Housing hangover not over yet

By GARETH KIERNAN - Sunday Star Times | Monday, 01 September 2008

Earlier this month, the Real Estate Institute trumpeted that their latest data showed "an unmistakeable degree of recovery" and speculated that "if this is as bad as it gets, then perhaps the market is in better shape than we thought".

Reading those statements, you'd be forgiven for thinking that the housing market might already have been through the worst of the downturn. But the REINZ's diagnosis of recovery is grossly premature.

In forecasting house sales activity and, by extension, house prices, two variables explain a good deal of what takes place. Population growth fundamentally determines underlying demand for housing.

Interest rates are a more cyclical variable that affect the affordability of property and buyers' willingness to pay a given price.

Let's look at population growth first, specifically net migration. Since peaking at over 42,500 people in 2003, the net inflow has slipped to its current level of 5200. Almost 20,000 more New Zealanders left permanently over the past 12 months than in mid- 2003.

Growth in migrant arrivals from overseas has been much slower, and more of them are leaving again, together accounting for a drop in net migration of almost 14,000 people.

Economic growth is a strong determinant of people's willingness to either come to New Zealand or stay here. Slow growth is a major turn-off for potential immigrants, particularly given that one of the best ways to meet the immigration criteria is to have a job offer.

Rising unemployment also tends to accelerate the flow of New Zealanders heading overseas.

With New Zealand in a recession, immediate prospects for migration are likely to be worse rather than better.

Decisions to shift country aren't followed through on instantaneously, so even if the New Zealand economy miraculously returned to full health tomorrow, the legacy of the weak economic growth so far this year would weigh on net migration numbers for another six to nine months.

Clearly net migration, or population growth, is not the only driver of the housing market. House sales volumes drifted downwards from 2004 in response to waning migration, but it has taken more than four years before the bottom has really fallen out of the market.

That is where interest rates come in. Changes in interest rates tend to be a catalyst exposing shifts in buyer demand, rather than a fundamental driver of activity over the long term.

After years of angst about the ineffectiveness of monetary policy in quelling the housing boom, interest rates have hit back with a vengeance in 2008.

Global credit market conditions, and their effect on fixed mortgage rates, are probably more responsible for the increase in financing costs and resultant collapse in buyer demand than anything the Reserve Bank has been able to throw at the housing market.

Mortgage rates have been trending upwards since 2004, but it has been only in the past nine months that higher financing costs have exposed an incredible shift in sentiment about the housing market.

Suddenly, the importance of long-term fundamentals has re-emerged - comparing house prices with incomes or rents shows that they're way out of line with historical norms.

Even a substantial drop in mortgage rates seems unlikely to be the catalyst that rescues the housing market from its current malaise.

In our view, high mortgage rates and the dip in net migration are less to blame for the housing slump than the fact that property is simply overpriced.

There are still potential buyers for property out there, but they're not willing to buy at just any price.

So far this year, house sales volumes are at such low levels because very few people are being forced to sell.

However, the "accidental landlords", who have decided to put tenants in their houses that they can't sell at the moment, will run out of patience over the next six to nine months, cut their losses, and run.

Some people, usually with a vested interest, would have you believe that house prices in New Zealand never fall.

That mantra is simply not true. Data on house prices stretching back to 1950 shows the biggest drop in house prices was 5.4% in 1998.

Remembering that, during the previous 60 years, housing has been nowhere near as overvalued or unaffordable as it is now, and unprecedented house price falls seem on the cards.

Experience of the past 60 years tells us that, after hitting a peak, real house prices (ie, adjusted for consumer price inflation) take anywhere between two and six years before bottoming out.

Given that real house prices peaked in June 2007, the "down" part of this cycle will run until at least mid-2009. Price falls will gain momentum over the next year, and an average drop of at least 10% is on the cards. Even then, affordability ratios will still be a long way from "normal" levels.

House prices in the UK are down 13% on a year ago, while American house prices have slumped 19% over the past two years.

House prices in New Zealand were caught up in the global property party from 2002 to 2007. It seems highly unlikely that our housing market will escape the hangover afflicting many other parts of the world given the change in buyer sentiment.

* Gareth Kiernan is managing director of Infometrics.