By Rodney Dickens, MD of Strategic Risk Analysis With summer holidays just around the corner it seemed appropriate to have an overview look at the coastal and resort property market on which we have released over a dozen reports on particular parts of the country over the last two years (the past reports are stored on our website in the Property Insights section). In this overview we look at why a speculative bubble developed in these markets, we look at where we are now in the boom-bust cycle, we look at the humongous affordability challenge facing the next generation of would-be holiday home owners and we look at the big-picture demand-supply challenge facing many coastal and resort markets. We use insights from several parts of the country, including Thames-Coromandel, Queenstown, Taupo, the Western Bay of Plenty and Mangonui-Far North, to highlight the issues or challenges facing the coastal and resort market, especially the section/subdivision segment. The making of a speculative bubble Often it is only generally accepted that a speculative bubble exists in a market after it comes crashing down (i.e. it must have been a speculative bubble because only speculative bubbles are followed by crashes). However, having seen several bubbles first hand, including angora goats, ostriches, mohair rabbits, the US IT sector, the Auckland apartment market and the Auckland office building market prior to the 1987 crash, I believe it is possible to identify whether you are dealing with a speculative bubble well before the crash. For some time it has been obvious to me that the coastal and resort section markets in numerous parts of the country were in the grips of a speculative bubble that would end in tears, so I took it on myself over the last few years to warn all and sundry about this with the hope that those with open ears and open minds would take the warnings seriously and act accordingly. Obviously, not everyone has wanted to hear this message, which is understandable given the number of people whose livelihoods and wealth are tied to these markets.
But trying to pretend there isn't a bubble will prove of little protection when the crash hits town (i.e. forewarned is forearmed even to some extent at this late stage). Speculative bubbles do not happen by accident but are generally a product of a combination of events coinciding, which means they have much in common with recessions and road accidents. In this instance the combination of events include: (1) the RBNZ's experiment with low interest rates between 1999 and 2005; (2) low international interest rates between 2001 and 2006 that fuelled global demand for property of all sorts; (3) above average net migration and population growth between 2001 and 2004; (4) a low NZ dollar between 1998 and 2004 that made NZ property look cheap to international buyers including Kiwis living overseas and Kiwis returning from their OE; (5) NZ's above average economic growth between 2002 and 2005 that created above average income growth for many business owners and employees and thereby increased the number of people who could afford a holiday section/home. This combination of events created powerful fundamental drivers of demand for coastal and resort property in the same why the upturn in foreign student numbers in 2002 and 2003 boosted demand for inner city apartments in Auckland (i.e. speculative bubbles usual start out as cyclical booms driven by fundamental drivers but somewhere along the way a cyclical upturn or boom turns into a rampant bubble). In the case of the coastal and resort section markets the surge in prices driven by this powerful combination of drivers was always likely to attract the attention of get-rich-quick investors. An investor rampage is a necessary prerequisite for a speculative bubble, but a couple of other factors fuelled or facilitated this bubble. Many experienced residential subdivision developers we deal with do not like doing presales. They would rather develop at least stage one of the subdivision so would-be section buyers can see and appreciate the quality, including nicely presented landscapes and tidy verges, and thereby achieve maximum price and return. However, the coastal and resort subdivision boom attracted some new developers, including some who didn't have the coin to proceed without borrowing from financiers, and being risk adverse the financiers often required certain levels of presales before committing to funding a development. In one extreme case we came across a would-be developer who offered to buy land from a farmer, and a condition of the sale was that the developer achieved a certain level of presales before going unconditional (i.e. the sections were being marketed in the paper before the land had even been bought). Presales played a critical role in creating the environment for a perverse demand-supply outcome to develop in many coastal and resort markets. Deposits on presales of coastal sections were as low as 5% or $5,000, while it was common for titles to take 18-36 months to be issued after the deposit was handed over. This meant that investors without much coin could get into the game, especially because they had lots of time to resell sections at a profit before title/settlement. For a while it was common for people to be able to make tens of thousands of dollars profit for an initial outlay of as little as $5,000. In some extreme cases we heard stories of 90% of sections in coastal subdivisions being bought by investors and in some places almost every section in a subdivision reselling before title. The use of presales, encouraged by financiers because it was seen as a way of mitigating risk, enabled a new breed of developers and investors to get into the game, the upshot of which was a level of new subdivision development in some parts of the country that greatly outstripped underlying demand by end-users. This is why when we have undertaken studies of particular coastal and resort markets we have focused on whether supply increases have been funded by investors versus people actually wanting holiday homes for their own use, and on how many investors are in the secondary market trying to sell (visit http://www.sra.co.nz/free.html to view the various coastal and resort market reports stored on our website). The irony is that if financiers hadn't been willing to fund subdivisions based on presales, an environment so conducive to a speculative bubble developing wouldn't have existed, although the backdrop for a speculative bubble of some variety already existed because of the coincidence of strong drivers described above. And just as financiers helped feed the bubble they are now doing their bit to kill the goose that laid so many golden eggs, in part because of funding problems caused by the global financial crisis but even without the financial crisis financiers would have changed their attitude towards lending on coastal and resort property once the inevitable crash raised its ugly head. We used Thames-Coromandel, Western Bay of Plenty Country and Taupo as case studies. They show that in terms of the annual number of sections being sold via real estate agents the bust has already hit town. In the case of Thames-Coromandel, the number of section sales peaked at 476 in the year to September 2005 but has fallen to 101 in the year to October 2008, the lowest annual level since data became available in 1992, while in the last six months only 32 sections have sold. In the cases of Taupo and Western Bay of Plenty Country section sales in the last six months have numbered 28 and 42 respectively (see the Appendix for the list of suburbs covered by these places). But one of the fascinating things about property markets is how long changes in the demand-supply balance take to impact on prices, especially during downturns. While demand for sections has now collapsed in Thames-Coromandel, Western BOP Country and Taupo, median section prices remain defiantly near peak levels. The same is true in Queenstown Lakes, with the annual number of section sales falling towards trough levels, while the median section price remains sky-high. Queenstown Lakes provides an interesting glimpse of what can happen during major downturns in demand. Between the peak in 1996 and the trough in 1999 the annual average of the Queenstown Lakes median section price fell 35% (although we don't know whether changes in the composition of the sections being sold over this period may have biased the result). Mangonui District in the Far North, which includes the likes of Coopers and Tokerau beaches based on the REINZ definitions, is another example of a coastal market that is crashing. A factor hurting the likes of the Far North in addition to excessive subdivision activity fuelled by investor money and tumbling demand will have been the high petrol prices. From a peak of 284 section sales in the year to May 2005 the annual number in Mangonui has fallen to 60 in the year to October 2008 while only 22 sections have sold in the last six months. And in Mangonui's case the crash in demand appears to have started biting prices, with the annual average REINZ median section price having fallen 22% since the peak in July 2007 (although changes in the composition of sales may have impacted on the median price). Again, see the Appendix for the list of suburbs covered in by the REINZ definitions of Queenstown Lakes and Mangonui. So while demand has crashed in most coastal and resort markets we assess that we are as yet a long way from seeing the full impact of this on prices. The current picture is a bit like the little Dutch boy with his finger in the dike, but in this case the dike is starting to spring leaks all over the country and there is no way the little boy can stretch his fingers and his toes to plug all the holes. As covered in our Housing Prospects reports (a must have for any business impacted by the housing or section markets), house prices have become extremely unaffordable while section prices have become even more so. We looked at the national median dwelling and section prices as multiples of the average employees' gross income. At 4x the average employee's gross income last year, the national median section cost not much less relative to incomes than the national median house did prior to the boom in 2001. During the speculative bubble, dwelling and section prices in most coastal and resort markets have increased relative to national average dwelling and section prices. For example, the median section price in Thames-Coromandel was around 1.2x the national median section price in 2001 but peaked at almost 1.7x and in the last year was still just over 1.5x. The optimists have argued that NZ property, and especially NZ coastal property, has only recently been discovered by the world, which is in part how they justify the increase in relative prices. But based on our assessment of the various relevant factors or drivers we believe the increased ratios more reflect an unsustainable boom or bubble in demand for coastal property (i.e. the grinding interaction between demand and supply will bring the ratios down). We conclude that the national housing and section markets face significant downward adjustment in prices while we expect most coastal and resort markets, which have become expensive relative to the overpriced national markets, to ultimately experience more of a fall in prices. The discussion about the affordability of NZ coastal and resort sections needs to be conducted in foreign currency terms, like in US dollars. When we look at Queenstown section prices in US dollars, the annual average median fell 58% from a peak of $69,638 in the year to November 1996 to a trough of $38,062 in the year to September 2001, making them a bargain. But even with the recent tumble in the NZD against the USD the median section price in Queenstown is over US$220,000. Foreigners will not rescue the NZ market. Welcome to the new demand-supply reality From the on-the-ground research we have done in various parts of the country we have identified that investors have in general played a significant part in funding the increased supply of sections, while in some parts of the country like the Far North they have played a dominant roll. This means stocks of sections in numerous coastal and resort markets are now above levels justified by current and at least near-term end-user demand, although the extent of oversupply varies significantly from place to place as we have identified in the reports we have produced on specific parts of the country (i.e. one size does not fit all in assessing either the demand-supply balance or prospect for prices, but there are certainly some themes relevant to all places, with unsustainably high prices being the most obvious). Over the last two years we have produced reports on: Lake Tekapo; the Far North; Whangarei northern beaches; One Tree Point-Ruakaka; West Coast lifestyle, Lake Brunner and Kaniere, Taupo/Kinloch; Wanaka; Kaikoura; Hanmer Springs; Maungawhai Heads; Whangamata, Waihi Beach and Whiritoa; Tauranga including Mt Maunganui and Papamoa,; and Kerikeri, Paihia and Russell. All of which are available from our website, although some of them are a bit dated now. While we have studied Twizel, Queenstown, Raglan and most parts of the Coromandel but not produced reports on them because we have been too busy doing paid work for clients. As identified in the reports some coastal and resort markets have enough supply of sections "“ including those sold to end-users but not yet built on, those still for sale by developers, those sold to investors but not yet back on the market, those sold to investors and now back on the market, those sold to spec builders that now have spec houses attached for sale, those sold to spec builders and now for sale as house and land packages and those still at the planning/landbanking stage "“ to satisfy between several and twenty years of likely future end-user demand to build holiday homes. While demand for coastal and resort sections has generally crashed over the last couple of years the number of sections for sale has climbed. As way of example, there has been an increasing number of for sale ads for sections in Thames-Coromandel and Queenstown Lakes, although again the situation can vary significantly from place to place depending especially on how many developers are still trying to sell and how many investors are trying to exit the market. A feature in some markets is developers and investors competing for a trickle of end-user buyers. There are many examples (see photos - pg 6) of developers competing with investors trying to exit the market. The new benchmarks for section prices (and dwelling prices) will be set by the weakest link (i.e. those under most financial stress/duress to sell). Unfortunately for some developers the crash of many local finance companies involved in the property market and the arrival of the international financial crisis and the impact it has had on the availability of funding from banks couldn't have come at a worse time. But when we step back from the trees we can see that there is a link between these events. The boom in subdivision activity was in part funded by investors' deposits but more so by financiers who probably didn't understand what they were getting themselves in for, so the failure of local property-orientated finance companies and the difficulties some developers will currently find themselves facing are inter-related, with the common denominator being supply increases well ahead of underlying demand. The finger can also be pointed at the RBNZ for its naÃ¯ve experiment with low interest rates (see this link to a report on our website that forewarned of the pain to come for property investors because of the RBNZ's experiment). The experiment with low interest rates by international central banks and especially the Fed is also heavily implicated in the international financial crisis that is now biting the local property market. But do not be fooled, there was a fundamental problem even without the failure of local finance companies or the international financial crisis because new subdivision activity ran well ahead of end-user demand. Although the financial problems have certainly sped up the day of reckoning for coastal and resort section prices. But this tale of woe has more angles than a hexagon. One of them relates to location, location, location, or, more accurately, location NOT, location NOT, location NOT. Examples were provided in a number of our coastal and resort market reports of new subdivisions, often but not exclusively small subdivisions or one-off sections, that are old mutton dressed up as spring lamb. When the speculative bubble was in its infancy and merely a well-founded upturn in prices the quality parts of the market led prices up (e.g. west coast North Island beaches lead the way relative to east coast beaches, as did absolute beach/water front and major resort centres like Queenstown). But this resulted in secondary centres and properties one, two or three back from the beach/water looking cheap on a relative basis, so the price increases in the primary sites filtered through to secondary and tertiary quality parts of the market. And in line with it being a speculative bubble, some property owners and developers carved up any old bit of land and tried to sell it at prices that would have looked outrageous before 2002. We expect the relative price game to be reversed on the way down, with the old mutton ending up only selling at dog-meat prices, which will make secondary and tertiary quality sections look expensive so their prices will shuffle down, which will in turn make absolute beach/water front and other quality sections look expensive. This process will mean that some parts of the coastal market, like Taupo Bay in Northland and Hahei in the Coromandel, where there has not been large supply increases and which are better quality, will not be immune to falling prices as prices in general in the coastal and resort markets adjust to the new demand-supply balance. Then there is the problem that the low deposits on sections in new subdivisions tempted some would-be holiday home owners into the market ahead of when they would normally be able to afford a holiday home, with some of these people no doubt now wondering about the wisdom of buying while some will no doubt already be or become would-be sellers. When we travel around the country we can see hundreds and hundreds of empty sections owned by this group of people. These buyers represent what I call the stolen generation. They are the people who would normally be the buyers of coastal and resort sections and properties over the next decade or so but because they got tempted into buying ahead of time, in part lured by the fallacy that NZ was about to run out of sub-dividable land on or near the coastal line or waterfront, the next generation of buyers are to a significant extent already in the market. So who will buy from the developers, burnt investors, and remorseful would-be holiday home owners over the next decade? The next challenge for holiday home/section prices is that the general property boom/bubble has meant the hurdle for people to buy their first home is now way higher than it used to be, so the next generation of would-be holiday home owners (aside from the stolen generation) will have to wait longer and save harder before they will be able to afford a holiday home, although this hurdle is in the process of being cut back from un-scalable to just downright near impossible to scale. And in addition to it taking longer to pay off enough of the mortgage on the primary residence before being able to afford a holiday home, the next generation of buyers face a much higher financial burden to buy a holiday home than the last generation because of the speculative bubble in holiday home and section prices. We looked at the cost of the median Auckland City house plus the median Thames-Coromandel section, and the median Auckland City house plus the median Thames-Coromandel dwelling. While the combo of the median Auckland house and the median Thames-Coromandel section cost just under $390,000 in 2001, it now costs just over $770,000 and that is without any fries. No matter which way we dice this challenge the answer is that until urban house prices and/or coastal/resort property prices fall substantially, or until incomes gradually grind higher, the next generation of would-be holiday home owners face a massive affordability hurdle. This hurdle will have major implications for the demand-supply balance in coastal and resort markets where demand is dominated by holiday home owners for some years. But there is a solution to part of the problem for people wanting affordable coastal and resort holidays, a problem made worse by the subdivision boom gobbling up many camping grounds. People will be able to stay at the holiday homes of family and friends or tent on their undeveloped sections (where covenants allow). We already saw the tent city phenomenon starting to develop last summer, while we expect it to feature at many coastal and resort destinations this summer. Then there is the growth in the holiday bach for rent market (see here and here as examples, the latter advertising having "2645 of the best kiwi holiday homes). We regularly make use of holiday homes for rent when we travel to coastal and resort markets to do research. These options will both help give people cheaper access to holiday homes and help current owners of holiday homes/sections deal with the associated financial challenges, but of course they will also eat into demand for sections and holiday homes and be another factor tilting the demand-supply balance in favour of lower prices. Upmarket developments, like Jacks Point in Queenstown, where supply increases have been large, will not be immune to the new demand-supply balance that has hit town and we expect to hang round for some years to come. While secondary or tertiary markets like Twizel, where there have also been large supply increases, face at least as large a challenge as the likes of Queenstown in finding end-users to soak up the increase in supply. Plenty of land banking has occurred on the fringe of some coastal and resort centres while in some cases longstanding land owner-developers have plenty more land earmarked for subdivision. So when the current oversupply of subdivided sections starts to get eaten into and the demand-supply balance looks more favourable to would-be vendors, another tranche of supply will hit the market. On top of that, demand for houses has tumbled in most coastal and resort markets while there are lots of people in the queue to sell houses in these areas. So we expect falling prices for developed properties to put downward pressure on section prices. The research contained in our Housing Prospects reports show that it is normal for section prices to be slower to adjust to a deteriorating demand-supply balance than existing dwelling prices, but the chill winds of capital losses are stalking the national section market. * 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.