Tighter credit policy will drive the housing market in 2017

Wallet being tightened by clamp

I am always frustrated by our media and how they report house prices. Tabloid rubbish bouncing from headline to headline with no substance.

Prices fell in November and in December, yet we still talk about prices being up 9 percent since December 2015 and “price growth easing”. The reality is that house prices have started to fall and that is not unexpected. The media reports that “industry experts” are not sure if the LVR restrictions will continue to work and are hoping/expecting to see the market pick up again. The market is not dead and certainly not likely to collapse but there are some big credit forces in play.

Let’s get clear on this, the single biggest change implemented by banks was restricting offshore income for mortgage servicing. This rule change has effectively stopped Chinese buyers in their tracks and nothing will change that. Our volume of NZ resident Chinese buyers is down around 65% and anecdotal feedback across the market is similar. Many Asians are self-employed and so taxable incomes are generally low. That makes servicing debt difficult to prove. In the past, the way around this has been “offshore income.” Business owners will be loathed to pay more tax simply to buy property, especially if the property market is softening.

The second change, equally not visible, was regulators encouraging banks to use higher interest rates to test borrower servicing capacity. All lending currently has to be tested on a Principal and Interest basis at a rate of 7.50%. This is a big challenge for property investors who will need strong income or low LVR’s to pass servicing requirements.

Combine the two, and it takes those on low taxable income out of market. So much is made of cashed up Chinese buyers (and of large amounts of cash coming out of China.) Whilst big fish do exist and are big investors, from what I’ve seen they haven’t been driving the residential market. It’s been NZ residents buying a 3rd, 4th or 5th property leveraging their own funds, equity growth in the Auckland market, and previously a light touch approach to verifying income.

More broadly, investor activity has slowed down. That is a combination of the 40% equity requirement, but also a sense that the market has peaked and prices may fall. So if we look at credit conditions in isolation of everything else the market is slowing and my view is that this slow down will be sustained.

HOWEVER, there are also some negating forces at work.

Immigration is still strong and most of that goes into Auckland. We had net migration of 69,000 in the year to August 2016. Although immigrants will struggle to buy multiple properties, they’ll still buy an owner-occupied property in areas where they want to live and they are coming in with healthy deposits.

House building activity is way too low and there is negligible activity in Auckland city other than apartments. Having built 35 town houses last year, I know how difficult it is. It is infuriating on just about every level, so little wonder we have a crisis. None of the meddling we are doing will fix it.

We have a growing population and a strong economy. We also have growing inequality that masks the drivers at a more micro level. Whilst some jobs have not had real wage growth, some sectors like IT have had significant growth. We see a number of home buyers in their early 30’s with double incomes over $200,000. That will continue to fuel hot suburbs that have a lack of supply.

That’s not to play down how difficult it is for first home buyers and I’ve written a blog post on that this month as well. My point is that central Auckland and parts of the wider city will continue to have a supply shortage relative to what people want to buy.

With investors out of the market, house prices in suburbs that are largely rentals are more at risk of outright falling prices. In places like the North Shore and West Auckland, less so, due to owner-occupied demand. South Auckland is where I see the greatest risk because first home buyers typically have much lower incomes relative to house prices and there aren’t enough of them relative to supply. If you overlay the Chinese/Asian influence, there could be some price softness in parts of the North Shore and East Auckland. For the most part I think it will create space for owner-occupiers and upgraders and prices will simply settle down.

Could house prices collapse?

I don’t think so but nevertheless it’s possible, so worth at least contemplating. House prices are for the most part a function of confidence and liquidity. If people believe prices will fall, then they won’t buy. Prices will fall when people are forced to sell into a falling market. But for the most part, sellers will withdraw property from the market if they can’t get their price.

We do have a supply shortage in parts of the city and in parts of the market that will counterbalance this. For prices to drop significantly we really need an economic wheel to come off (like 2008) and significantly higher unemployment, a collapse in our currency forcing up interest rates, or people en-masse getting themselves into financial hardship. It may also be different across the market.

For example, small investment apartments could be more susceptible due to tighter credit rules and increasing supply. Also South Auckland as previously noted. The more likely outcome, and the one I’ve been suggesting for a good few years, is that prices will stabilise and we’ll have a long period of broader house prices going nowhere. Of course I have been saying that for about three years. Stability is what everyone wants and I’ve always backed policy to eventually get us there. Some wish for a property collapse, for some sort of “told you so” satisfaction. But our regulators and politicians certainly don’t want that. The ultimate call is whether or not our meddlers can get their policy settings right.