Property Report: Low demand means new boom isn't within a bull's roar

It's still a somewhat subdued market, says Dr Rodney Dickens. Photo / Thinkstock

The height of New Zealand's latest residential property boom was a little over four years ago and left us all a little wiser. But already the quiet talk in some quarters is that a new boom may not be far away. To sift the fact from the fanciful, Bruce Morris puts questions to economist Dr Rodney Dickens, a specialist in the housing market

The market is said to be bubbling away nicely - "perky" as one blogger has it, with prices now back around the market peaks of 2007. The worst is well over, say the bulls, and from here the only way is up. What's your view on that?

"Perky" might be in the eyes of the beholder and it certainly differs depending on what the current situation is compared with. But a balanced assessment should conclude that the market is still somewhat lackadaisical by historical standards and slumming it compared to the conditions that reflect a boom, though that's not to say the number of sales will not head higher on the back of the further small falls in mortgage interest rates.

Most recently the national number of dwelling sales reported by the Real Estate Institute is 16 per cent below the historical average number, while in Auckland the number is 7 per cent below the historical average.

From the perspective of the depths of despair in late 2010 and early 2011, things might well be described as being perky. But in the context of a housing boom the recent numbers are disappointing, with the national number 46 per cent below the average of the 2003-2007 boom.

I suppose to some people something below average might seem "perky", but to me it reflects a somewhat subdued market. The demand-supply balance isn't even close to the state that would justify talk of an imminent bubble in prices.

Mortgage rates are very low and will stay that way for some time yet. Those rates are a powerful part of the argument from people who suggest now is a great time to buy and that we could be on the verge of another boom.

By historical standards mortgage interest rates are low, and the falls since October will drive some further increase in the number of house sales. But floating and short-term fixed rates are the lowest rates and haven't fallen much.

If cheap money was going to drive a "bubble" in the housing market the number of sales should already be well above historical average levels rather than somewhat below.

A housing bubble needs significant participation by investors and, while money is cheap, investors are not playing a major part because the financial incentives don't stack up for them.

While the most recent BNZ/REINZ survey points to an increased involvement of investors, I would still contend they will not play anything like the role they played during the boom because the yields don't stack up.

Viewed from an investor's perspective, unaffordable housing equals the prospect of at best mediocre medium-term returns. Great returns are to be had when there is blood on the street and assets are so cheap they are screaming out to be bought, although most would-be investors are frightened by the blood and interpret the screams as reason for caution. Great returns are not achieved by buying unaffordable assets and housing market bubbles don't start from a platform of unaffordable prices.

We read often about the lack of homes being built and the overall shortage of properties to house our growing population. What impact will that have on prices in the future?

The number of sales largely reflects the level of demand, while prices are driven by the combination of demand and supply. If supply is greatly restricted there could be a surge in prices even with demand being below average.

The suggestion that "we aren't building enough houses fast enough to house our growing population" carries an inference that existing house prices could boom.

But a moment of thought is all that is required to conclude that the low level of building doesn't represent unsatisfied demand for housing.

If there is unsatisfied demand for new housing who or what is stopping people from building? Interest rates are low and banks are lending. Our research shows there is no shortage of sections to build on in our national and regional markets.

No, the low level of building is because demand is low and it should not be viewed as an ingredient for a bubble in existing house prices. Low building reflects a rational response by people to new housing and especially section prices being unaffordable.

What about the powerhouse of Auckland - after four years of negative growth in real terms, is there any evidence we're seeing the start of a new spurt?

There is no doubt that the demand-supply balance is tighter in the Auckland market than nationally. However, at the moment the gap between the number of sales and the number of listings is around half what it was in 2007.

This suggests that Auckland is heading for solid increases in house prices as distinct from a "bubble" or a "boom". And these increases are likely to halt when mortgage interest rates are eventually and inevitably increased.

How do things look for the provincial cities and towns?

Upper and central North Island centres often follow in the footsteps of Auckland, but house prices in the provincial centres don't go up by magic.

In Rotorua, for example, the number of sales remains depressingly low, with Whangarei not much better.

A number of North Island provincial centres are still recovering from prices having been driven well above what locals could afford by investors during the 2003-2007 boom years, and that makes them unlikely candidates for booming house prices any time soon.

So what are the real ingredients of a looming boom - how do we see one coming?

Booms in prices start from sound fundamentals. Normally the combination of low interest rates and above average net external migration/population growth drives a fundamentally sound increase in demand that leads to solid increases in prices (like low double digit annual increases).

The normal cyclical upturn will turn into a bubble if a combination of factors coincide, but these factors only coincide every few decades - the early 1970s, for example, and most recently in 2003 to 2007.

The factors that will drive a mega-boom or bubble might differ from bubble to bubble, but there won't be a bubble without at least a couple of factors coinciding: one, sustained low interest rates; two, sustained well above-average net migration/population growth; three, the starting point being one in which housing offers good value to investors; and four, the timing being right for a new group of investors to enter the market.

At the moment only one of the four requirements is met (low interest rates), but the Reserve Bank has learnt the lesson from having kept interest rates too low for too long last decade and won't be making the same mistake again.

But we're out of the woods and the only way is up, right?

In terms of actual prices this might be the case, but a number of our provincial centres remain vulnerable if or when mortgage interest rates head higher.

If the number of sales is still near rock bottom in Rotorua, despite mortgage interest rates being low, what will happen when mortgage interest rates increase?

But what really matters is real house prices, measuring the purchasing power of house prices - in other words, how many pounds of butter and pork sausages your investment in housing will convert to when you need to use the equity in it to survive during retirement or in terms of what it will be worth to your children in their inheritance.

The critical issue is what will happen to house prices relative to what will happen to prices in general, and in this context it is highly likely that we haven't seen the bottom yet.

Just as the rise in house prices in 2009 was transitory and followed by falling prices, especially in real terms,

I believe the unfolding increases in national and Auckland house prices will prove to be transitory rather than being the start of a sustained boom or "bubble".

And I expect the increases to be followed by falling real prices.

Some commentators have made much of the fact that house prices nationally are now back to around the peak level. But in terms of pounds of butter and pork sausages the purchasing power of housing is still around 12 per cent below the peak level.

Rodney Dickens, a former head of research at ASB Bank, is managing director of Strategic Risk Analysis, a boutique economic, property and industry research company with a focus on the housing and residential building markets. Find out more from the company website: www.sra.co.nz