Brian Fallow: Crunch on house prices

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It's an ill wind, they say, that blows nobody any good.

The credit crisis radiating out from Wall St offers the prospect of some relief from another crisis closer to home - housing affordability.

Or at least that the crisis will not continue to deepen.

That may seem a paradoxical conclusion, when the effect of the credit crunch has been to drive up the risk premium in interest rates.

Interest rates are one component of housing affordability but so are incomes and house prices.

What the global credit crunch has done is nail down the coffin of the housing boom.

Better late than never. It is one of those good things you can have too much of.

While we use positive terms to describe it and its spillover effects like "boom" , "capital gains" and the "wealth effect", we are really talking about house price inflation which creates losers as well as winners.

The winners from an 80 per cent increase in real house prices over the past five years have been the one-third of households who own their own homes outright.

Another third of households are owner occupiers with a mortgage. They will have seen the equity in their homes climb but will be facing now, if they haven't already, stiff rises in mortgage costs.

The real casualties are to be found among the remaining third of households, who rent but for whom any aspirations of home ownership have evaporated.

A government report released last week puts some sobering figures around this phenomenon.

It uses data from Statistics New Zealand's survey of family income and employment (affectionately known as Sofie) to estimate what proportion of couples and single people who rent could afford to buy.

To buy, that is, a house from among the cheapest 25 per cent available in their region while keeping their mortgage payments at no more than 30 per cent of their gross income.

They reckon that in 2000, 59 per cent of renting couples and 11 per cent of single people could have afforded a lowest quartile priced house.

By 2006, however, that had dropped to 29 per cent of couples and only 2 per cent of single renters.

It gets worse if you exclude those who could have afforded (based on their net worth) a 20 per cent deposit but who for whatever reason had decided not to.

Among the rest, the proportion of couples who could afford to buy dropped from 40 to 12 per cent since 2000.

"At current prices and interest rates, the gap between the income of those who cannot afford to buy a lower-quartile-priced house and the income needed to service a mortgage on such a house while keeping the payments at or below 30 per cent is large," the report says.

"On average to bridge the gap, a couple would need a deposit of $122,000 and non-partnered individuals would need a deposit of around $177,000."

For many people, the officials drily note, this would pose a considerable hurdle.

They conclude there is a growing group of people who cannot afford a mortgage on a house but are not eligible for state housing assistance.

Another report, by the Ministry of Social Development last year, showed that by 2004, 22 per cent of households spent more than 30 per cent of their net income on housing costs, twice as many as in 1988. With another three years of double-digit house price inflation, the proportion is likely to be even higher now.

House price inflation looked to have done its dash before the credit crunch struck.

As measured by the Real Estate Institute's national median price, it plateaued in the $350,000 to $352,000 range between August and November last year. It has fallen 4 per cent since its peak in November.

But we have been caught out before with the market seeming to have run out of puff only to gain a second or third wind.

Not this time.

The effective or average mortgage rate is climbing relentlessly. It is the highest it has been since October 1998 and 1.6 percentage points above its lows in late 2003. And it won't stop there.

About 30 per cent of mortgage debt on fixed rates, representing about a quarter of of all mortgage debt, comes up for an interest rate reset over the next year, from an average rate of just over 8 per cent.

On the basis of the mortgage rates available now, the Reserve Bank says, those borrowers will face increases of 70 to 150 basis points.

The money markets expect the bank to have cut its official cash rate, now an eye-watering 6 percentage points higher than the Federal Reserve's, by 75 basis points by this time next year.

The OCR is only one influence on mortgage rates, however. It has not increased for eight months but retail rates certainly have as credit spreads have widened dramatically in the overseas markets New Zealand banks tap for much of their funding.

It has provided governor Alan Bollard with a "Look Ma, no hands" tightening - just as the earlier glut of cheap money overseas nullified his attempts to rein the housing market in.

Like the OCR that will ease eventually, though in the current state of world credit markets it would be a brave man to say when.

So if house prices are already falling and interest rates will too, eventually, what about the third driver of affordability, incomes?

We go into this downturn with the unemployment rate at a 22-year low of 3.4 per cent.

Wages are rising at the strongest rate since 1992.

The tightness of the labour market is only partly cyclical. It is underpinned by structural factors such as an ageing population and having a common labour market with Australia where the average wage is about a third higher.

It is one of the reasons even those economists who forecast the economy to stray across the line into recession this year expect it to be mild and brief.

And there is the prospect of tax cuts, whichever party leads the next government.

Historically, housing booms have been followed by relatively shallow falls in house prices - as people hunker down and cut back on other things rather than crystallise a loss of housing equity - followed by several years where house prices go sideways.

Incomes rise over that period, allowing affordability ratios like household debt to income and debt servicing costs as a share of income to improve.

- NZ Herald

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