Auckland - Here we go again

Rugged dwelling for rent

It looks like the Auckland property market is going to build up another head of steam in 2015. There is confidence in the air. We got through the election unscathed. However, the main catalyst is the prospect of lower interest rates. The link between interest rates and asset prices is undeniable. Since August we’ve seen the Reserve Bank back off its tightening stance, frustrated with a high kiwi dollar and lower dairy prices. Add to the mix new rating valuations, high immigration, money coming out of China, and nervous first homebuyers worried they will miss out. All of this demand for houses, combined with a lack of supply equals higher prices.

In Avondale there are 40 listings and 12 in New Windsor. That’s against a backdrop of as many as 2,000 households looking to buy in Auckland in any given month. Roughly 40% of the 1,500 active listings in Auckland city are apartments.

But rent yields are falling. Rents are not keeping pace with price increases so there’s not a shortage of dwellings per se. A $650,000 house in Avondale will rent for around $520 per week or a 4.25% gross yield before rates and insurance and maintenance. So when will we see rents increase? We aren’t seeing a shortage of property for occupancy. Rather we have a shortage of property relative to those that want to own property. Nobody wants to rent, and conversely everyone wants to “pay off his or her own house” or be a landlord. So prices go up in the short term, but at some point yield becomes important again, usually when interest rates go up, if interest rates go up.

In the long-run (however long that is) we will reach a point where we simply cannot leverage ourselves into further capital growth. New Zealanders have already collectively borrowed $200 billion in mortgages. Essentially, we have taken the same stock of houses and borrowed more, then more again, to buy the same properties off each other. It’s a money go-round. There are so many issues with the sustainability of house prices. Focusing on rent keeps it simple. Rents won’t increase faster than incomes. You will also see bigger behavioural shifts in response to price signals. Rent is where the relationship between incomes and prices comes to the fore. How much can rents go up before tenants modify behaviour? Who can afford to pay $600 per week rent? Arguably homeowners will sacrifice lifestyle for ownership. But will renters? With several thousand apartments coming on stream next year what will that do to support lower rents. Would you pay $600 per week to rent in Avondale or $500 to rent an apartment and walk to work? Will apartment rents fall with a massive increase in supply from July 2015 onwards?

Ultimately the issue is going to manifest itself in low yields. That makes servicing a challenge, whether that is as an owner-occupier or a landlord. The Reserve Bank has at least talked about servicing calculations as part of its macro prudential toolkit. If they were to take a longer-term view of interest rates and require banks to test new lending on these higher rates, then it would become increasingly difficult for Investors to buy up low yielding Auckland property. As for prices, my view is that we will see a strong surge in price in the first half of the year driven by demand, but it will grind to a halt by the end of 2015 due to soft rents and yields simply not stacking up, especially if the RBNZ throws servicing criteria into its macro prudential toolkit.