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 - November property market insights

Welcome to Tony Alexander’s November property insights. 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.

Challenges ahead but the need for new builds remains

In my last article written three months ago, inflation was 3.3% and my view was that the likes of the one-year fixed mortgage rate would reach 4.5% late next year. The rate has in fact already climbed from the record low of 2.19% to nearly 3.5% for most lenders, and a peak above 5% now looks likely come 2023. Why the change?

We learnt in the middle of October that New Zealand’s inflation rate has climbed to 4.9%. That is almost double what both the Reserve Bank and Treasury were predicting just six months ago. Not only that, but the unemployment rate has also fallen to a record low of 3.4% rather than rising to 5.2% as Treasury predicted in the Budget back in May.

The economy has surprised all of us with its strength, and it looks like very soon the rate of inflation will be close to 6%. This represents a failure by our central bank to do one key thing – keep inflation on average between 1% and 3%. One outcome is likely to be a period of catch-up, tightening monetary policy somewhere down the track.

The financial markets however are not waiting for the Reserve Bank to act. Borrowing costs have already soared in response to deepening inflation concerns, and bank fixed mortgage rates have risen so far by between 1.3% and 1.7%. More rises will come as we go through 2022 into 2023. Naturally, the question becomes one of whether this will depress house prices – something which traditionally may cause a sharp pullback in house construction.

We need to ask this question because it is not just rising interest rates which will bring housing restraint. There is also likely to be a repeat of the past year’s low 0.6% nationwide population growth and Auckland’s 0.1% shrinkage. A key driver of this will be a flow of many young Kiwis to Australia to gain higher wages, a lower cost of living, and better house prices.

There will also be price restraint from the recent reduction in the amount of low deposit lending which banks can do. This also includes increased requirements for them to scrutinise applicant expenses and income data in detail. Investors will be adjusting to the loss of their ability to deduct interest expenses, except on purchases of new builds. And finally, there will be price restraint from banks applying debt-to-income limits to borrowers (usually six times income) and recent moves aimed at freeing up more urban land for intensification.

If prices fall, don’t expect it to be far

There are a great number of factors which argue against house prices falling as some people are now suggesting. Just because something is not soaring in price any longer by 35% over an 18-month period does not mean it is about to fall in price.

First, construction costs are rising firmly. These cost increases reflect numerous factors. Shipping costs are soaring internationally due to container capacity issues. Materials costs are rising because of many factories in different countries being closed at times because of Covid, and because of low availability of shipping capacity.

Shortages of some staff are making planning of projects difficult for some builders as well as pushing up recruitment and retention costs. We have seen this situation before. A key learning from those past occasions is that firms which have only been around for a short time are the ones tending to struggle the most in this area – especially if they have just the one site to work on at a time.

Development businesses which have been through several cycles are more equipped to handle these cyclical pressures as they arise. Even if, because of Covid, some of these pressures are more intense than usual for this point in the cycle.

A second factor arguing against prices falling is the fact that over the past decade when someone has borrowed funds to purchase a property, their lender has calculated their ability to service the debt not at the rate they actually pay, but at a rate of 3% or higher. A stronger servicing buffer is built into bank lending and that buffer matches the extent to which interest rates are likely to rise in this cycle.

Third, the value of New Zealand’s housing stock has risen almost $400bn since the Reserve Bank started cutting interest rates in 2019. This considerable lift in wealth will act as a strong buffer in the minds of many as they watch cash outflows rise to service higher interest rates.

In addition, over 40% of homeowners do not have a mortgage. For them higher interest rates will probably be a net benefit via improved returns on bank deposits.

Fifth, the labour market is now extremely tight. This is causing the pace of wages growth to lift, with a lot more to come. More importantly, once we get into the New Year and are living with Covid more than fighting it, people are likely to feel a lot more job security than they currently do. The current drive to 90% vaccination is accompanied by ongoing restrictions and job worries in many sectors.

Sixth, household inflation expectations are rising. For investors that means some veering of their wealth towards assets which hold their value as the general level of prices for goods and services goes up. Property falls into that category. The challenge is to limit the debt used to gain increased property exposure and to minimise exposure to rising short-term interest rates.

Finally, every case over the past four decades that has forecast a price crash has been wrong. History shows us that on the three occasions when house prices have fallen over the past four decades, the economy was either in recession or being affected by a financial crisis.

We can never predict when a financial crisis will come along so we can’t factor that into our outlook. But the chances of a recession in the NZ economy in the near future are low. There is not just a multi-year period of catch-up house construction underway to address shortages of affordable accommodation built up since the mid-1990s, there is also good growth in farm incomes underway.

Some sectors such as health and aged care are experiencing firm long-term growth. As people get freed up there will be some catch-up spending, then support for more spending from rising incomes. Businesses will also need to boost capital spending levels to adjust to the new structural shortage of labour.

We cannot rule out a recession entirely at any point in time. But for the moment the chances look slim for the next 2-3 years. On that basis, the thing most likely to happen with average house prices is a flattening of growth in most locations.

The case for new builds

Perhaps a key thing to note when it comes to the new build sector is the following:

The government continues to favour construction over price adjustment. For instance, rule changes are to be forced on councils in the four biggest NZ cities, removing the need for resource consents for developments of up to three stories with three dwellings. This change comes in from August next year.

In addition, councils of five cities will no longer be able to prevent construction of buildings up to six stories within walking distance of mass transit stations and commercial centres. This change will commence from October 2023 rather than 2024.

For the next 5-10 years the level of dwelling construction in New Zealand is likely to sit well above the average for the past two decades of 26,000 consents issued per annum. Expecting the current number of 47,300 in the past year to be sustained beyond the next couple of years though is perhaps optimistic, considering the restraining factors coming into play.

But as the world increasingly looks towards housing intensification as one means of reducing carbon emissions, and Kiwis accept that the main city prices for standalone houses will remain out of reach for many, demand for multi-unit complexes is expected to remain strong.

Did you like this article? Read more insights from Tony Alexander here and here.

Tony Alexander is an economics commentator and former chief economist for BNZ. Additional commentary from him can be found at www.tonyalexander.nz