Leaky homes and the housing bubble

01:43, Jan 31 2009
Deflation: New Zealand has been experiencing a property bubble, and bubbles can burst.

Pffft ... the sound as the value of your home disappears into thin air.   

Psst. Want to earn an extra $32,000 a year for doing absolutely nothing?

Perhaps this advice has come a little late, but all you had to do was own a middle-of-the-range home for the past five years and sit tight. Simple as.

Or to have really coined it, you could have played the landlord and bought up half a dozen rentals.

Just as New Zealand once had a sharemarket run-up to beat all other sharemarket run-ups yes, the one that ended in the October 1987 crash so we have now outdone all comers with our national property bubble. Which has been the source of some easy money.

In 2002, a median-priced house in Canterbury cost $152,000. By last year, this had vaulted to $315,000. A doubling in property values (and nearer a tripling in land values).


Admittedly, not all such houses would have earnt $32,000 a year. For many, there would have been a mortgage to service. And for all, inflation must knock off some of the gloss.

But even assuming a worst case of a 100 per cent mortgage, 7 per cent interest rates and inflation running at 3 per cent, you would still have ended up $14,200 a year better off simply for the privilege of being the owner of a bog-standard Kiwi home.

And wait. Capital gains are tax free, so that jumps us back up to a wage equivalent of around $18,000.

Property investors are the ones who would be really smiling. What with rental income and government tax breaks helping cover any mortgages, you could have snapped up half a dozen rentals and be looking at the easiest way anyone ever earned an extra $150,000 a year.

The figures are extraordinary. Of course, a rising house price is not the sort of money you can spend directly. But economists say it does create a wealth effect. Feeling richer, we spend more freely.

"It's been a phenomenal source of consumer growth over the past five years," says ANZ National Bank chief economist Cameron Bagrie. Knowing there is this cushion that just grows bigger every year, we feel less urgency to save for our retirements, more inclined to splash out on life's luxuries.

Certainly, a few years into such a boom, it can seem silly denying yourself that better mountain bike, that extra Gold Coast holiday.

As for a new kitchen or landscaped garden, why that becomes a positive investment in your largest asset.

Armed with one of those line-of-credit or revolving mortgages, tapping the value locked up in your house has been child's play. No wonder the national accounts show we have been spending more than we officially earn. Showered with apparently free money, we have been doing the natural thing.

But it has been a property bubble. And bubbles can eventually burst.

The real-estate-agent and property-seminar industry will be screaming on reading these words.

Yet the statistics show New Zealand house prices are now more out of line with national wages, average rents, and just about every other measure of housing affordability than anywhere on the planet. It is a close call with Australia and Britain.

The United States has some cities and states with a particular problem. But many analysts agree.

Ratings company Fitch recently ranked New Zealand No. 1 in the world most exposed on housing-debt risk. Broker Goldman Sachs reports homes have risen above income more here than any other country surveyed.

Housing researcher Demographia says property is considered sensibly priced when the cost of the average home is around three times the average wage.

In Demographia's 2008 housing-affordability report, New Zealand ranked the worst of anywhere.

The multiple here has reached 6.3 times the average wage, with absolutely every part of the country falling into the "severely unaffordable" bracket.

Co-author of the report, retired Christchurch property developer Hugh Pavletich, says our house prices are a good 30% out of whack, judging on the fundamentals. Whatever your house was worth in late 2003, well, that would be closer to the mark.

So it could be about to get sticky.

Pavletich says estate agents claim property is different because home-owners simply will not sell at a loss.

The boom has peaked, yet the worst we face is a few years of the market going sideways. Those who have been on the escalator have their gains locked in.

However, overseas, prices have actually dropped. In the United States, the S&P/Case-Shiller index, considered the market's best measure, has tumbled 15 per cent over the past year.

And analysts are saying this "correction" already steeper than anything seen during the Great Depression may be only half way through.

Britain and Australia are also showing the jitters. In Britain, building societies reported last month that prices were falling by 8 per cent, and predictions were of a near 30 per cent fall over the next two years.

In Australia, market watcher Residex points to a sudden dip in the latest sales figures. The percentage is still small, says Residex boss John Edwards, but it is abnormal to see it across every part of the country at the same time.

"Australia is headed for a once-in-100-year real-estate slump. I have never seen the convergence of so many negatives," Edwards is reported as saying.

So is New Zealand set for a slide, slump or crash? And what is it about us that we seem to be out on a limb, even compared to all the other over-inflated housing markets around the world?

On the official figures, all we have experienced so far is a lull. Since our housing market hit its peak last November, prices have eased just 2 or 3 per cent.

However, hardly anything is moving. Buyers and sellers seem to be waiting to find who will blink first.

On a dank afternoon down at Harcourts Grenadier's central-Christchurch office, auctioneer Roger Dawson is doing his race-caller's best to generate some buyer enthusiasm.

A different note has recently been creeping into the sales blurbs. Alongside the traditional "Foxy in Strowan" and "Perfection in Pacific Park" has appeared the rather more urgent "It has to go", "Realistic owner says sell" and "Hell for my vendor".

However, Dawson is pitching this as buyer's opportunity rather than market panic. After a little mid-winter uncertainty, we could be away again in the spring, he says. So now is the time for the astute investor to be pouncing.

Dawson is pleased to announce that the first house on the list ("Romance and the sea in Sumner") sold pre-auction, handily beating its rateable value of $770,000 by over $100,000.

But back to today. "What will you offer me?" he barks. Four double bedrooms in Huntsbury. Owners' plans dictate definite sale. Ignore the rateable value of $550,000. "Stunning, lovely, convenient. Start me off anywhere you like, buyers."

But Dawson is running a race without horses. Long empty seconds drag while the sparse audience studies its nails. "Right, all out, done and silent?" The gavel crashes and the property is passed in.

The same for a "must-sell" central-city house. Very swish and modern from the pictures being projected on the wall. But even with a reserve set at $200,000 below its $700,000 rateable value, there is not a flicker of interest.

It was just a bad day, Dawson says later. Sure sales have slowed, but counting up recent auctions, nearly half are still going under the hammer, he says. Come back and see the action on one of our mortgagee days.

Christchurch mortgage broker David Tillman says it is a grieving process. Sellers still have last year's prices in mind when they come to put their homes on the market.

"It may take a few more months before people accept a new level of pricing. Buyers are also holding off to see how low the market will go," he says.

One of the psychological snags is that the last round of government valuations came at the height of the boom and people feel they should at least reach that benchmark. However, Tillman says he sees most sales now at $30,000 to $40,000 under rateable value.

Property prices always go in cycles. The reasons why this most recent boom kept going so long are complex, say the pundits.

Neville Bennett, a Christchurch economic historian and financial columnist, says immigration is always a major driver of house prices as it puts more people in competition for the same homes.

So a surge of arrivals in 2001 and 2002 certainly triggered the initial jump. But the boom kept rolling even as immigration slowed again and a wave of building caught up with any shortage in housing stock.

A combination of factors turned the market into a speculative bubble.

A big factor, says ANZ National's Cameron Bagrie, was the unsophisticated Kiwi investor or even the sophisticated investors who felt that New Zealand does not offer too many other options apart from property.

Bagrie says because we were enjoying good economic times, with low inflation, full employment and easy credit, there was too little consideration of risk. Whipped along by estate agents and property-investment seminars, the market went way past its natural level.

"There developed this perception that the property market was bullet-proof and you always get these double-digit returns."

Bagrie says the appetite for piling up rental investments was all the more remarkable as New Zealand has some of the highest interest rates in the world. Yet investors seemed completely insensitive to this "signal".

"You had Dr Alan Bollard standing up three years ago and telling New Zealanders if you keep investing in property, I'm going to put up interest rates until it really hurts. But those warnings were largely ignored. So the bigger the party, the bigger the chance of a hangover," says Bagrie.

Tillman says even those buying their own homes got carried away, pushing prices up.

"When our generation was young, we would start out with a very modest house in not the best area and expect to trade our way up. But the younger couples today want their first home to be as nice as their parents' or even nicer.

"They will really go to the limit to have what they think they should have," says Tillman.

Now he is having sobering conversations with couples as they find they can no longer tap the rising equity of their homes.

"The banks are saying, no, you can't borrow any more against your house. Some are having to face living only on their wages for the first time."

Part of the answer seems to be that Kiwis simply give less thought to investment risks. Bagrie says that shows in the way we also got carried away by stocks in the 1980s and high-interest finance-company debentures just recently. We don't ask enough questions.

But another big factor, at least according to Pavletich, is a lack of cheap building land.

Pavletich blames local councils for freezing development on the edges of towns supposedly to prevent sprawl, but also because of the cost of having to lay on new roads, new sewers. With a squeeze on land, section prices have been soaring.

"The development ratios are a million miles out of line," he says.

"People are having to pay $200,000, $300,000 for lots when they should be paying no more than $30,000 to $50,000. We should not be spending any more than 20% of the total house price on the land."

Whatever the reasons for house prices spiralling so high, what do the pundits predict will happen next?

A year ago before the credit crunch and soaring oil and food prices began to threaten the entire world economy almost everyone felt the house market would have a soft landing.

Prices would go flat for a few years, inflation doing the dirty work of gradually bringing the cost of a home more into line with wages. An inflation rate of just 3 per cent can effectively knock $50,000 off a $400,000 house in a little over four years.

But now it seems there could be a real slide followed by a period of stagnation.

"People say house prices seldom actually fall. But we've just been through the biggest property boom in history, so why do you think historical averages are going to be any guide on the downside?" asks Bagrie.

Bennett says with the economy going into recession, pressure must grow.

"They're saying unemployment could double in the next year or so. Once you get unemployment coupled with high interest rates, then you'll find that housing goes down quite quickly," he says.

Bennett echoes many others in saying that if we are a third over-valued in historical terms, then a third is how much things probably need to drop, one way or the other.

Yet he still sees room for optimism. The Government has big spending plans for roads and other public works. That will help the economy through its rough patch. There is also the dairy bonus.

Bennett says it can even be argued that because we are now building larger, higher-specification homes, property will always remain above the old historical ratios.

Bagrie sees light for hope, as well. Immigration may take off again. The recession looks likely to be short.

Rising wages could eventually help bring New Zealand homes back into the affordable range. But really, he admits, because markets are never completely rational, what happens next remains anyone's guess.

For the moment, we should perhaps just look back and marvel. That last property boom was quite a ride for those who caught its wave.

Worth more, spending more

How big is the wealth effect? If the price of your house is going up, how much more do you go out and spend?

Research suggests it starts out at a modest 2 per cent, but after a few years as you get used to the idea of sitting pretty on an appreciating asset it grows to as much as 9%. So if the value of your house went up by the median figure of $32,000 each year, that meant you began by spending $640 of the capital gain and ended up spending $2880.

Enough for an extra holiday or wide-screen TV at least.

The boomer effect

If you want something else to worry about when it comes to house prices, what about the baby-boomer retirement peak of 2010?

In a couple of years, the first wave of those born in the aftermath of World War 2 will be reaching retirement age.

If they all decide to cash in their properties at the same time, selling off rental investments, downsizing to more sensible dwellings, taking off on overseas adventures, there could be quite a glut of homes on the market.

Graeme Kennerley, a Christchurch property developer who sold up early to fund his own three-year world trip, argues prices may more than halve because of this. Certainly, it could be a new factor dampening any recovery a few years down the track.


The Press