Cheap loans, speculation prop up a rural land prices

A combination of low financing costs, poor alternative returns and speculative behaviour is propping up rural land prices, a bank economist says.

The inflated land prices suggested "a degree of sectoral vulnerability", said BNZ economist Stephen Toplis. But Mr Toplis, head of the bank's market economics department, said in its latest Economic Monitor today that it would be "overly dramatic to suggest a bubble existed in land prices".

Similarly, the bank would not suggest there was a "bubble" waiting to burst in housing, but at least there was potential for improved future returns in the rural sector which gave "some justification for price movement that the housing sector may not be able to provide".

The bank said there was a lot of excitement over the residential property market, where prices had surged 16 per cent in the past year, but most commentators had overlooked the fact that rural property prices were soaring too.

"In some ways the rural price move may be more insidious as prices in that sector should reflect the future expected earnings stream off the land," it said.

"The rural economy may be falling prey to the same demons that are afflicting the residential sector, ... speculative behaviour and default investment status as high net-worth individuals fear putting their money elsewhere". Rural land-owners' behaviour patterns were being affected by wealth gains in just the same way as their townie cousins: consuming a portion of their wealth gains as confidence rose and expanded their ability to take on greater debt.

Rural sector retail spending had been robust and investment activity increasing.

" That farmers have not closed their wallets in the face of an income downturn is, one suspects, being driven in part by the pace of growth in the price of their underlying asset," the bank said. "This, ... is a major factor explaining the ongoing strength in the broader economy."

In the year to June 2003, rural land prices rose 8.9 per cent to be 20.4 per cent up over a two-year period. In comparison, house prices rose 14.2 per cent and 22.7 per cent respectively. Since June 1980, the price of rural land has soared 6.4 times and residential property 6.7 times. Key drivers of rural land prices should include: Farm profits (both actual and expected), cost of finance, fashion, returns from alternative investments, and speculative behaviour.

But farm profits had been hurt by poor global commodity prices and the rising New Zealand dollar, made worse by the effect of bad weather on milk and meat supplies.

Overall farm profitability fell by around 10 per cent in the year to March 2003 and would decline another 20 per cent this financial year, led down boy the lowest dairy payout, in real terms, since the 1991 global downturn.

"Farm prices should have responded to these factors with dairy land, in particular, usually highly leveraged to the payout, but they did not," Mr Toplis said.

This was disconcerting.

"It is somewhat surprising that the hit to profits that has already occurred has not impacted adversely on land prices yet," Mr Toplis said.

"We believe that perhaps the strongest pressure on prices has come from a shortage of supply as landowners are simply unwilling to sell their property as they feel there is nowhere else to put the proceeds".

Cash rates were considered low, so did not appeal, and bond markets offered poor value in an environment where the risk of a bond sell-off was high, and total returns from fixed interest both past and present wre unlikely to excite landowners.

The only other alternative was the equity market, but recent past performance suggested that landowners have done much better with their property investments.

"The current uncertainty surrounding equities is giving them the jitters," Mr Toplis said.

"Consequently, land is becoming the default investment, which is not really a great justification for price appreciation".

The investment in land was being stimulated by the extremely low cost of finance: the current appreciation in land prices meant that "real" interest rates were around minus seven per cent, which spurred on speculators.

Increased turnover and pricing in the "rural lifestyle" sector wa partly the result of speculative behaviour, as was increased interest being displayed by foreign purchasers.

But he noted farmers were still confident and improving weather was good news for overall production levels.

At the same time, expectations for growth in global markets were rising, and the growth of New Zealand's trading partners was expected to rise to 3.5 per cent for 2004 from 2.5 per cent in 2003.

Significantly, the US economy was expected to grow at almost 4 per cent.

Rising trading partner growth was normally accompanied by rising commodity prices, and the world price for the commodities exported by New Zealand had risen 9.4 per cent in the past year.

The bank said the rising exchange rate for the kiwi dollar had hurt the sector, "and will hurt more over the next twelve months as hedges roll off and new hedges are adopted".

"Fonterra is on record as saying that the current season's production is hedged at around US52c ... new hedges are being established at US57c to US59c".

Much of the agriculture sector was exposed to the exchange rate for the US dollar, and the BNZ was forecasting a peak of around US62c early in the new year.

- NZPA