The tide has turned on the housing tsunami

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Lodging

The recent housing policy will help balance the real housing needs of society, but it will do little to meet the demand for investment in housing. Michael Rehm looks at some long overdue solutions.

Comment: Warren Buffett joked “you don’t know who swam naked until the tide went out”.

During the Covid-19 pandemic, the tide has died down in New Zealand property markets and exposed throngs of skinny speculators. Foreclosure-weary homebuyers were filled with cheap credit and frolicked naked in the waves. National housing prices increased by 45% between the start of the pandemic and December 2021.

That month, the tide turned and a financial tsunami hit in the form of amendments to the Credit Agreements and Consumer Credit Act (CCCFA) and rising interest rates. With real estate prices in full reversal, market analysts are reading their tea leaves for explanations.

The Covid-19 experience has pierced most theories about what drives house prices while providing an illustrative natural experiment on how bank credit manipulates housing markets. Despite this, many analysts remain obsessed with land supply as the main failure of the housing market, as noted in the government’s recent report titled “Assessment of the Housing System”. However, exorbitant land prices are a symptom, not a cause.

A vacant residential section on its own has very little use or use value until you place a house there. When a real estate developer bids on raw block land, their calculation begins with the value of the homes that will occupy the paddocks in several years. The price paid for the land reflects its residual value after deducting infrastructure, construction and other development costs from the projected sale prices of the houses. Interestingly, the banking puppeteers of the housing market are timid when it comes to financing land, often limiting the supply of credit to 50% of the loan-to-value ratio.

However, once a completed dwelling graces the grounds, the banks open their arms and, with the flick of a key, spout new money from the ether. This new money supply is what allows house prices to defy gravity and fundamentals such as income. Unfortunately for those with significant mortgage debt, when credit flow declines, gravity returns, house prices fall and negative equity looms.

In the same report, the authors refer to housing markets in the United States where the supply of land tends to be less tight and plentiful. In addition to more liberal land use regulations, there is another key difference between US real estate markets and ours. The Kiwis are real estate fanatics and we have given a new dimension to the financialization of housing. New Zealand investors tend to buy between one-third and one-half of all homes transacted. However, Forbes reported last February that US investors took a record share of home purchases – nearly 10%.

Unlike first-time home buyers who must commit to years of diligent savings to secure an adequate deposit, investors can simply recycle their accumulated capital into other investment property purchases. Leveraging unearned capital gains to create new money that is pumped into the housing market has dislocated property prices from fundamentals, not overzealous city planners limiting the supply of land. As my recently published research revealed, such purchases are speculative in nature and target capital gains. Of course, investors are panicking now as capital gains are no longer on the horizon and they face tax bills rather than refunds thanks to changes to interest deductibility rules last year. .

While rents are closely related to income, house prices are not. For-profit banks rely on borrowers’ future earnings and their willingness to lend has changed over time. Masked by swings in interest rates, banks have burdened homebuyers with debt increasingly disproportionate to their income. Despite two rounds of consultation, the Reserve Bank has yet to design or implement a debt-to-income lending limit. Mortgage debt should be tied to borrowers’ income and property speculation should be curbed.

Recent policies, namely the National Policy Statement on Urban Development and the Townhouses Bill, are supply-side solutions. This will help balance the real needs of society for housing and being rooted in a community, but it will do little to meet the demand for investment in housing. Demand-side solutions, such as debt-to-income ratio limits and anti-speculation measures such as the Income Tax Act’s intent test being implemented, are long overdue.



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