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House prices are well out of kilter compared with incomes, rents and other countries, and with prices as much as 26 per cent over-valued are at risk of a sharp fall, according to a report by NZIER.
But there is no silver bullet to fix the problem - instead there needed to be a set of solutions "like taking a Swiss Army knife to a knotty problem" NZIER says in its report on housing affordability.
NZIER says New Zealand's crippling home affordability rates could not be fixed by a single solution such as changing immigration policy or urban planning rules, or imposing a capital gains tax or lending ratios.
"There is no one fix to rule them all," says Shamubeel Eaqub, principal economist at NZIER. "It's not just Chinese investors, it's not just a lack of an effective capital gains tax, it's not just councils' planning rules, or cheap credit."
House prices are now at record highs compared with historic and global benchmarks, NZIER says.
The average house price used to be about three times the annual average household income. Now it is six times the annual income. A few regions have seen house prices rise so far that housing is unaffordable for people on average incomes. Auckland, for example, was now "one of the most expensive cities in the world" NZIER says.
High house prices were a "serious concern" because of the potential effects on the financial stability of the banking system, because a widespread collapse of house prices could cause "significant financial sector turmoil".
And debt-fuelled consumption, as people borrowed to spend, driven by expectations of everlasting capital gains, "throttled" business and the export sector.
Current house prices were so high they effectively assumed capital gains of up to 8 per cent a year forever and were "unsustainable", NZIER said. The expected returns were well ahead of the long-term reality of between 4 per cent and 6.5 per cent.
With such high prices, buying a house was increasingly out of reach for new generations and so had a potential impact on social stability, NZIER said. There was now an intergeneration gap in the buying power of first home buyers now and 20 years ago.
People buying a home in the early 1990s could have paid off the mortgage within about 30 years. But for a home buyer in Auckland now, it would take at least 50 years, leaving little time to build up other retirement savings.
There was a fear that foreign investors were pushing up house prices in New Zealand, the report says.
New Zealand does not restrict foreign purchases of assets, except for very large deals. But NZIER said there was little evidence to back up stories that foreigners were coming in with wads of cash to buy expensive homes in posh neighbourhoods and leaving them empty.
Property sales were dominated by investors accounting for about 45 per cent of annual transactions. Some 28 per cent were people moving from one home to another and 19 per cent were first home buyers.
Other investors, including foreigners accounted for the remaining 8 per cent. But data showed no obvious bulge in empty homes.
NZIER says policy changes should include things like reform of rental policy so renting becomes more palatable and a comparable alternative to owning a home.
New Zealand had one of the least "renter-friendly" policy settings in the world.
Lease terms were typically short, tenants could be asked to leave with short notice, and leases could be ended on almost any condition if notice is given.
Renting could be made more attractive if tenants had rights more like those seen in Britain, Germany and Switzerland where renting is seen as a normal alternative to buying a home. In Germany for example, lease terms are indefinite, with notice periods of three months, compared with 30 days in New Zealand.
There should also be reform of regulations that favour mortgages over other types of lending and removing tax advantages of real estate investment over other investments. The Government should also clarify tax rules on investment property.
The report says New Zealand's obsession with home ownership is one of the key reasons that it took so long for New Zealand's economy to recover after the 2008 Global Financial Crisis.
"Our reliance on future capital gains to pay for debt-funded spending caused a long hangover when households realised they needed to pay off the mortgage," Eaqub said.
Eaqub says if New Zealanders are not cured of their housing fixation, the nation's financial and economic stability will continue to be put at risk every time there is a recession.
The fixation with home ownership is also causing social inequity and despair. "People fear being locked out of a traditional route to financial security, as almost 70 per cent of New Zealand's household net wealth is stored in housing."