Housing price pressure unlikely to ease off

Affordability is not just about what it costs to buy a house or apartment, but also the cost of servicing the loan almost all buyers require. Photo / File

We can be pretty sure that housing affordability will worsen over the next few years, for reasons that have nothing to do with the presence of non-resident buyers in the market.

It is because affordability is not just about what it costs to buy a house or apartment, but also the cost of servicing the loan almost all buyers require.

The current judgment of the financial markets is that the Reserve Bank will start raising interest rates early next year and that in three years' time the official cash rate will be 2 percentage points higher than it is now.

That would imply an increase of about a third for people's mortgage bills. Incomes are not likely to rise by a third over the same period.

The markets might be wrong, of course. They constantly adjust their view of the outlook for interest rates as new information comes to hand. The adjustment can be in either direction and lately the trend has been upwards, for both domestic and global reasons.

As for house prices, Auckland's double-digit annual increases clearly reflect too much demand chasing too little supply.

So the top of any list of what to do about it has to be measured to boost the supply side.

The Government says the legislation now before Parliament embodying the Auckland housing accord will free up land and speed up consenting.

But will it deal to the market failure that has seen the building of entry-level housing dry up?

The average value of new dwelling consents issued in Auckland in the year to June 2013 was $315,000. That's just the building, not the land.

The national average was $302,000 and the average floor area 197sq m - and most of them were outside Auckland. That suggests that the need to build large homes commensurate with Auckland's expensive sections is not the only factor skewing construction away from smaller dwellings.

Labour's Kiwibuild policy aims to increase supply at the lower end of the market.

The problem is that supply-side measures will take years to redress the imbalance between supply and demand in Auckland.

In the meantime, policymakers, especially at the Reserve Bank, have to deal with the demand side.

And "deal with" means frustrate, burn off or crush demand - harsh words for an unpleasant process.

But the alternative of doing nothing to curb the pace of house price inflation, when house prices and household debt are already very high relative to incomes, is dangerous.

The risk is that incomes are hit if the economy gets sideswiped by another shock from the other 99.7 per cent of the world economy or from Mother Nature.

The bursting of a property bubble in the United States saw one mortgage in four under water - that is, the loan was worth more than the house.

People are trapped.

Avoiding that, and the attendant risks to the banking system and wider economy, is the main reason the Reserve Bank wants to limit the proportion of low-deposit lending banks can do.

As a secondary effect, it might slow the growth in house prices by excluding some buyers from the market.

But it will only delay, by a few months, the day when governor Graeme Wheeler has to start raising interest rates.

There is another dimension to the affordability issue: tax.

When a would-be owner-occupier and a property investor (local or offshore) are competing for the same property, the tax system gives the investor an important advantage.

It is not the absence of a capital gains tax; that applies to both of them.

It is the ability to claim a tax deduction for interest payments. It means that when interest rates rise the impact on the owner-occupier can be up to half as large again as on the landlord.

The tax system treats the investor has having gone into business and entitled therefore to deduct all the costs, including interest, incurred in earning the taxable income, rents.

But most businesses cannot debt-finance themselves to the same extent as a property investor.

Multinationals can, but the tax system has long restricted their ability to claim interest deductions.

It is called the thin capitalisation regime and something similar to its 60 per cent limit on interest deductions might lessen price pressure in parts of the housing market where investors and first-home buyers compete.