Property prices have been the hot topic in the past few months as property prices have gone ballistic across the country.
Fundamentally, rapidly rising property prices are being driven by low supply. However, the removal of the “loan to value” or “LVR” restrictions and the significant reduction in interest rates has thrown fuel on the fire by stoking demand. The removal of LVR has allowed more first home buyers access to the market with the deposits they had already saved and low interest rates has increased demand for investment properties as the yield on term deposits is too low to sustain income needs for those with savings. Therefore, unsurprisingly very low supply + very high demand = higher price growth. Talking to real estate agents, multiple offers have become the norm in most locations and price brackets.
The Government has been coping a lot of flak on property prices and is now starting to respond. The Government needs to walk a tight rope here because rising property prices sustains consumer/business confidence and stimulates the economy as people are more willing to spend when their personal wealth is rising. Realistically, the Government wants houses prices to rise at sustainable levels (no more than say 5% per annum) – the last thing the Government wants to see is a fall in prices.
Reserve bank intervention
Finance Minister Grant Robertson has written to the Reserve Bank asking them to expand their monetary policy settings to specifically include house prices into their decision-making process. The New Zealand dollar rose sharply on this news, meaning the markets took this as a signal that interest rate cuts that had previously been signaled for early 2021 will not occur. That may or may not be the case.
A few weeks ago, the Reserve Bank quietly made some subtle changes to bring forward the reintroduction of LVR restrictions from 1 May to 1 March. It seems that the timeline for this may be accelerated further now.
Increasing interest rates is not an option for the Reserve Bank in the current economic environment. Therefore, other than LVR, the Reserve Bank may have to mandate restrictions such as debt to income ratios to slow residential lending. Banks already test debt applications in this way to an extent, so a change here would not be a dramatic.
The ASB Bank has already moved to voluntarily reintroduce LVR and the BNZ Bank have recently announced that they will do so from 7 December. There has been some speculation that the banks have been keen for LVR to be reintroduced to reduce their lending workload.
The reintroduction of LVR is going to hurt first home buyers the most. They are the ones struggling to save for deposits. Investors will face tougher LVR restrictions than first home buyers, but much of the investment into property at present is coming from people who have money but are chasing higher yields – LVR has minimal impact to these investors. Likewise, any sort of debt to income ratio testing would mainly impact first home buyers.
At this stage, the Reserve Bank has talked of LVR being re-introduced to investors and owner-occupiers at the same time. However, it would not be surprising if political pressure was applied to the Reserve Bank to reintroduce LVR to investors before owner-occupiers (particularly first home buyers).
Treasury review
The Finance Minister also announced that he asked Treasury to review the impact of supply-side measures including the previous extension of bright-lines and rental loss ring-fencing and the ban on foreign investors.
The specific reference to the prior extension of bright-line rules from 2 to 5 years is interesting. A few media outlets have commented that this review is with the view to extending bright lines further, although the press statement refers to reviewing the impact of the prior extension. Expanding the bright-line rules to 7 or 10 years is a measure that many commentators have been speculating that Labour will try and sneak through despite their promise of no new taxes.
We expect that Treasury will conclude that the extension of bright-line from 2 to 5 years has increased the “lock-in effect” (people holding onto properties that they would otherwise sell due to the tax implications) and this has reduced supply and added upwards pressure to house prices. This is exactly what we see at the coal face – we frequently have clients seeking our advice about selling a property and our advice to them that they need to hold it for another few years or face a significant tax bill.
We note that the Treasury advised the Tax Working Group a few years ago that the introduction of a capital gains tax would increase house prices due to the lock-in effect and the “mansion effect” (people investing in their own home as it is as asset class that is not taxed). Further, an item was quietly added to the Inland Revenue’s Work Programme towards the end of last year to review the impact of the lock-in effect caused by the 10-year rules in the land taxing provisions.
If sustainable house prices is the Government’s serious goal, then our view is that the bright-line period should be reduced back to 2 years as soon as possible. If the Government comes out and announces an extension to the bright-line period, we will know that they are just trying to sneak in a capital gains tax by stealth.
RMA changes
Grant Robertson also announced that addressing land supply through a replacement for the Resource Management Act (RMA) is a priority, however no timeline or scope has been given for this. The need for a reform of the RMA has been obvious for years. National and Act have been campaigning on this for at least a decade but could not get the changes through when they were last in power as they needed the vote of United Future who did not support the change.
If you want evidence of the need for addressing the RMA then look at the impact that opening-up the supply of land in and around Christchurch under emergency powers after the earthquakes has had. Greater-Christchurch prices have been stable since 2014 whereas prices in areas with critical land shortages (including Marlborough, Nelson-Tasman, Wellington and Dunedin) have skyrocketed, particularly in the past 2-3 years.
Other measures
The Prime Minister has previously mentioned increasing social assistance to help first home buyers. This is likely to be in the form of extensions to the existing schemes such as the KiwiSaver withdrawal scheme.
The Government is also talking about partnering with the private sector to increase the supply of social housing. Social housing has been in crisis for several years, so intervention there is much needed. Hopefully, this is better managed that KiwiBuild.
The Government continues to rule out any new taxes such as capital gains tax, or land tax. As discussed above, Treasury modelling shows that a capital gains tax would increase property prices anyway.
Strangely absent from all discussion is New Zealand’s incredibly high cost of building. More specifically, our cost of building materials. To truly make a sustained long-term difference in property prices, the red tape around approving building materials needs to be reduced so that the replacement cost of houses is reduced. The impact of relatively cheap replacement properties in areas surrounding Christchurch (Rangiora, Kaiapoi and Rolleston) has been evident in the past 6 or so years. In that case the cheap properties (brand new houses at or less than $500k) was driven by cheap land. The availability of cheap new housing (which incidentally has an LVR exemption) restrained price growth across the Christchurch market.
Property prices – long-term trend
Over the past decade, New Zealand has had a large increase in population, and in the aftermath of the Global Financial Crisis house construction was well below normal/required levels. This led to a housing shortage for both rentals and owner-occupied properties. Construction picked up over the second half of the last decade, but a significant housing shortage remains.
Another more puzzling change is the structural decline in the number of houses listed for both sale and rent. In most parts of the country this decline is significant, so anytime demand picks up there is significant upward pressure on prices. The cause for this long-term decline in listings is not obvious, however, we think the following few things that are at play:
- The lock-in effect caused by the bright-lines rule.
- Many owners upgrading from the first to second home (or second to third etc.) are keeping the old home as a rental and using the equity in it to purchase their replacement home. Therefore the “property ladder” isn’t a ladder in sense that it used to be and the cheaper houses for first home buyers are hard to find.
- People are living far longer and only requiring rest home care at a much later stage in life.
- Retirees are staying in their old family home to a much greater extent. Downsizing to small flats just isn’t occurring to the extent that it used to. This is probably in part driven by the fact that those reaching retirement age now do not live anywhere near as modestly as their parents.
- For rentals, many landlords have shifted their properties to short-term rental (AirBNB etc). This is driven by a mixture of better yields or an escape from the ambit of Residential Tenancies Act.
Construction levels remain high in centres where new land is available or where intensification/in fill housing is allowed. However, construction is lower than is required in areas where land supply is low or critically low. Further, Covid-19 has paused migration into New Zealand. Net migration was very high just before Covid-19 but has reduced to near zero since the borders closed. Therefore, the housing shortage may ease in parts of the country in the next 12 to 18 months. Beyond that who knows, but the smart money is on a return to high migration.
Conclusion
If done properly, RMA changes should have the biggest impact on property prices in the long-term. However, these changes are not going to occur overnight. Therefore, LVR changes will be the first line of defence to slow property price growth.
Ultimately, you can’t help but feel that the Government’s action seems to be more in the nature of signaling rather than actual intervention. However, the threat of Government intervention together with the reintroduction of LVR should take some of the heat of the property market.
All things considered, the signs continue to point towards house prices continuing to increase in the near to medium term, albeit at a level lower than the past 3 or so months and, ultimately, that is what the Government wants/needs.
Long-term the cost of building materials needs to be addressed so that the cost of replacement properties is lower.