Grant Spencer: Trends in the New Zealand housing market
Speech by Mr Grant Spencer, Deputy Governor and Head of Financial Stability of the
Reserve Bank of New Zealand, to the Property Council of New Zealand, Auckland,
15 October 2013.
* * *
It is a pleasure to be here today at the Property Council of New Zealand to participate in your
residential summit. Your speakers will have various perspectives on the New Zealand
housing market. The Reserve Bank's perspective is a macro one. We see the housing
market as an important driving force in the overall New Zealand economy. It is not just of
relevance for the building industry and for people buying and selling houses. The housing
market is also relevant for upstream manufacturers of building products, for the net worth of
all existing home owners, for banks seeking to fund home purchases, and for exporters
facing pressures on the exchange rate. As a central bank mandated with price stability and
financial stability objectives, the housing market is a key factor influencing our policy
decisions. Most recently, we introduced restrictions on mortgage lending with a high
loan-tovalue ratio (LVR), starting from the first of October.
The main purpose of the LVR restrictions is to reduce risk in the financial system by
moderating the current excess demand pressures on house prices, which are particularly
evident in Auckland. We agree with most commentators that the key underlying issue here is
a chronic housing supply shortage, and I will come back to this topic. But the period of rapid
price increases over the past two years has coincided with very low interest rates and easier
bank credit. Banks have competed aggressively for mortgage business and this has
contributed to a ramp up in housing demand, which has far exceeded the available supply.
If the growth in demand continues to exceed the growth in housing supply, house prices will
become increasingly vulnerable to a sharp correction, which could be prompted, say, by a
global financial shock. As seen in many developed countries in the global financial crisis
(GFC), such a correction can come with significant financial and economic costs. Further,
growing momentum in house price inflation would risk a return to the "borrow and
spend"mentality of the last housing boom. The consequent growth in consumption would add
to general inflation pressures and ultimately prompt stronger interest rate increases than
would otherwise be necessary. In this way, a housing expansion can easily start to crowd out
other economic activity including, in particular, export production through upward pressure on
the New Zealand dollar exchange rate.
In my talk today I want to look specifically at the current supply and demand pressures in the
New Zealand housing market, at how the imbalance might be alleviated in coming years, and
the impact that the LVR restrictions are expected to have.
Housing market pressures are growing
Between 2000 and 2007 house prices in New Zealand more than doubled, and household
indebtedness increased from 100 to 150 percent of household disposable income. When the
cycle turned in 2007, house prices fell 10 percent - a relatively benign fall compared with
some countries, such as the United States, Spain and Ireland, where house prices fell by
30 to 40 percent. This is a key reason why the New Zealand economy has performed
relatively well amongst OECD countries through the post-GFC period.
But while New Zealand households' balance sheets fared relatively well in the downturn, the
vulnerabilities built up during the 2000s housing boom have not unwound: house prices and
household debt both remain elevated relative to international and historical norms. These
imbalances leave New Zealand vulnerable to a fall in house prices at some point in the
future. Such a fall, potentially triggered by an external financial shock, could cause real
damage to New Zealand's financial system and broader economy. Figure 1 shows that
house prices are high relative to household disposable incomes and rents, even though they
have eased from their 2007 peak. On these sorts of measures, the OECD estimates that
New Zealand house prices are 25 percent above their long-term averages.
Figure 1: House prices relative to income and rents
Source: Quotable Value Ltd., RBNZ, Statistics New Zealand, Ministry of Business, Innovation and
Employment.
From this high starting level, New Zealand house prices are now rising rapidly once more.
Over the year to the September quarter, New Zealand house prices increased 9 percent.
According to REINZ, house prices have increased particularly strongly in Auckland and
Christchurch, with annual rates of 17 and 8 percent respectively (figure 2). House price
inflation in the rest of New Zealand is running at around 3 percent. Some of the stronger
regions include Nelson, New Plymouth and Queenstown. As a consequence of these rises,
national house prices are now 11 percent higher than at the peak of the boom. Auckland
prices are 26 percent above their previous peak.
Figure 2: House price inflation by region, three-month moving average
While we are currently satisfied with the soundness of the financial system and the stability of
general prices, the increasing stretch in house prices presents a risk to future financial
stability and future general price stability. The stretch is being driven by supply constraints,
combined with an expansion in credit-based demand.
The housing supply shortage
In Christchurch, the supply of habitable homes was significantly reduced as a result of the
Canterbury earthquakes in 2010/11. Both house prices and rents increased substantially as
permanent residents sought to re-establish themselves and temporary residents moved in to
work on the rebuild.
In Auckland, the picture is different. The housing shortage has emerged over a longer period,
and is more evident in homes for sale than in rental properties, with house prices moving up
well in excess of rents. This pattern is consistent with an increasing trend of existing renters
seeking to become first home buyers. In the last June quarter, available listings of houses for
sale in Auckland reached the lowest level ever recorded.
Looking back, the building of new homes in Auckland has been weak for many years. A
significant number of new homes were built in Auckland between 2002 and 2005 when
overseas immigration into New Zealand was strong. However, the rate of new building
slowed dramatically in 2005, as immigration flows moderated, and has remained low since.
In the rest of the country, construction of new dwellings remained elevated from 2002 right
through until the 2008/09 recession, with many houses built outside of the main urban
centres in regions such as Waikato and the Bay of Plenty (figure 3).
Figure 3: New dwelling consents in selected regions (annual average)
Source: Statistics New Zealand.
While many dwellings were built in Auckland between 1991 and 2005, research suggests
that, relative to population growth, districts in Auckland have the lowest supply
responsiveness in the country.1 If we exclude apartments from the picture, the construction
of new dwellings has been weak or declining since 2004 (figure 4).
Figure 4: New building consents in Auckland (quarterly)
Source: Statistics New Zealand.
Low rates of building have led to a gradually increasing shortage of homes in Auckland. This
is reflected in a consistent upward trend in population-per-dwelling in Auckland since 2005.2
Auckland Council estimates that there is a shortage of 20,000 to 30,000 homes in the region
currently, and that 13,000 new dwellings will be needed each year to meet projected
population growth over the next 30 years.
A significant limitation on new home building in Auckland appears to be a scarcity of
available land. This has been an increasing problem as the Metropolitan Urban Limit (MUL)
has become more binding. As the availability of land within the MUL has decreased, land
prices have been bid up, which, in turn, has probably curbed housing supply. The
Productivity Commission (2013) estimates that, in 2010, land just inside the MUL was worth
nine times the value of land just outside the boundary - up from six times in 1998. This is a
key reason why land costs now comprise 60 percent of the cost of building a new dwelling in
Auckland, compared with 40 percent in the rest of the country. In its report on housing
affordability, the Productivity Commission (2012) identified restrictive urban planning, and the
time and costs associated with land development and construction, as additional factors
constraining the building of new houses.
To help alleviate supply constraints, the Government, in agreement with the Auckland
Council, has passed legislation to implement the Auckland Housing Accord. The accord
seeks to free up enough land for 39,000 new homes in the next three years. To do this, the
resource consent process will be sped up for housing developments within specified areas,
consistent with the rules outlined in Auckland's Unitary Plan.3
Auckland Accord targets aim to make enough land available for 9000 new dwellings over the
year to March 2014 - well above the current rate of 5600 new dwellings consented over the
year to August. So far, the council has announced the release of enough land for
6000 homes under the accord. The accord targets are ambitious and it will take time for land
to be developed and houses built. Nonetheless, the accord is an important step forward in
helping to alleviate the Auckland housing shortage.
Pressures on construction
As more new homes are built in Auckland, this will create construction jobs and contribute to
economic growth. However, this new building will occur at the same time as the Canterbury
rebuild is taking place, creating significant resource pressures in the national construction
industry.
Figure 5 shows the amount of new dwellings that might be built over the coming three years
if accord targets were fully met and 12,000 new homes were built in Canterbury over the
same period. To achieve this, new dwelling construction would need to be 9 percent higher
than at the height of the recent housing boom, even assuming no growth in home building
through the rest of the country. At the same time, a significant amount of repair work,
infrastructure and commercial construction will be taking place in Canterbury. In reality, we
expect the targeted house building in Auckland and Christchurch to occur over a longer
period than three years. How much longer will depend on the extent of improvements in
approval processes and on the ability of the construction industry to expand its current
capacity.
Figure 5: New dwellings consented in an unconstrained building scenario
Source: Statistics New Zealand, RBNZ calculations.
Note: This scenario assumes that Auckland Accord targets are met, 12,000 homes are built in
Canterbury over the next three years, and that building through the rest of New Zealand continues at its
current rate.
While phasing of this major home building programme will help to limit resource pressures,
some wage and price pressures will inevitably result. The upward pressure on construction
costs that we are currently seeing in Canterbury may well extend more broadly across the
industry. On a moderate scale, this would help to attract resources into the construction
industry and hence facilitate the building expansion. On an excessive scale, this would risk
spilling over into general inflation and put upward pressure on interest rates and the
exchange rate.
To avoid the potential problems associated with excessive house price and construction cost
inflation, we will need a more responsive supply side that includes:
•
A responsive and innovative building sector;
• An adequate supply of labour, some of which will need to be imported; and
•
A responsive planning and consenting process.
We will also need the demand side to be kept in check while the supply response takes
place.
The demand side and credit
Clearly, the supply of houses is an important determinant of house prices- but it is only one
side of the story. We have seen the shortage of homes in Auckland emerge due to low
construction rates over many years. But house price inflation has accelerated only over the
past two years, over the same period that credit conditions became easier and population
growth picked up with stronger net inward migration. It is relevant that house price inflation in
Auckland has not been matched by rental inflation, which is less affected by credit
conditions.
Looking more closely at credit conditions, interest rates are currently very low by historical
standards. Indeed, the sub-5 percent mortgage rates on offer earlier in the year were the
lowest since the 1960s. Low interest rates increase the incentive for households to own
rather than rent. Over the past 18 months, as housing demand picked up, housing credit has
also been easier to obtain than previously, with banks competing aggressively to write
mortgages. As a consequence, credit growth has risen, with outstanding housing credit rising
6 percent through the year to August. Lending to borrowers with high LVRs has grown twice
as fast, causing the share of high LVR lending to rise (figure 6).
Figure 6: High-LVR loans as a share of new lending
Source: RBNZ.
Households who borrow at high LVRs tend to be the most vulnerable to a fall in house
prices. In the event that house prices fall, these borrowers are more likely to see the value of
their house fall below the amount of debt they have outstanding - particularly if they have
entered the market recently. This can lead to financial hardship, mortgage defaults and,
potentially, stress across the broader financial system.
Apart from easy credit conditions, housing demand over the past year has been boosted by a
growing net inflow of immigrants (figure 7). Net immigration to New Zealand has risen
substantially over 2013 due to fewer departures of New Zealand citizens to Australia at the
same time as inflows of returning citizens and non-New Zealand citizens from Europe, the
United Kingdom and Asia have continued to increase. Over the year to August 2013, a net
13,000 people moved to New Zealand with the intent of staying a year or longer - the highest
annual inflow since early 2010. As more people enter the country, this increases the demand
for housing, tending to put upward pressure on rents and house prices - particularly in
Auckland, where immigration flows have been strongest.
Figure 7: Permanent and long-term immigration to New Zealand (quarterly)
Source: Statistics New Zealand.
The role of high-LVR lending restrictions
The LVR lending restrictions in operation from 1 October 2013 are primarily intended to
reduce systemic risk by slowing house price inflation. They seek to reduce the risk that a
subsequent price correction in an increasingly overvalued housing market could pose for the
financial sector and broader economy. Given the relatively slow response of housing supply,
it does not make sense to let credit-based housing demand get too far out in front. Further, to
the extent that the LVR restrictions dampen overall demand in the economy, they could also
reduce the extent of interest rate increases, and hence exchange rate pressure, that may be
needed over the coming cycle. At this point, we estimate that the LVR restrictions are worth
approximately 30bp of OCR adjustment. The LVR restrictions are also expected to reduce
risk in the banks' balance sheets.
Estimating the impact of the LVR restrictions is complicated by the fact that this is a new tool
and New Zealand appears to be unique in using a speed limit approach. Quantitative
estimates of impact are necessarily approximate, with key uncertainties including the extent
to which low-deposit borrowers find other sources of funds, and the extent to which lower
credit growth feeds through to house sales and prices.
We estimate4 that:
•
Mortgage credit growth will be 1-3 percentage points lower over the first year.
•
Home sales will be 3-8 percent lower over the first year
•
House price inflation will be 1-4 percentage points lower over the first year.
Beyond the first year, these effects will be reduced. Also, the impact of LVR restrictions will
not be uniform across the country. Market segments with a higher proportion of high-LVR
borrowers are likely to see larger effects, as will areas where house prices and borrower
incomes exceed the criteria for Welcome Home Loans, which are exempt.
An important point to make here is that while house price inflation should be reduced by the
LVR restrictions, New Zealand house price levels will remain high on most metrics, for
example, relative to incomes and rents. In this sense it is hard to see how these restrictions
will materially reduce the existing incentives to develop new residential property. Provided
the "red tape" costs and delays are reduced, there will remain a strong price incentive to
expand the housing stock, particularly in Auckland and Christchurch.
In due course, we expect housing supply to catch up with demand, and for demand to be
further moderated as interest rates return to more normal levels over the next couple of
years. As the imbalance between demand and supply is reduced, we will look to lift the LVR
restrictions. The indicators we will assess in this regard include house price inflation,
mortgage approvals, credit growth and house sales. We will be looking for clear signs that
excess demand pressures have substantially reduced and that a removal of the restrictions
will not result in a return of such pressures.
Conclusion
The underlying issue in the New Zealand housing market is a shortage of supply. In
Christchurch there is a specific housing shortage as a result of the earthquake-damaged
housing stock. In Auckland, the shortage has been growing over a much longer period, with
weak or declining rates of house building since 2005. While the trend in people-per-dwelling
in Auckland has been moving steadily upwards since 2005, demand for home-ownership has
accelerated in more recent times due to the ready availability of cheap credit and a growing
trend amongst renters to become first home buyers. The recent growth in net immigration is
also adding to the excess demand situation.
Plans to increase the housing supply are well underway. Residential building consents are
trending upwards in Christchurch and Auckland, and indeed in the rest of the country. The
residential consent process has improved in Christchurch and efforts are being made to
streamline planning and consents in Auckland via the Government/council accord and the
Unitary Plan. However, meeting the combined three year targets of Christchurch and
Auckland would require a major mobilisation of national construction resources. In all
likelihood, the build will be stretched over a longer period.
Expanding housing demand through easy credit will do nothing to speed up the housing
supply response. It simply adds to housing demand, pushes up house prices and makes
housing less affordable. The Reserve Bank has introduced LVR restrictions on bank
mortgage lending aimed at moderating house price inflation by reducing the effective
demand for housing. This is intended to reduce the build-up of systematic risk in the New
Zealand financial system. It will also potentially reduce the extent of interest rate increases,
and hence exchange rate pressure, that may be needed in the coming cycle.
References
Bloor, C and C McDonald (2013) "Estimating the impacts of restrictions on high LVR lending"
Reserve Bank of New Zealand Analytical Note, 2013/05
Grimes, A and A Aitken (2006) "Regional Housing Markets in New Zealand: House Price,
Sales and Supply Responses", Centre for Housing Research Aotearoa New Zealand,
Department of Building and Housing, and Housing New Zealand Corporation, Wellington.
New Zealand Productivity Commission (2012), "New Zealand Productivity Commission
Inquiry into Housing Affordability", Final Report, April 2012.
New Zealand Productivity Commission (2013) "The effect of Auckland's Metropolitan Urban
Limit on land prices", Research Note, March 2013.