construction of new dwellings now running above 44,000 from fewer than 14,000 ten years ago.
The government and Reserve Bank are also moving to discourage investors from purchasing and holding existing properties through tax and lending rule changes. In particular, the Finance Minister has now explicitly instructed the Reserve Bank to take into account the government’s desire to improve housing affordability for first home buyers, whilst discouraging investors from buying existing property when setting their various policies.
That incentive to purchase new dwellings is perhaps the important thing which property investors need to take note of. Although we still await clarification on some details of the tax changes such as how long a new dwelling is considered new, and whether it will still be classified as “new” when the investor sells it down the track, the direction of purchase preference for investors is clear.
In fact, in a new monthly survey which I run with Crockers Property Management we can see that 55% of investors planning to make a purchase in the coming year intend purchasing a new property. When they make that purchase, 40% intend buying a townhouse and 14% an apartment. This is important because in the likes of Auckland over 65% of properties being built now are in multi-unit projects rather than standalone houses.
Of interest, from a price change point of view, is the speed with which supply can in fact rise in the context of an economy less and less constrained by a traditional lack of people buying things – customers here and overseas – and more and more constrained by a lack of resources such as people, materials, land, and ancillary services such as council inspections and speedy consenting processes.
In a recent survey by NZIER which has been running since the 1960s, only 34% of business respondents said that the main reason they cannot increase sales is a shortage of customers. The average for this response is around 55%, and the latest outcome is the lowest since 1974.
It is quite likely that the current surge in house construction will need to be spread over several years and that is where buyers of new properties, be they investors or owner-occupiers, need to be thinking about something quite important.
The construction industry is one in which there are many thousands of operators spread across a wide range of services, with a huge range of different experiences, capital bases, and managerial abilities. History here and offshore over the centuries has shown us that even in booming construction markets, some operators struggle.
For some it is a matter of handling growth rather than a big decline in customer flows – which is the challenge. That is where sticking with an established operator, with a long record, is a safer approach than letting one’s FOMO drive one towards those of perhaps more tender vintage, new to the ups and downs of construction.
8 reasons why prices growth won't completely stall
Reasons why prices growth will slow are relatively easy to find. But why won’t prices growth completely stall? First, because supply growth will be constrained by resource shortages.
Second, with inflation now at 3.3% and set to rise, the real after-tax return to fixed interest assets, like bank term deposits, is now very negative at about 2.5% using a 1% interest rate.
Third, as inflation expectations rise, investors will gravitate towards assets which tend to rise in price in higher inflation environments. Property is one of those assets.
Fourth, very few people actually want house prices to fall because that could dent the strength of the economy and count poorly for a government heading into the late-2023 general election, needing to retain the property-owning middle voters who deserted National last year.
Fifth, there is a substantial backlog of frustrated buyers eager to pounce and purchase should other groups of buyers step back.
Sixth, construction costs are rising strongly, and in some cases, this is going to cause buyers to switch back to looking for an existing property whilst naturally raising the prices of new and recently constructed dwellings.
Seventh, wages growth is picking up, jobs growth is strong, and feelings of job security, which heavily influence big decisions like buying a house, are yet to kick in according to the Tony’s View Spending Plans Survey.
Finally, what will be the impact if our borders remain closed to Australia through summer? The diversion of money we traditionally allocate towards overseas travel will remain focussed on other things such as housing, spas, and home renovations for longer than we may currently be thinking.
All up, the housing market in New Zealand has had a strong run-up in prices over the past 30, 10 and one-year periods. Now we are seeing those surges get translated into a long-overdue supply response, which is going to keep many people in construction very busy for a good number of years.
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Tony Alexander is an economics commentator and former chief economist for BNZ. Additional commentary from him can be found at www.tonyalexander.nz