Addressing housing supply — is it too little too late for New Zealand?
House prices in many countries have been increasing again after a period of correction during the global financial crisis (GFC). The explosion in house prices in the years leading up to the GFC — where house prices tripled — was largely driven by the availability of cheap credit. Since that time, for New Zealand at least, the cause of price hikes seems to be more related to supply constraints. There is little evidence that New Zealanders are rushing to get new home loans, despite experiencing the lowest interest rates in fifty years.
The Reserve Bank’s recent attempts to cool the market had the desired effect at least temporarily, but there are growing concerns that New Zealand’s house prices are bubble territory. Real estate bubbles are notoriously difficult to spot, except in retrospect, so economists use a range of indicators to judge whether a market is getting frothy. New Zealand ranks high on almost all measures so should we be worried?
House Price-Rent Ratio
The House Price-Rent ratio measures house price relative to annual rent income. Investors use this ratio to estimate the profitability of home-ownership. A dramatic increase in this ratio is usually seen as a red flag of a housing bubble. New Zealand and Canada have seen their ratios almost double since 2015. Currently, the top four countries where house prices are significantly out of balance with rents are:
New Zealand 196.8
House Price-Income Ratio
The house-price-to-income ratio is used internationally as a measure of housing affordability. The “median multiple” is defined as the ratio between median house price and median annual household income. The World Bank refers to this ratio as “possibly the most important summary measure of housing market performance, indicating not only the degree to which housing is affordable by the population but also the presence of market distortions”.
It is accepted that a median multiple of 3.0 times or less is a good indicator of housing affordability. The latest Demographia Survey shows that there are three major housing markets which are currently “severely unaffordable”. These are:
New Zealand 9.0
New Zealand’s price to income ratio has ballooned from an already high 5.9 in 2004, to a whopping 9.0 in 2018.
Real House Prices
This is a ratio of nominal price to the consumers’ expenditure deflator in each country. Real house prices have been increasing across OECD countries, but as can be seen in the graph below, New Zealand’s real house price growth has far exceeded the OECD average:
Household debt-Disposable income
Very high debt ratios put households under financial strain and increase the probability of default in a financial downturn. Household debt in New Zealand has been steadily increasing since 2012 and is now at 163.9 percent, up from 60 percent in 1991.
Underlying Issues constricting housing supply
Since the GFC New Zealand’s housing boom appears to be related to supply constraints driven by a range of factors including:
Limited house supply: According to a Kiwibank report, New Zealand now has a deficit of 130,000 houses largely caused by surging net migration which began in 2013. Net migration peaked at 70,000 in early 2017. Even though net migration is tapering off, it will take some time for the housing supply to meet population needs.
Urban containment policies: Urban containment policies have not only restricted the land available for houses but have kept land prices artificially inflated. The government has responded to the housing pressures by announcing it will remove Auckland’s urban growth boundary, although it is currently only at discussion document stage.
Housing consents levels have failed to keep pace with population growth: Residential housing consents are now at the highest levels in more than a decade, but historically the rate of growth was insufficient to cope with the burgeoning demand.
High construction costs: The construction sector is at capacity, pushing up construction costs and driving down affordability.
In 2013 the Reserve Bank tried to contain constraining excessive house price inflation and household credit, particularly in the Auckland market, by introducing a cap on the loan-to-value ratio (LVR). The stringent LVR policy was introduced as a “temporary” measure in 2013. Since January this year, the policy was amended to allow banks to lend 20 percent of their new loans to owner-occupiers with a deposit of less than 20 percent. While the LVR policy did appear to temporarily reduce house price growth, it also disproportionately affected first home buyers, which exacerbated the affordability for people wanting to enter the housing market. The IMF points out that while macro-prudential measures can be effective in the short term, they are not effective to target housing booms caused by housing supply shortages.
It seems there are now a number of measures being put in place or at least proposed to address supply constraints in New Zealand’s housing market. The question is whether those measures will be enough and whether they can be delivered in time to avoid a costly correction.