The issue now is how long the correction will take, writes Gareth Morgan, director of Gareth Morgan investments. (Charts reference click here.)
London's Economist magazine has suggested New Zealand property prices are 20 per cent overvalued.
No news in that, really - some of us have been saying it for yonks as well.
As far back as 2007 I said publicly that houses in New Zealand were 30 per cent overvalued. That
comment met with much derision from the real estate industry (funny, that) whose state of denial at that time was at its most fervent and unintelligent. The industry is a little smaller today.
But the important issue is how far through the inevitable correction in that market are we? A couple of the approaches I use can give us some feel for that.
At peak, June 2007 (point A on the first graph) - real house prices were 45 per cent above (60-year) trend, so would have to fall 31 per cent in order to be back in line with that indicator.
Since that time, real house prices have fallen 15.5 per cent (to point B on the graph, comprising a 5 per cent fall in nominal prices while general consumer prices have risen 12.6 per cent).
Meanwhile, the long-term trend value for housing has risen by 7.8 per cent over the four years. This suggests real house prices today are only 14 per cent overvalued - so would need to fall a further 12 per cent to be in equilibrium (14 per cent up being the same as 12 per cent down - got it?)
Of course an overnight drop in real prices (to point D on the graph) is but one scenario, and most unlikely. So let's posit a couple of others.
If house prices were just to keep pace with inflation from here on, how long would it take for them to be back in equilibrium (point C on the graph)? The answer is another six years.
I doubt the market will have that sort of patience - despite the banks' heroics thus far in avoiding as many mortgagee sales that would precipitate a domino tumble in prices. So we could posit that a reasonable scenario would be they continue to stay calm and that might see another three years for us to get back to "normal" (point E).
But another word of caution. It is unlikely house prices will approach their long-term equilibrium value predictably. It's actually more common for them to undershoot before they settle - and given the huge size of the overvaluation we have just experienced, you could just as credibly argue that. Don't be surprised, then, if the picture we're painting here ends up being pretty conservative - ie, things will get considerably worse before the housing market stabilises.
A double-dip economic recession would certainly make an undershoot more likely. The ramifications of that for an economy that has been founded for two decades on bloated property values would be very serious.
Now, the above is just one type of indicator analysis of many you could deploy. Here's another: Looking at our history, the ratio of average house prices to average household income has varied a bit over the years but averaged about 3.3 - at least up until the orgy of property speculation that began in 2002.
That ratio peaked at about 5.7 times average income in 2007 but now is back to about 4.5. So it looks to be about halfway back to "normal". A slightly more pessimistic message than you get from the real house price trend analysis.
I could go on - and talk about the role the ageing baby boomers have played in the speculative orgy, loading themselves with mortgages and multiple homes in their late-life quest for riches. Pretty ignorant, really, but now they have to back out of a weak market and fund their early years of retirement. That will put a further dampener on the sector.
The Economist bases its allegation of a 20 per cent overvaluation in New Zealand housing on the ratio of house prices to rents.
There are any number of other indicators to build the picture.
The Economist points the finger at poor regulatory environment for fuelling the property frenzy and boom-and-bust cycles which result.
Again, this is precisely what I have written about in the Herald previously - that central banks that direct banks to lend out on mortgages as a preference is the root cause of the instability. They argue that property is somehow less risky (because it used to be so apparently it follows it will be again) and their directives to therefore lend more on it ensures that it isn't.
Picking winners like this is a dangerous game and underpins major misallocation of scarce investment monies in the economy, less gross domestic product and fewer jobs.
There is no sign our Reserve Bank has learnt that truism yet.
But there's good news here - lots of it.
Here we go:
* Houses will become more affordable for the younger folk, so keep your powder dry and be patient.
* Agents are too expensive and you don't need them now with online listings, so don't accept that you have to use one - only good ones can make any difference, most are just an added cost.
* The younger baby boomers - those about 50 years old - have time to rebalance their assets, so get real, dump a couple of houses and get a balanced distribution of wealth.
* The funds freed up from the housing frenzy can be put to investment in New Zealand and increasing our ability to generate genuine income, jobs and wealth, as long as the Government's tax and welfare policies - and the Reserve Bank's directives to the banks on what they should lend on - don't continue to be dumb enough to thwart that (a big ask, I'll admit).
Anyway, all the messages are the same - the property orgy is correcting; it's not over but we're well into it - and that is very good for New Zealand.
