NZ’s housing prices: opportunity or crisis?

Europe-based legal and business commentator, author, and former NZBusiness columnist Ashley Balls offers his unique viewpoint on New Zealand’s housing price crisis.

Local commentators and the Reserve Bank may have got it wrong when attempting to explain New Zealand’s current residential property price boom, which is looking more like a stampede with every month. Many assume it is the ‘market’, despite not being able to find another that is operating so precariously.

In May renowned business commentator, Bernard Hickey, wrote a piece for Newsroom https://www.newsroom.co.nz/the-reasons-why-new-houses-cost-so-much concluding that there is a problem, but that stopping this particular runaway train may not be possible.

Reserve Bank governor Adrian Orr was reported to have said in the week ending 13 November that he may have to consider increasing loan-to-value (LVR) ratios. Such action dashes the hopes of the first-time buyer and may well assist the ‘mom & pop’ investor who can use equity in their home as security, further fuelling the market.

Most (all?) commentators appear to have forgotten history with its numerous investment ‘bubbles’ which burst. The New Zealand sharemarket crash of 1987 and the GFC of 2008 being recent examples. Property investment is currently sucking up 70 percent of all investment funds – a figure unmatched anywhere else.

What we are seeing is reminiscent of The South Sea Bubble in early 18^th century UK, when greedy investors got burned chasing ridiculous returns. (See: https://en.wikipedia.org/wiki/South_Sea_Company) A similar event occurred in Holland at around the same time – and again for the same reason.

In the South Sea case it was a share ‘spruiking’ operation and in Holland a grossly inflated asset price. In both cases the bubble burst and investors lost a bundle. Arguably, it could be said, deservedly, though unlike today they lacked research data of the kind we can so readily access with the click of a mouse.

Let’s get some perspective

Property in New Zealand has, for a growing number of people, become a tradeable investment asset. A culture has emerged which sees property investment as a ‘must have’ for retirement or for ‘passive’ (unearned) income. A ‘let’s get something for nothing’ mentality is now normalised and otherwise perfectly sensible people are leveraging the notional value of their own property to buy a ‘renter’. Yet the investment is illiquid and cannot be traded online like other investments.

Residential property investors borrowed a staggering NZ$7 billion in September 2020. To put that in perspective that’s 14,000 people each borrowing half a million. According to Stats NZ (https://www.stats.govt.nz/topics/property) just over 40,000 properties were sold in the whole of the three months of the third quarter of 2020. This should be a warning signal and confirms that some houses are not for living in, just for trading. When prices nationwide are rising at 15 percent to 18 percent annually and banks are lending money at two percent (or less) and inflation is a distant memory, it will end in tears.

I have stopped listening to the investor brigade who insist that housing is ‘different’ and you can’t go wrong with bricks and mortar. There are two golden rules of investing; diversity (never place all your investment money into a single investment class) and don’t buy what you can’t afford to lose. Would these same people borrow a sum equal to several times their income for an investment in an iconic Kiwi business because its share price was going up fast?

Mum and dad property investors appear to be relying on a spurious supply and demand argument alone and are not asking prudent questions like:

What is a reasonable investment return in times of near zero inflation?
Am I looking for a long-term tenant or short-term holiday rentals?
How much do I know about the property market in the area I am considering and what do I know of the local demographics?
What is a reasonable mix of income and capital gain for a person with my economic profile?
How can I be sure there is tenant demand?
What is my attitude to investment risk – high/medium/low?
What income will my tenant need for the rent I want/require?
What annual property management costs will I have (redecoration, garden maintenance, replacement of fixtures and fittings – cooker, water heating etc)?
What is a reasonable occupancy rate per annum; 85%, 90%, 95%?
What is the total of all annual fixed and variable costs for the property I am considering?
What would be the impact of an interest rate increase of 1%, 2%?
What happens if the government freezes rents?
How many weeks/months can I survive with no income/tenant?
Will I use a professional property manager and what is the impact on my return?
How much time each week am I prepared to devote to property management issues?
What would be the impact of a wealth tax on imputed rents?[1]
How would the introduction of a Capital Gains Tax affect the economic model for my property?[2]
How familiar am I with the law concerning property rental in NZ?
What is the history of rates/local authority charges in the location I am considering?
How comfortable am I with borrowing money against my home to generate income/capital gain, and would I do the same with shares, bonds etc.,
What multiple of my existing annual income am I willing to borrow to become the owner of an investment property?
Will I arrange for a full structural survey to be carried out on my proposed investment property?
Am I willing to accept the maxim applied to all financial investment products; ‘Past performance is not an indicator of future performance’?
What’s happening in Australia?[3] (the loan is almost certainly going to be from an Australian owned bank.)

There are other questions but I have never seen a single ‘mom & pop’ investor ask more than a handful of the above. Even so-called professional investors rarely ask more than six to eight.

Investors would be wise to learn what happened in Europe and the US prior to the 2008 GFC when people walked into banks, laid out a sketch plan for a building development and walked out with a loan. The result was oversupply and empty, unsaleable properties, a collapse in the property/banking industries and a large number of people bankrupt.

A factor that may have been overlooked is the purpose for which people buy residential property. The presumption is that property is to live in or to use for income/capital gain. However, there is a third – as a substitute bank account.

These owners buy new or nearly new properties – often without a mortgage and leave them empty to appreciate in value as no bank account can deliver ten percent plus for several years. Leaving them empty facilitates speedy liquidation and eliminates some management costs. StatsNZ have some data on the number of empty homes but don’t separate out the reasons for being empty – deceased owner, divorce, owner overseas etc. The motives of the purchaser are unknowable.

There is anecdotal information that suggests the number of deliberately empty homes in Auckland exceeds that of London, despite having less than 20 percent of London’s population. Queenstown Lakes is reputed to have a similar number but primarily because of the very large number of second homes bought specifically for the holiday rental market. That market has collapsed since the borders were closed.

The likelihood is that there are up to 25,000 deliberately empty homes in New Zealand. This is a sufficiently large number to skew the market and could house the entire population of Lower Hutt with 101,000.[4]

The impact of high prices

The impacts of excessive house prices include permanently excluding a growing proportion of the population from home ownership, growing inequality, the acceptance of excessive debt, the deprivation of funds from mainstream investment and excessive risk taking, all of which distort the economy. Yet government seems immune to requests for action to alleviate and restore some equilibrium to the market, reduce the risk of the bubble bursting and free up capital that could be used for productive purposes.

Any change of policy, according to statements from the Beehive, are likely to be tinkering rather than a serious attempt to stop the bubble bursting.

Watch out for a bumpy ride.

NB: In a part two on New Zealand;s housing price crisis, Ashley Balls covers the remedies, which may surprise a few. Read part two here: https://nzbusiness.co.nz/article/nz%E2%80%99s-housing-prices-finding-remedy

Ashley Balls can be contacted at: [email protected]

[1] In some European countries a small annual levy is raised by the local authority on the imputed rent. Typically, this is around 2% of annual rent – and payable whether the property is occupied or not. Imputed rents are set by the local authority, not the owner.

[2] In the OECD, NZ is the only country with no CGT and most levy it at the same rate of income tax paid by the owner on their other income – whether or not the property is in a trust, a company or other form of ownership.

[3] Prices in Melbourne and Sydney are falling and many pundits presume the market won’t stabilise until it has fallen 20% or more.

[4] 1919 population data.