Brian Gaynor 's Opinion

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor: Approach to house price bubble too timid

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Reserve Bank needs to take action to avoid problems with economy

The Reserve Bank is fully aware of the potential housing bubble, and the negative consequences this will have on the economy. Photo / APN
The Reserve Bank is fully aware of the potential housing bubble, and the negative consequences this will have on the economy. Photo / APN

The red-hot housing market, particularly in Auckland, is grabbing the headlines and making Reserve Bank Governor Graeme Wheeler look like North Korean dictator Kim Jong Un.

The similarity is that Kim has declared a "state of war" on South Korea while Wheeler is on the verge of declaring war on our overheated residential property sector.

At this stage both Kim and Wheeler have far more bark than bite and if the latter doesn't take some action then the domestic housing market could cause major problems for the New Zealand economy and financial sector in the years ahead.

There are three main measurements of domestic house prices - by the Real Estate Institute of New Zealand (REINZ), Quotable Value (QV) and Barfoot & Thompson. The three organisations have released the following figures in the past few days:

REINZ's median New Zealand house price sale was $400,000 in March compared with $382,000 in February and $370,000 in March 2012, an annual increase of 8.1 per cent. By contrast Auckland's median house price increased by 13.5 per cent, from $495,200 to $562,000 over the same period.

QV data showed the average property value increased by 6.5 per to $429,100 in the year to March while Auckland values increased by 11 per cent to $620,600. QV's figures are an estimate of the increase in values rather than a measurement of house sale prices.

Barfoot & Thomson's sales figures, which are confined to Auckland, show that the city had an average sale price of $645,900 in March, a 13.1 per cent increase over the $571,100 average in March 2012.

These figures are slightly different because REINZ uses median sales figures, QV estimates property values and Barfoot & Thomson, which has a strong presence in the wealthier Auckland suburbs, uses average sales figures.

We continued to borrow, partly from offshore, to push up existing house prices when this has proven to be a disastrous strategy in many countries, particularly the United States, Spain, Ireland and Portugal.

Housing bubbles have been a major contributor to the global financial crisis yet buyers in this country continue to believe that house prices will never fall.

US economist Alan Blinder, a former vice-chairman of the Federal Reserve's Board of Governors and a member of President Clinton's Council of Economic Advisers, addresses the housing bubble issue in his recently published book After the Music Stopped. The book is an excellent analysis of the global financial crisis from a US perspective.

His analysis shows US house prices were remarkably flat in real terms - after adjusting for inflation - from 1890 through to the 1990s. He writes that real US house prices increased by less than 1 per cent a year between 1890 and 1997.

Binder goes on to say: "Then things changed dramatically. After 2000 the graph (of real US house prices) gives the visual impression of a rocket ship taking off. Real house prices soared by an astounding 85 per cent between 1997 and 2006 - and then came crashing down to earth from 2006 to 2012. America had never seen anything like it."

New Zealand house prices, in real terms, have increased by an average of 6.2 per cent a year since January 1992 while Auckland prices have soared by 8.1 per cent a year over the same period.

Over the past two years NZ house prices, in real terms, have increased by an average of 5 per cent a year while Auckland prices have rocketed by 9.8 per cent a year.

Thus Auckland house prices are now accelerating at a far faster pace than the rest of the country and there are plenty of warning signs that a house price bubble is developing.

These include escalating prices and rising sales volumes as well as aggressive bank lending and the widely held view that potential buyers need to purchase now because prices will be much higher in the months and years ahead.

The housing market was the focus of a speech by Reserve Bank Deputy Governor Grant Spencer on Monday but he was careful not to use the bubble word.

The basic problem, as identified by Spencer, is that we are not building enough houses. We had only 17,000 new houses built in 2012 compared with 154,000 in Australia, whereas we should be building over 30,000 each year if we had the same house building to population ratio as Australia.

The Auckland Council believes the region has a shortfall of around 20,000 to 30,000 homes and needs to build 13,000 a year, yet new dwellings in Auckland are running at around 5000 new homes each year.

Spencer noted housing is an important part of the domestic economy because it represents 73 per cent of household assets, compared with 56 per cent in Australia, and house price movements have a big influence on consumer confidence and spending.

In addition, 51.9 per cent of bank lending in New Zealand is in the form of residential mortgages compared with 38.4 per cent in Australia.

Spencer said that gearing of New Zealand households was relatively low but "some households have very high levels of debt, and interest payments consume a large portion of their income. A first-home buyer borrowing 90 per cent of the value of a house could have debt servicing costs of 35 per cent of disposable income, even at today's low interest rates".

He noted that an increasing proportion of new mortgage lending is going out at high loan-to-value (LVR) ratios with around 30 per cent of new lending at LVRs over 80 per cent compared to around 25 per cent in 2011 and early 2012.

The Deputy Governor warns: "The more that house prices continue to overshoot their long-run sustainable levels, the greater the prospect of an eventual significant downward correction. The impact of such an adjustment could be worsened by existing economic headwinds in the form of an overvalued exchange rate, drought-affected agriculture and the Government's significant fiscal consolidation".

The problem is that house prices could continue to go higher and higher, particularly in Auckland. Factors contributing to this include the strong internal migration, a low level of new building because there is limited funding for property developers due to the collapse of the finance company sector and a large number of speculative investors who want to obtain a leveraged exposure to rising house prices.

The Reserve Bank is fully aware of the potential housing bubble, and the negative consequences this will have on the economy and the financial sector, but it is taking an extremely timid approach to the problem.

The central bank released a consultation paper, Review of bank capital adequacy requirements for housing loans, on March 26 with submissions due by next Tuesday.

The purpose of the consultation is to determine whether there needs to be more stringent requirements in relation to high LVR residential loans.

It is difficult to understand why the Reserve Bank has to consult on this issue. The central bank is in the best position to determine whether a property bubble is developing. If it believes a property bubble is developing then it should take quick and decisive action because the countries that did not take decisive action, including the United States, Spain, Ireland and Portugal, have paid an extremely high price.


• Brian Gaynor is an executive director of Milford Asset Management.

- NZ Herald

Brian Gaynor

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the Financial Markets Authority (FMA) in 2011. He is also a Portfolio Manager at Milford Asset Management.

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