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Opinion: Housing affordability problem to re-emerge as interest rates rise
October 28th, 2009
By Rodney Dickens
In a February 2009 report I looked at how section prices had increased more than existing house prices between 2002 and 2008 and suggested that section prices would need to fall relative to existing property prices to restore the competitiveness of house and land packages.
In general section prices have fallen since February but not by more than house prices, although we are now seeing section prices fall relative to existing house prices via house prices increasing relative to section prices (see the charts below).
In our property research this year in different parts of the country we have found five developments:
(1) in some segments of some markets section prices have fallen significantly, partly associated with mortgagee sales and more the case in some coastal and resort markets;
(2) numerous examples of developers trimming 5-15% off prices for sections;
(3) two cases in parts of Auckland where a developer recently put up asking prices in response to the market starting to tighten;
(4) cases of developers not dropping carded asking prices but doing selective discounting or deals, often with builders; and
(5) cases where developers felt they were in monopoly or pseudo-monopoly positions and have not dropped prices but are instead waiting for demand to recover enough for people to pay the asking prices.
The last development is probably why the national average section price didn’t fall relative to the national average house price during the downturn despite the demand-supply balance in the section market suggesting it should have.
The upturn in new housing demand we have been predicting for some time in the monthly Building Barometer reports is unfolding and feeding a sharp upturn in section sales. I have also written about the prospects for a stronger than generally expected upturn in new housing demand in a previous Raving. Part of the upturn is being driven by the lagged stimulus from the large interest rate cuts. The massive cut in interest rates has gone a long way to temporarily restoring housing and section affordability, but without dealing with the underlying problem (i.e. house and section prices being unsustainably high relative to incomes).
The upturn in demand is also partly driven by stronger net migration, with higher population growth inevitably meaning increased new house building and more section sales, but again without solving the underlying affordability problem.
In our regular Housing Prospects reports we have consistently warned our clients of a two stage adjustment in house and section prices, with the first stage, which is dominated by falling actual prices, now over. The second stage, which we expect to be a long and winding path, has started with house prices rising, which is helping to improve the competitiveness of house and land packages.
Builders have also put in some sterling efforts to get new housing costs down, although the introduction of double glazing and some other developments, including increased council charges in some places, has reduced the ability of builders to cut house building costs. However, the underling poor economics of house and section prices is just being disguised by low interest rates and a temporary cyclical rise in housing demand driven by net migration.
If our analysis of economic growth and interest rate prospects contained in the monthly Interesting Times reports and our analysis of net migration prospects contained in both the Housing Prospects and Building Barometer reports are close to the mark, the affordability challenge will re-emerge next year in response to rising interest rates and a cyclical fall in net migration.
Housing and section affordability from an international-competitiveness perspective
In our regular pay-to-view reports we look at house and section prices relative to the likes of incomes and rents to assess the underlying value, and we include the impact of interest rates to help assess affordability. However, it is also interesting to look at NZ house and section prices from the perspective of the international competitiveness of NZ firms (i.e. from the perspective of the impact especially section and land prices have on the international competitiveness of the NZ economy).
NZ is a small, export-orientated country a long way from many of its main markets. It is also a country with a low population density meaning one of its major competitive advantages should be cheap house and section prices. Housing is a major part of the cost of living, and it would seem a crime if NZ was uncompetitive in housing costs. Section prices are a key driver of new housing costs, with the charts above showing the relationship between section prices and house prices. So it would be a crime if NZ section prices were expensive relative to section prices in our major trading partners.
The charts below provide some frightening insights into NZ versus US housing affordability. The left chart shows the REINZ NZ median house price (black line) and the Realtor US median house price converted to NZD using the spot NZD/USD. Based on the current exchange rate the median NZ house costs 43% more than the US median house! This compares to early this decade when the NZ median house cost around half the US median house, when both were considered in NZD.
However, the NZD/USD has a habit of swinging wildly, which can temporarily distort the picture. Consequently, the right chart shows the REINZ NZ median house prices relative to the Realtor US median house price with the latter converted to NZD using the post-float average rate of US 60 cents. Even when the post float average NZD/USD is used the NZ median house price still weighs in at 20% more than the US median house price, while early this decade the NZ median price was around 30% below the US median price in NZD.
How can a small, export-orientated country facing huge disadvantages because it is half a world away from some of its major markets expect to be competitive when housing costs 30% more than in the US?! We don’t have historical data on US section prices, but just as is the case in NZ, there will be a distinct link between US house prices and US section prices (i.e. US section prices will also be distinctly cheaper than NZ section prices).
Of course, we can debate whether NZ house and sections prices are artificially and damagingly high or whether US house and section prices are ludicrously low. The short answer to this question, as justified in the Housing Prospects and Building Barometers reports, is that NZ, not US, house and section prices are the ones that are out of line with the likes of incomes and rents. However, this doesn’t mean the problem will disappear any time soon. What is clear to me is that the speculative bubble in house and section prices has defused in the US, while it is still a work in progress in NZ.
In August 2009 the average UK house price was GBP 155,968 according to the UK Land Registry. This converts to NZ$340,829 at the current spot NZD/GBP and to NZ$434,451 using the post-float average. This compares to a NZ median price of NZ$350,000 based on the REINZ September 2009 data, which at face value suggests NZ is cheap in comparison to the UK.
However, comparing the UK to either NZ or the US is problematic because it has a much higher population density. NZ has a land area of 270,500 sq km and a population of just over 4.3m (i.e. around 16 people per sq km), the UK has a population of approximately 61m in a land area of 244,110 sq km (i.e. around 250 people per sq km), while the US has approximately 307m people spread over 9,158,998 sq km (i.e. around 33.5 people per sq km). Of course adjustment should be done for land that cannot be occupied, like deserts and mountains, but even after this adjustment the UK population density would dwarf that of NZ meaning land prices should be significantly higher in the UK even before allowing for it having a higher average income.
The same problem exists when comparing NZ and Australian land prices. The Australian land area is 7,692,024 sq km, meaning 2.9 people per sq km based on 22m population. However, with only around 10% of Australian land being arable versus around 50% for NZ (assuming we can believe what we find out from Google searches), the population densities in NZ and Australia aren’t too different if calculated based on arable land.
The median Australian section price in the June quarter was reported to be A$174,000. This converts to NZ$213,324 at the current NZD/AUD exchange rate, which is below the average rate for the last 10 years, or to NZ$204,705 using the average NZD/USD over the last 10 years. At face value this seems high relative to the NZ median section price of $170,000-175,000, but with Australian incomes reported to be around 25% higher than NZ incomes it is eye-ball with NZ section prices on an income adjusted basis. However, Australia, like NZ, is listed as one of the markets that is “severely unaffordable” in the latest Demographia study.
Demographia is an international organisation that among other things provides annual insights into housing affordability in developed countries including NZ and Australia. The 5th Annual Demographia International Housing Affordability Survey: 2009 was released early this year. New Zealand is among one of the markets that is “severely unaffordable”.
As Dr Shlomo Angel says in the introduction to the latest survey, “Wendell Cox and Hugh Pavletich repeatedly remind us of the causal connection between land supply restrictions and housing affordability in their annual surveys.” Hugh is based in Christchurch and oversees the NZ survey. He is constantly campaigning for more affordable section prices in New Zealand, with the key issue being around land supply restrictions and the need to free up more land for Greenfield residential development on the fringe of existing urban centres.
‘Smart growth’
We see councils as having played a part in driving section prices to unaffordable levels in some parts of the country. In one extreme case the total fees paid to one council associated with subdividing new sections is around $50,000, which makes providing affordably new sections laughable.
The “smart growth” philosophy adopted by some councils has contributed by limiting supply increases (this seems to be relevant to the two Auckland subdivisions we are aware of where prices were increased recently). Councils have a major financial headache with infrastructure costs that is making them less inclined to rezone new Greenfield areas for residential development.
However, we believe councils need to seriously rethink trying to recoup full infrastructure costs up front from developers/section buyers versus on a drip feed basis from ratepayers. We see a competitive advantage being available to councils that can take a lead on this issue (i.e. the ability to compete population growth away from neighbouring councils that are wedded to the flawed/dubious “smart growth” philosophy).
However, part of the issue relates to the scramble to land bank on the fringe of urban areas during the 2002-2008 boom and the associated high raw land prices some buyers have paid. The high prices paid by some investors/developers during the boom years limit their ability to supply sections at the sorts of prices we expected to be needed to achieve significant sales over the next several years (i.e. assuming interest rates increase roughly as we expect and the recent upturn in net migration abates).
The problem in parts of the country is that the land market isn’t a competitive market in the true economic sense. In some places, a relatively small number of people/firms own much of the subdividable land and quite understandably they are not keen to cut asking prices where they have monopolistic or pseudo-monopolistic positions. Where this situation coincides with a council wedded to smart growth (i.e. focused on trying to squeeze people into higher density housing that many don’t want to live in and generally doesn’t stack up on a cost effective basis), there is a recipe for “trouble at the mill”.
The long arm of the law (of economics)
The wonderful thing about economics is that it works, even if some of the laws of economics can take a long time to come home to roost. This can be the case in the property market when vendors respond to an adverse demand-supply situation by opting not to sell rather than sell at lower “market clearing” prices. This happened in the Auckland CBD office market after the 1987 share market crash, with no properties selling for two years after the crash. However, the laws of economics are patient. Where section/land asking prices are too high the market will respond with lower sales than hoped for by would-be vendors.
_________________
* Rodney Dickens is the Managing Director and Chief Research Officer for Strategic Risk Analysis (SRA), which is a boutique economic, industry and property research company. Rodney produces regular free reports on topical issues and on specific property markets. Find out more about SRA here and sign up to SRA’s free reports here.
Tags: House prices, Land prices, Rodney Dickens, Section prices, Strategic Risk Analysis
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October 28th, 2009 at 2:20 pm
“and it would seem a crime if NZ was uncompetitive in housing costs”
yes – it is a crime what we pay for property. And who are the criminals responsible – REAs, banks, and investors. But most of all continual APPALLING govt policy designed to foster and continue the bubble on the back of tax payer largesse and selling out of the NZ lifestyle. The only word for it is greed.
October 28th, 2009 at 2:43 pm
Jimmy, if you were nearing retirement and wanted your savings to last at least as long as you do, and you think you might last another 20+ years, where would you put your savings?
October 28th, 2009 at 2:47 pm
The title of this piece seems rather nonsensical – affordability problem to re-emerge?
I was unaware that the problem had ever gone away.
October 28th, 2009 at 2:47 pm
Better than dropping 30% as some crystal ball experts forecast.
October 28th, 2009 at 2:50 pm
Jill
Hang in there. Rodney is saying we need to wait for inflation and income growth to do its nagging work.
You prepared for a couple of decades of minimal capital gains?
cheers
Bernard
October 28th, 2009 at 2:54 pm
jill thinks you’re an expert , Bernard . Better give her one of those jobs in the office ! ( see the men’s clinic about the crystal balls ….. ouch ! )
October 28th, 2009 at 3:34 pm
ROFL Roger!
Bernard, seriously, if you bought a house at the start of the year (as I did) and it dropped in “value” by 30% due to inflation and income growth over 20 years, you are STILL making money!!! Let me explain…
House value now: $100
House value in 20 years adjusted by inflation of 2.5%: $164
House value in 20 years with your 30% drop: $134 (ish)
Profit on BANKS money, assuming your interest costs are no more than what your rent would have been: $34
So, those of us who are buying a house to live in, rather than an investment, are winners, assuming the mortgage is not costing anything compared to renting costs! WOOT
October 28th, 2009 at 3:40 pm
Bernard, at the rate the councils are going with their parks and services contributions, resource/building consent fees and compliance costs, I’m expecting property prices to increase 30% not decrease 30%.
The interesting thing will be when the councils go to upgrade all the tired mains and sewer pipes and find they need to increase capacity rates as the average 2.5 person/house has doubled or tripled. The reason being is the average owner is filling their house with boarders or tenants are maxing out with flatmates to cover the rent increases all because of the increase in rates.
But I might be over exaggerating 14%. :-p
October 28th, 2009 at 3:44 pm
Good work.
Housing affordability is a big big problem for this country. We should have some of the cheapest housing in the developed world but no we have massive over investment in housing in terms of input and serious economic loss to other parts of the economy. The pricing is insane relative to incomes the social cost huge with the bottom end and young of society being absolutely screwed and probably contributes to elevated crime rates and poor family formation. The role in this by many councils is a national disgrace. In Christchurch the CC is involved in social engineering trying to force large numbers to live in the crime ridden inner city. They keep restricting new zoning forcing up land and housing costs and consequently the city has some of most expensive housing in the world on a per income basis. Christchurch is the size of couple of bigger city suburbs, a large country town with land for miles nobody lives in NZ by international standards. This combined with poor infrastructure planning and maintenance, developers joining into the restrictive zoning game excess credit many young and poor people in this country are screwed. Large tracts of land should be rezoned with a use it or loose it tag.
National promised action during the election where is it.
October 28th, 2009 at 3:53 pm
I’m with Jimmy on this one, it is greed. And J.S. is right, if one can exploit then one will.
I’d be curious to know how many houses will be dumped by Politiician’s between now and changes in land/capital gains tax. They must be selling like crazy
October 28th, 2009 at 4:02 pm
colin, u must be new to this blog!
Go back to the history section of the blog spend a few hours or days reading previous comments….
Tho good to see more ppl waking up to what is happening to this country’s housing RORTE brought on by
*Greedy Banks
*Greedy Smart Property Investers (spi ‘es)
*Greedy Real Estate Agents (Agents)
*Greedy Politicians
*Greedy Councils
October 28th, 2009 at 4:04 pm
Picking up from another thread the, Kristian J, that process in your last paragraph would make it ‘the chimps selling to the chumps….”
October 28th, 2009 at 4:10 pm
colin…”action” ….we got action from National didn’t we!…I mean to say, they got down to churning out the spin and BS with gusto…must have heard the ’strategy’ speech a dozen times by now…even that old coot Brash has been wheeled out to be the poster boy for change and rebalancing the economy…what more could we expect, from National?
October 28th, 2009 at 4:15 pm
Good one Rodney.
I particularly likes the US comparison. My only caveat is the US is like a couple of dozen different countries. But … in the early 1990s I sold a house in Nelson for NZD$170,000 and bought one in Texas for USD$24,000. They were not quite comparable in quality, but not far off. However, at the time a similar house in California was more like USD$500,000.
There is a lot disguised in the range of figures, but the fact is the “authorities” don’t seem to care and think asset prices going up is a good thing. The real estate chaps are only exceeded in their hype by the stock market types. Why is it a good day on the sharemarket when prices go up? It would only be good if dividends went up and prices went down.
Anyway, what’s to be done? The average city councillor wouldn’t understand the argument would they? They like to build sports stadia. Why can’t those who want them afford to build them themselves without everyone being forced to? Sod the Rugby World Cup I say. What a waste of resources. There should be a regulation against that.
October 28th, 2009 at 4:24 pm
Roger Witherspoon Says: “Why can’t those who want them afford to build them themselves without everyone being forced to?”
That is a pretty lame thing to ask. If your rates were not spent on sports grounds and arenas we wouldn’t have any sports would we. Should we “Sod” Soccer, Basketball, Hockey, Ice Skating, Swimming, Track, Cycling etc etc as well???
What about roads? If someone does not own a car, and walks to work, should they not have to pay for the roads? What about parks? The list goes on…
Lets “Sod” them all eh?
October 28th, 2009 at 4:26 pm
Hi Roger,
I agree about the Rugby World Cup. What a complete and utter waste of resources and taxpayer money. We’d be better off developing world-class football (soccer) players who can earn the country some decent tax receipts by playing in the European leagues and endorsing Gillette razors.
October 28th, 2009 at 4:28 pm
I was doing my best to be provocative. The point is councils will waste the money they charge developers on pet projects that only a minority use. Also the people that want these things should be able to pay for them.
October 28th, 2009 at 4:31 pm
Bernard in fairness to you ,i was really thinking of a guy called Keiran.cheers
October 28th, 2009 at 4:32 pm
A good read from PIMCO, via Businessspectator, Roger Witherspoon; the body of the article touching on a couple of your points. Bill Gross explaining why interest rates are to stay at zero for some time, while asset prices ’stay put’ to catch up with the $10trillion that the productive economy has fallen behind asset price escalation over the last 50 years. Skip the first bit if you don’t want a fear of aging to get to you !!!
http://www.businessspectator.com.au/bs.nsf/article/economy-of-errors-pd20091028-x8sxf?opendocument&src=blb&
October 28th, 2009 at 4:35 pm
Osty,
Small problem here
“House value now: $100
House value in 20 years adjusted by inflation of 2.5%: $164
House value in 20 years with your 30% drop: $134 (ish)
Profit on BANKS money, assuming your interest costs are no more than what your rent would have been: $34″
Based on current rental market you need about a 50% deposit to make your interest payment as low as the equivalent rent after allowing for rates and maintenance.
So I have invested your $50 deposit instead in a bank deposit at 5% for 20 years and the magic of compound interest gives you at least $130 extra at the end.
Only if you want to rent for the next 20 years but that is a personal decision not a financial one.
October 28th, 2009 at 4:40 pm
Osty,
‘those of us who are buying a house to live in, rather than an investment, are winners, assuming the mortgage is not costing anything compared to renting costs’
I agree that it makes sense if you live in it and the interest is less than the rent, but the interest is almost always more expensive than the rent. And it’s worth accounting for the rates, insurance and maintenance.
Check out our rent or buy analysis here. http://www.interest.co.nz/HLA/Rent-or-buy-NZ-October2009.asp
cheers
Bernard
October 28th, 2009 at 4:41 pm
Jill
No worries.
Cheers
Bernard
October 28th, 2009 at 4:41 pm
Being cynical today, but isn’t it simpler to say – house prices have risen a LOT more than incomes = become less affordable?
Do we have to compare to other countries to see that?
I am trying to get my head around a thought. If CGT is introduced, landlords try and fail to increase rents (assuming rents are market not individual house based), they sell due to large losses, house prices fall? Less available houses to rent, but more affordable to buy. Are we better off? Is this too simplistic? Why does my head hurt still?
October 28th, 2009 at 4:45 pm
Too much effort into trying to do your bit to reduce the wine glut, Novo.
But you’ve nailed it! That, as I posted a few days ago, is what happened initially in Sydney 25 years ago, when they made CGT/Negative gearing changes. But it all ‘normalised’ to where it was before. ie: tenants pay the maximum that they can afford regardless of the financial calculations of the landlord.
October 28th, 2009 at 4:46 pm
Roger how does the LGA set out how development contributions can be gathered? the answer to that might rectify your statement.
Simon7 you left everyone off the list. Everyone is Greedy [noting there will be an exemption somewhere]
How does one get rich? They screw someone else whether it be in this country or some poor sod in another.
So to become rich is to be greedy and selfish by definition. Why should a dentist, journalist, accountants, economists, surveyors, builders charge so much?
Ever thought what it would cost if you had to dispose of your own poo’s, source your own water, build your own roads, provide your own parks, light you own streets, provide you own library, employ someone to complain to if your neighbour is too loud/smelly/dirty etc etc the list goes on……. all for 50 buxs a week……mate you guys really need to prove your intelligents as I am not seeing it!
Want cheaper sections and housing, cut services/standards and standards of living and lets just get on with it and do not complain about it.
October 28th, 2009 at 4:50 pm
Roger, have you even thought about the economic benefits of a stadium resource, or even the social benefits from promoting a sport? To say “the people that want these things should be able to pay for them” is a bit silly if you ask me mate.
Oh, and the people that use a stadium WILL pay for a large chunk of it, via admission prices, subscriptions, advertising etc etc.
It is like anything in society. The dodos who don’t use something want to kick up a stink about how they shouldn’t have to pay for it, but they are happy for everyone to contribute to something they use themselves.
For example, should I have to pay for facilities relating to sports that I don’t play? Yes, because I get a benefit from the economic and social boost that each sport has in the area that I live in.
October 28th, 2009 at 4:50 pm
Thanks Harriet,
That was a concentrated read by someone who looks at these issues from a much more sophisticated level.
There seems to be a bit of groupthink on this site that a capital gains tax is the answer to all ills. I keep trying to point out that the economies with the worst problems already have this. My command of the rich expanse of the English language is obviously inadequate as they still think CGT is the bees knees. Believe me it IS NOT. It is a nasty bastard.
I like Rodney’s article because it shines a new and subtly different light on the subject: international competitiveness is prejudiced. Very interesting.
October 28th, 2009 at 4:50 pm
Novo,
“Do we have to compare to other countries to see that?
”
No we dont. And you need to be careful not to compare bad with bad, because then bad looks normal. Thats why I dont like comparisons with Aus, they have a worse bubble than us. US is a good comparison because there price v income are back to where they should be thanks to a much needed housing crash which they should be celebrating.
October 28th, 2009 at 4:55 pm
Hickey,
Nice info on the rent to buy figures. Are you bringing that out each month?
Are you able to mass mail it to every inbox in the land of the long white weatherboard home?
October 28th, 2009 at 4:55 pm
Maybe the headline could read “US houses 30% undervalued compared to NZ prices”.
End of the day they can’t be that over-valued as people are still buying them at that price, so surely they’re bang on the going market rate.
October 28th, 2009 at 4:55 pm
Osty,
My point is that people should be able to afford to pay for the things they use.
Rodney’s point is that our international competitiveness is compromised by our high house prices.
So we earn less, and so are unable to afford to pay for the things we use.
October 28th, 2009 at 5:00 pm
@ Logical Dave – I don’t see how you need a 50% deposit given current house and rental prices. For example, a $350k house may rent for $320 pw. For $320 pw you can afford a mortgage of $238k given a 7% interest rate. That is a 32% deposit. This will result in about the same profit after 20 years each way.
@ Bernard Hickey – Yes you are right, you have to account for insurance, rates, fees etc etc. However, given the satisfaction one gains from owning their own home I would rather own any day…
Also, as you pay off your mortgage, the interest cost reduces and so the balance swings.
October 28th, 2009 at 5:03 pm
Roger,
So a complete “user pays” society would be better? To some extent I agree with you, however, you cannot have “user pays” for everything. At some point it becomes ridiculous LOL. Also, who would support any sport if a ticket cost $500 to an average game? Surely there is a “for the better of society” aspect to it.
October 28th, 2009 at 5:04 pm
RDee – I think people are snapping up houses in the US currently because they can AGAIN get 110% mortgages… Silly US.
October 28th, 2009 at 5:09 pm
Osty,
As I said, I was trying to be provocative. I don’t know where the line is and I’d far, far, far rather live in NZ than the US.
I think the point I was trying to make was that there is a problem with our ability to pay for stuff. Which is, in a roundabout way, what Rodney was saying.
October 28th, 2009 at 5:11 pm
Osty,
Point taken about the percentage deposit but the “opportunity cost” of your use of the deposit is almost without exception left out of the equation.
Remember also that to pay back the mortgage you need the extra income to cover the capital repayment and that also has its own OC.
I have an acquaintance who is very well off and has never owned his own house or any non commercial property.
October 28th, 2009 at 5:17 pm
So if land is not really being made at any great rate relative to human timespans, then by supply and demand prices will continue to rise?
Maybe we just need less people, that will result in cheapers sections and houses.
October 28th, 2009 at 5:20 pm
Bernard,
I think your rent or buy analysis is excellent.
I have one nagging doubt about the assumptions though. You are comparing median rent against buying a first quartile house. Is this appropriate? Are you sure you haven’t unwittingly fallen into the trap of assuming renting is worse than buying?
I see comparing median rent against median house price would not be right either as more rented houses are lower in value.
Someone I know rents a $650,000 house for $540 a week. It is brand new with double glazing and tiled bathrooms with underfloor heating. He wants to buy but has a problem – a house costing the same per week is unacceptable to his dearly beloved!
October 28th, 2009 at 5:30 pm
@ Roger – “He wants to buy but has a problem – a house costing the same per week is unacceptable to his dearly beloved!” – oh, I hear you on this one!!! I rent a $450k house for $390 a week – I shudder to think what $390 a week would buy me. Something I could barely move in, or something I wouldn’t let a dog live in.
To that end, I no longer want to buy
October 28th, 2009 at 5:57 pm
Thanks Veedub,
It’s not just the standard of accommodation, it’s the neighbours.
A median rented house is probably in a reasonably decent area. A first quartile house is probably not. That is my problem with Bernard’s valiant effort.
Not being large and muscly, covered in tatts and the proud owner of a pit bull for protection, I have a predjudice against first quartile housing. It’s not the housing you understand.
October 28th, 2009 at 5:59 pm
Roger, and further to your comment, there are even more factors to consider. The rent vs buying comparison changes rapidly in different parts of New Zealand so you must take the analysis lightly.
October 28th, 2009 at 6:09 pm
Yes, the curse of averages you might say.
On your argument in favour of buying, I think the certainty of return is important. The return is the place to live in, pretty important. The monetary value of that is hard to capture, but the rate of interest the bank charges is a reasonable estimate in my mind.
October 28th, 2009 at 6:17 pm
Hi Bernard
Your calculation of home affordability on the BNZ site uses nominal interest rates, not real interest rates. However, the inflation component of interest payments should be classified as savings, not as a cost of housing. This is the standard economics approach to the treatment of inflation component of interest payments, because inflation is eroding the real value of the debt, even though most measures of housing affordability in NZ persist in using headline nominal interest rates.
If inflation in the next two years is 1.5% per annum – likely an underestimate given recent history – the inflation component of interest payments in your calculation is 1.5%*$200,000= $3000 per year, or approximately $60 per week. This reduces the financing cost of buying the housing by 4.5% of weekly income, to 22.7% of income – more or less the same as renting.
It is true that if you buy a house you have to find the extra $60 per week now, and this may cause cash-flow problems. But that $60 is properly counted as saving, and should not really be counted as a financing cost.
Incidentally, if you calculate a real housing affordability index (using real interest rates, not nominal interest rates) it has scarcely changed in the last year, because the decline in average nominal interest rates to date has largely reflected the decline in headline inflation. The nominal affordability measure has improved, however, as inflation has come down, because the inflation component of interest payments (which is saving) has reduced. As such, much of the improvement in housing affordability is misleading – just as much of the worsening in housing affordability (as measured by the nominal measure) between 2005 and 2007 was misleading. In both cases, much of it was driven by changes in the inflation rate. It should be noted that both real and nominal affordability measures are still about 20% higher than than their 20 year average.
regards
Andrew Coleman
pecunia non olet
October 28th, 2009 at 6:46 pm
Roger Witherspoon: First-quartile area also means awful schools. Solution: buy first quartile in second/third quartile area, put in some elbow grease, expect functional (warm and dry, neutral and secure) not flash. Result: interest, rates and insurance = less than rent.
October 28th, 2009 at 7:07 pm
Hi Andrew,
That’s an interesting point you make about using the real interest rate over the nominal interest rate in the calculation to measure affordability. This may be a stupid question, but given that the rate of inflation is relatively arbitrary (correct me if this is erroneous), would accounting for it through “officially reported” figures necessarily give a better indication of affordability? I know this is probably a silly question but I’m interested to know what people think.
October 28th, 2009 at 8:13 pm
I think the more confusing it can be made, the better for Bill and John, the chance for them to paint a picture of affordability being oh so great, would cheer them up no end.
October 28th, 2009 at 8:20 pm
Andrew Coleman and J.C I would of thought if you use real interest rates you would have to use real incomes as well because inflation reduces both debt and incomes at the same time.
October 28th, 2009 at 8:23 pm
Wally,
I understanding your feelings about the Dear Leader(s), but I’d also imagine the banks, REAs, Mike Pero, etc. would like to paint the prettiest picture possible. If everyone feels good about themselves, it keeps the wheel of fortune spinning for both the house and the punter.
October 28th, 2009 at 8:28 pm
Kieran,
I also thought about income because it doesn’t really make sense to account for inflation’s effects on servicing debt while completely ignoring its effect on the ability to consume goods and services. And as we all know, inflation doesn’t treat all things equally.
October 28th, 2009 at 8:38 pm
“In August 2009 the average UK house price was GBP 155,968 according to the UK Land Registry. This converts to NZ$340,829 at the current spot NZD/GBP and to NZ$434,451 using the post-float average.”
Shouldn’t you be using PPP in ANY comparison of prices of physical goods? Run the numbers through the Big Mac PPP and see what you come out with
October 28th, 2009 at 8:44 pm
A house should cost like:
1)Subdivision fee(including council fees) 90K
2)Building a 150m2 house 300K, 2k/m2.
so the total cost sould be 390K. Anything more then that should be a bubble.
October 28th, 2009 at 9:42 pm
Fletchers have put up their prices at the Stonesfield development in Mount Wellington yet they are still selling them! Where’s the logic in that?
October 28th, 2009 at 9:44 pm
All affordablility measures should use a medium/ long term average interest rate to give a more realistic figure of what the true interest costs will be. The historic average since 1996 is 8.5% all buying versus renting decisions should be based on that rate not 6.5%
October 28th, 2009 at 9:46 pm
Problem Beat traders is that everyone is greedy and wants to get rich.
It is like saying fish should cost (w) as (w) = bait(x) + petrol(y) + labour (z)
But the problem is someone wants to make a profit(Au) or be paid a profit….for what?
October 28th, 2009 at 10:17 pm
This calculator is a great way to assess renting vs buying given any set of rent, home price,deposit, mortgage rate and rate.
http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html
October 28th, 2009 at 10:21 pm
Look what a pile of crap $870,000 buys you in Mt Eden! Madness!
http://www.raywhiteonline.co.nz/?p=904
October 28th, 2009 at 10:40 pm
Bank Manager,
Based on that price tag, looks like the new owners will need to wait another 38 years to get their money back. insanity.
October 28th, 2009 at 11:05 pm
William: Lovely calculator. Many happy hours to be had. thanks.
October 29th, 2009 at 1:15 am
Mt Eden is booming. Thats for sure
The following link seems to describe a little of what I see going on in Mt Eden and surrounds over the past few months
http://www.reuters.com/article/newsOne/idUSTRE59Q27X20091028
In Central Auckland the animal spirits and speculative impulses are rampant.
October 29th, 2009 at 6:38 am
This is one of the best NZ property articles I have read for some time. It is very well written and backed up by some good hard evidence. Very interesting to see the US comparative stats. There is definitely a lot to think about in there.
Bank Manager – is that article the real thing? That must be some kind of a hoax.
October 29th, 2009 at 7:19 am
If you want to have some real money in twenty years time (or 10 for that matter) then buy a house now! If you had brought a property on the North Shore of Auckland at the bottom of the cycle (Dec 08 / Jan 09) you would have picked up at least 50K already.
October 29th, 2009 at 8:13 am
A close family friend bought an investment house in central Wellington in 2002 – they paid 550k for it. When they bought it, everyone said to them (incl. myself) why buy an old house, put money in shares (they kindly ignored everyone advices!). They did nothing major to the house over the years. Now living in Australia, they recently sold it for 1.35 millions – I guess who’s laughing now…
October 29th, 2009 at 8:26 am
Did I see the report clearly….the 5,10 and 30 year US treasuries all went up…ie the rates lifted and by quite a bit….anyone have a link?
October 29th, 2009 at 8:26 am
Thanks ruru,
Your advice to buy a first quartile house in a 2nd/3rd quartile area is excellent. Basically the worst house on the best street but put differently.
I think Bernard should be comparing first quartile rental with first quartile house purchase though.
The argument about inflation is exactly why owning a house has been the way to go for so long.
The economists tell us that deflation is bad and must be avoided at all costs (actually that is nonsense, LCD TV price deflation has been strong and as far as I’m concerned a good thing). As we all now know most economists should be publically defrocked for not seeing the credit crisis coming. However, that is not realistically going to happen although it should be easy to score them at this point in time.
The RBNZ, who I rather respect, say they will do their best to engineer 2-3% inflation. They are rather bigger than me so I expect they will have their way. Now 3% compounded is a doubling time of 23 years. So I’m for buying in general.
As to when to buy, I’m with Keiran on that – when the delationary forces have done their work and affordability is restored to sane levels. Affordability is the critical link.
October 29th, 2009 at 8:28 am
ginger – property is always better than shares
UK Kiwi – that is typical of what old dumps are selling for in Auckland central. It is fair dinkum. A worse one in Ponsonby just sold for an even higher price.
The housing market is more frantic now than it was in the 2002 to 2007 period – it makes no sense with fixed interest rates well up on 6 months ago but it appears that people/house buyers believe interest rates will come down.
October 29th, 2009 at 8:38 am
Here’s another gem LOL! http://www.realestate.co.nz/1065372?search=bargain
$329,000 in Otahuhu one of Aucklands dodgiest suburbs and rental income of $16,380
That’s a 4.9% return! No allowance for rates, insurance, maintenance!
The agent says If you can paint you’ve bagged a bargain ! Yeah Right
October 29th, 2009 at 8:48 am
And another thing.
What is all this about bad debts at the ANZ rumoured to be $1 billion in NZ, at least half of it mortgages???
October 29th, 2009 at 8:49 am
Clean your ears out you lot and prepare for another jawboning from our Bolly…just minutes away now…will he or won’t he…heads or tails…
October 29th, 2009 at 9:01 am
Leaving the wax in , until after Bollys tirade ( hate the shrill hamster sqeaks ) . Can clear the wax out after , and make some more candles . …… . special order for Bernard . ………… . steady at 2.5 % until second half of 2010 ………. Wax out !
October 29th, 2009 at 9:09 am
The trend is in Roger…by the next jawboning we can expect the wording to be “sometime soon” because Stevens across the ditch is being forced to go again in Nov and Dec. I think once again we have the RBNZ chasing the curve….too late and it will be too little.
October 29th, 2009 at 9:17 am
How much tax did your close friends pay on the $800,000 income they made on their investment property, gingerbreadman?
I’m genuinely interested, because your answer will give a wide audience a perspective on just how lucrative investment property is.
October 29th, 2009 at 9:17 am
I think the authorities usually do far too much, far too late.
October 29th, 2009 at 9:32 am
Also gingerbreadman, let’s just say that your close friends opted to invest in our largest listed company, Fletcher Building, in 2002 as ( as you, also, advocated something simliar). Their $550k would have got them +/_ 350,000 ordinary shares. Today they would be valued at $2.9 mio, and would have had paid a valuable divedend across the run. Did your close freinds get an above costs rental return, consistently, and if not, how did that sacrificed income effect the capital gain that was made?
October 29th, 2009 at 9:47 am
Kieran
You don’t need to adjust incomes for inflation in an affordability index, because you are dividing by a house price index. You could of course use real incomes and real house prices, but as you divide by the same CPI index this amounts to the same thing. You do need to make the extra inflation adjustment on the interest rate, however, or else the component of mortgage payments that is saving (that is, the inflation component of interest rates multiplied by the capital amount) is included as a financing cost not saving.
I don’t quite understand your question J.C. If you are questioning the accuracy of the official measurement of the CPI, there are some concerns with long term biases, but these are reasonably small and almost certainly smaller than the 2.5 average inflation we have had over the last decade.
Andrew Coleman
October 29th, 2009 at 9:50 am
Harriet: I, and I suspect a whole lot of other people, find it much easier to pick a good property buy than a good share. That’s why Kiwis are so hooked on property: we understand it (to a degree).
October 29th, 2009 at 10:02 am
That very interesting about the Fletcher share facts. I don’t own a house and I am unsure if our friend and CGT liablity. However, I assumed most of their 550K purchase price was borrowed – Now, in the same situation if i go to the bank and ask if i can borrow 550K to buy shares – I suspected that they probably have a good laugh and ask me to try again. What I am getting at is that one must have lots of cash to buy shares.
October 29th, 2009 at 10:13 am
I understand your comment, GBM, but then conversely, one must assume lots of debt to buy a house. I have no problem with well managed and responsible debt, but debt stack-ups ( using the increasing equity in one asset to leverage up to buy the next etc), I believe, are fraught with disaster if the fundamental investment descision is flawed. ie: the income does not match the expenses.
I have nephews, who in their early 20’s, are- as we speak- charging headlong into the Auckalnd property market with NO IDEA of the sorts of matters we are discussing here. That concerns me. However they do have 50 years to either enjoy the benefits of their “investment”, or to recover from the implications.
October 29th, 2009 at 11:33 am
Nice cherry pick on one company Harriet.
The couple before could have brought Telecom, which seemed to have a share proce of around $4.50 around then (Blue Chip Company, Largest company on the market) . At $2.55 thats a loss of 56% and be left with $311K. A loss of $239K excluding dividends.
Of course you will say that no one buys one share and you should buy a portfolio of share and spread the risk. If you did that I would be very surprised that you make $800K without been an extremly talented active trader (or have the benfit of hindsight.) I would be interest to know what a unit trust return would be from 2003 to now.
The couple could have put that money into finance companies too, which would have likely lost them a huge amount.
The fact remains that been highly geared and buying property in 2002 was an extremely smart decision and your attempt to say otherwise is based solely on your sour grapes and your dislike of the housing market.
Whether this holds true for the future is open for debate (I don’t believe it is, but then I missed the boom in 2002)
October 29th, 2009 at 11:39 am
arctor,
“The fact remains that been highly geared and buying property in 2002 was an extremely smart decision and your attempt to say otherwise is based solely on your sour grapes and your dislike of the housing market.
”
i think the word you are after is “lucky”. There would have been NO industry commentators predicting such excess as we have seen and continue to see. How do you predict bubbles? Bubbles are irrational and irrational behaviour is impossible to predict.
“Whether this holds true for the future is open for debate (I don’t believe it is, but then I missed the boom in 2002)
”
It was probably up for debate in 2002, whch is why I use the word “lucky”.
October 29th, 2009 at 11:49 am
Yeah I believe it was luck for most people. And it was open debate for 2002 and I didn’t think it would happen (I was wrong.)
However there was a large amount of people who recommended buying a house at that time. Some people here refer to them as idiots because they make comments that property will also go up and the only place to make money is in houses. Regardless of whether this was luck, these people have been proved right for that decision (hence time has preoved it as smart.)
Meanwhile a whole lot of industry commentators have been proved wrong (with 30% fall comments, missing the stock market plunge, the dollar now been up round 72 cents.) As a man in the street who do you believe when the thes eleading commentators historic track records are so poor.
October 29th, 2009 at 11:52 am
Jimmy, bubbles are not irrational at all. They are hard to predict before they get going. Check out itulip for some excellent background on bubbles.
Basically a good bubble starts life as a good solid investment that over time attracts more and more attention and more and more debt until the price of the asset is far above the earning ability of the asset.
October 29th, 2009 at 11:56 am
Arctor – you don’t necessarily believe any of them. You do what’s right for you, and be wise with your hard earned money. You don’t over-leverage or over-commit. Make allowances for “rainy days” and be knowledgable about what you’re investing in/taking on. What’s right for one person is not necessarily right for another.
October 29th, 2009 at 12:00 pm
“the price of the asset is far above the earning ability of the asset” – sounds like a house to me!!!
October 29th, 2009 at 12:14 pm
jimmy – I tend to cringe when people tell me I’ve built my equity by luck. Owning property over the years has for me involved taking calculated risks and a hell of a lot of hard work.
Someone once told me that luck is the crossroads where preparation and opportunity meet…..
October 29th, 2009 at 12:20 pm
arctor,
in 2002 it was not silly to buy a house. They were not cheap, but neither were they overly expensive by historical measurements. Now is clearly different. Always look to fundamentals – reality always catches up (even if you have a lame duck govt and RBNZ delaying the inevitable). Remember that yields are much lower now than 2002. This means you need that much more of a capital gain to break even. Given that we have seen record growth in the past 8 years, is that a reasonable expectation?????? I would say not.
October 29th, 2009 at 12:49 pm
“Mummy, what’s a property ponzi scheme”
“We’re living in one dear”
“Mummy, I feel sick”
October 29th, 2009 at 1:57 pm
Jimmy
What is your prediction for rent in next two years?
October 29th, 2009 at 2:04 pm
“If you are questioning the accuracy of the official measurement of the CPI, there are some concerns with long term biases, but these are reasonably small and almost certainly smaller than the 2.5 average inflation we have had over the last decade.”
Andrew,
I’m not so much questioning the accuracy of the CPI, but I’m rather wary of the composition of the CPI and its relevance to a house-buying individual. I’m not trying to imply, as Marc Faber does, that inflation is rampant in some respects (which makes sense given all the stimulus). As I said before, inflation doesn’t treat everyone and everything equally.
October 29th, 2009 at 2:11 pm
Here’s the laugh, Arctor !
I bought my house on 16/9/01, Brand new 431 sq mtr. 10 acres outside Rangiora. Roger will probably know it, cnr Fernside and Flaxton. So, no I don’t have sour grapes at all. I bought it because it made economic sense versus the cost of renting at the time. And I sold up it’s sucessor on 15/2/08, for the mirror image of why I bought in the first place. Renting has proven to be economic ever since.
And I chose Fletchers simply because it’s our largest company and has a relationship to property development. It’s also been mile higher than current market as well. But I do take your point re Telecom.
October 29th, 2009 at 2:15 pm
Joe Blog,
I am expecting rents to stagnate.
October 29th, 2009 at 3:11 pm
Andrew I can’t quite get my head around what your trying to say. Affordability is a snapshot of the percentage of weekly household income required to buy a house with a 20% deposit and a 25 year mortgage, banks don’t deduct inflation from interest rates so it makes no difference in reality infact all so called real inflation adjusted figures are meaningless in the real world.
I agree with arctor, murray & ruru property can be an ok investment if it gives you a positive return but using negative gearing is far riskier than shares. If share prices drop 20% then you lose 20% if property prices drop 20% (and they could) you lose everything and more which is why shares are a safer investment you don’t need massive debt and you don’t have to put all your eggs in one basket.
October 29th, 2009 at 8:11 pm
Hi Kieran,
The issue is the converse of what happens if you lend money. Suppose inflation is 2% and nominal interest rates are 7%. If you lend $1000, you earn $70 interest, so at the end of the year you have an IOU of $1000 and $70 cash; but $20 is to compensate you for the loss of purchasing power of the initial $1000. Your increase in real purchasing power is $50 so the real interest rate is 5%.
From the borrowers point of view, they make a payment of $70, and then have an IOU remaining of $1000. In real terms, this is only worth $980; if they get a 2% wage rise (which most people do when the inflation rate is 2%) it takes 2% fewer hours work to pay off the debt. This reduction in the real value of the debt is counted as saving. You can think of the payment as $50 real interest, which reduces the nominal debt to $1020 (which has real value of $1000, the same as at the start); and a $20 payment that reduces the nominal debt to $1000, or $980 in real terms. The additional $20 is saving. The SNA (System of National Accounts) rules recommend that the inflation component of interest payments be treated as saving in the national accounts, although Statistics NZ does not make this adjustment. (Surprisingly, Treasury doesn’t adjust saving figures for inflation either: in the last couple of years, this adjustment has been several billion dollars, and has been larger than the official saving figure.)
You are right that Banks don’t distinguish between nominal and real interest payments. But when calculating housing affordability, you should treat the inflation component of the interest payments you make as saving. It is true that you have to make the payment every fortnight, and this can be difficult. But a large chunk of that payment is saving, just as if you had put the money in the bank. For this reason it should not be counted as part of the financing cost of buying a house.
This analysis is completely standard. One of the main earlier advocates of it was the Nobel winning economist, Franco Modigliani, who coined a name for it “mortgage tilt”. I don’t know why real housing affordability indices aren’t more popular in NZ, but there you go.
Incidentally, I have a 2008 paper investigating the mis-measurement of saving in NZ because of inflation on the Motu Economics website, http://www.motu.org.nz. Also on that website are a couple of papers arguing that the government taxation of the inflation component of interest rates is the root cause of many of the problems in the housing market. In my view, taxing the inflation component of interest income is one of the silliest things the government does to distort saving decisions…. but that is a different story.
After