We are finally seeing the consequences of the Reserve Bank's increased capital adequacy requirements, with the banks' appetite for risk now muted and their focus on capital preservation more prevalent.
For property developers, it means constrained access to capital or limited access at a higher cost. For New Zealanders, it means an exacerbated supply-demand imbalance in the residential market.
Record low mortgage rates and the collapse in term deposit rates have helped to boost expectations for additional house price growth.
When the international border eventually reopens, New Zealand will resume adding people via positive net migration which will further increase pressure on the housing demand-supply imbalance.
The supply of 'brownfield' land ready for development also remains a hurdle in Auckland, with infrastructure investment continuing to lag demand for housing - particularly affordable, low-cost housing.
NZ's housing crisis remains unsolved
Increased capital requirements imposed by the Reserve Bank last year are now making it harder for property developers to access bank financing. Since March, the banks have further retreated due to perceived heightened risks as a result of Covid-19.
While the RBNZ has delayed implementing its increase to banks' capital requirements, the reality is that this is a short term fix so the banks are already preserving capital in anticipation of the higher capital requirements coming into effect.
In addition, credit criteria has also become tighter due to uncertainty that has arisen through the pandemic.
So, there is more than one issue impacting the ability of retail banks to execute traditional property development transactions that they would have been happy to fund previously.
At the same time, migration-driven growth has increased the demand for new housing. RBNZ's Financial Stability Report from November 2019 states, "a key driver of house price growth over the past decade has been strong population growth, which has outpaced growth in the housing stock." Annual net migration has exceeded building consents in Auckland since 2013.
While our closed borders may have stemmed the flow of new migrants, returning Kiwis are driving some of the recent activity we have witnessed in the housing market.
Young professionals with plans to move overseas pre-Covid-19 are now also making the decision to put down roots in New Zealand for longer.
With funding constrained for property developers, some are concerned that not enough residential housing and apartments will be built to meet the burgeoning housing demand.
Non-bank lenders step up
During the capital consultation process, the lending banks warned the RBNZ that further lifting capital requirements may increase the cost of credit, while also reducing its availability.
It is therefore unsurprising that we have observed a reduction in the appetite of the banks to provide development funding following tightening regulation in the banking sector.
Non-bank lenders are increasingly able to fill the gap in the market left behind by the banks, by targeting lower risk investments traditionally covered by retail banks – effectively turning the funding tap back on for property developers.
While the Auckland Unitary Plan has been in place for several years, it took a while for property developers to assess and maximise the benefits that it provided in terms of increased yield.
Experienced developers now have an understanding of the Unitary Plan and the ability for multiple terrace and townhouse developments to be accommodated on what were previously single house sites.
Urbanisation and densification are a necessary and inevitable part of every city's development and non-bank lenders will play an important role enabling the future growth of the Auckland metropolis.
It seems we are also seeing a generational shift in first home buyer demand for new houses on smaller sites, instead of the usual purchases of traditional "second-hand" housing on larger sections.
Millennials appear less eager than their parents to take on the responsibility of maintaining large, time-intensive sections. Given new regulatory requirements, investors are also more likely to want to invest in brand new product to avoid potentially expensive remedial and or upgrades to meet new tenancy rule requirements.
Pearlfisher recently launched a new first mortgage fund, unique in New Zealand. The fund will help to address concerns around the increasing demand for residential housing by allowing property developers to access the finance they need to complete their development.
The fund will target net investor returns of 6.0 per cent to 7.5 per cent per annum on invested capital, a significantly greater return than could be expected from a term deposit with one of the major banks in the current environment. Ultimately, funds like this will help to address housing affordability concerns by increasing the supply of new product at a faster rate.
The current non-bank market for development finance is estimated to be less than $2 billion, half the size of what it was pre-GFC, but with the traditional bank model under threat in the short to medium term there is room for growth in the sector to pre-GFC levels.
There is already a well-established shift from traditional bank finance to non-bank funding in offshore markets such as Europe, UK, the US and Australia, and there is increasing evidence that the non-bank lending market will have an increasing and sustainable presence here in New Zealand.
Going forward, we can expect non-bank lenders to continue to offer more debt funding for property developers in the market, which should go some way to bridging the housing supply-demand gap.
- Tony Abraham is a founding shareholder and director of Pearlfisher Capital.
This article reflects the opinions and views at the time of publication, and is not to be relied upon as a basis for making any investment decision. Please seek specific investment advice before making any investment decision.