House prices may continue to rise over short term, but unlikely to resume momentum seen last decade, Reserve Bank says

New Zealand house prices may continue to rise over the short term but are unlikely to develop the momentum seen over the last decade, the Reserve Bank of New Zealand says.

While tight housing supply, particularly in Auckland, was a factor currently contributing to rising prices, sustained momentum seemed unlikely. Housing credit growth remained subdued, and many homeowners already had significant debt loads, making it more difficult to ‘trade up,’ the Reserve Bank said in its May 2012 Financial Stability Report.

House prices still appeared elevated on a number of measures, such as relative to incomes and rents, it said.

The Reserve Bank noted the Productivity Commission’s report on housing affordability released earlier this year, which made recommendations targeted at making the supply of new housing more responsive to demand.

With still-high household indebtedness, sharp falls in house prices remained a key financial stability risk for the New Zealand economy, the Reserve Bank said. A period of stagnation in the housing market had helped to reduce this risk, with nationwide house prices sitting slightly  below their nominal 2007 peak.

In line with this stagnation, transaction activity within the housing market had been low or the past five years. Buyers became more hesitant in the weaker financial climate, and some prospective sellers chose to wait for better market conditions.

More recently, the housing market had started to return towards more normal levels of activity, in part spurred by lower interest rates, the Bank said.

“House prices are now rising again and a significant resurgence would be of concern given that they still appear elevated on a number of metrics, such as relative incomes and rents,” the Reserve Bank said.

“While house prices may continue to rise over the short term, they seem unlikely to develop the sort of momentum seen over the 2002-2007 period,” the Bank said.

“Even if confidence becomes strong, many homeowners already have significant debt loads that make it more difficult to trade up, and banks may not be willing to expand lending to the sector at fast rates in the current funding environment,” it said.

Tight supply

A factor driving recent increases in house prices had been tight supply.

“House building has been low for the past four years compared to historical rates, and relative to population growth,” the Reserve Bank said.

“The average number of people per dwelling has risen on a national basis after trending down for some years. This rise could signal pent up demand, although it may also be that post-crisis there is lower demand for housing (less interest in owning second homes, and more interest in sharing accommodation, for example),” it said.

“The Productivity Commission has recently published a study of housing affordability that makes recommendations targeted at making housing supply more responsive to demand.”

Underbuilding relative to estimated population growth was most pronounced in Auckland, where the property market had been robust recently. Prices in Auckland had increased 5.9% over the past year and sales activity had been strong.

The Reserve Bank said Auckland house prices were back at their peak nominal levels recorded in 2007, which was not true in most other regions. Rents in Auckland were also increasing relatively rapidly, it said.

Credit growth slow-down

Weak credit growth over recent years signalled a change in household behaviour, the Reserve Bank said.

“Since 2007 credit growth has slowed significantly from peak annual growth of NZ$19 billion to less than NZ$2 billion currently,” it said.

Only around half this slowdown in credit growth could be explained by the slowdown in house sales, based on the correlation between the value of house sales and net credit growth. The unexplained component of the slowdown – about NZ$8 billion over the past year – was likely to be due to a range of factors.

Scheduled principal repayments had picked up modestly over the past few years as the mortgage stock had aged and lower interest rates had front-loaded principal repayments.

“More significantly, anecdotal reports from banks indicate that the number of households making principal payments ahead of schedule has increased, with many households using some of the savings from lower interest rates to make these payments,” the Reserve Bank said.

“If all of the interest savings from lower mortgage rates were being used to make excess mortgage payments, this could explain around half of the unusual decline in credit growth. Some households may have also paid back debt by increasing their saving over and above the effect of lower interest rates, or allocating savings away from investments towards debt repayment,” the Bank said.

The gradual reduction in house prices since 2007 had helped to reduce credit growth.

“Before 2007, rapidly rising house prices meant that new buyers had to take on more debt to purchase property from existing owners who had built up large equity positions through capital gains. People reselling property bought in recent years are likely to have less accumulated equity, while for buyers, banks have tightened up on new lending with very high loan-to-value ratios,” it said.

“These factors are likely to have reduced the extent to which housing turnover drives net credit growth. On the other hand, the continuing relationship between mortgage approvals and housing transactions suggests that borrowing behaviour by purchasing households may not have changed materially.”

Equity withdrawal down, insurance payouts deposited

Anecdotal evidence also suggested there had been less topping up of existing mortgages (active equity withdrawal) over the past few years, the Reserve Bank said.

"There is currently no reliable way to gauge how important this has been, but it is likely to have been another factor behind weak credit growth," it said.

"Finally, a temporary factor is the payouts from the Canterbury earthqukes. To date it is estimated that around NZ$3 billion has entered the banking system from insurance payouts, some of which may have been used to reduce outstanding mortgage balances until rebuilding activity starts," the Bank said.