John Bolton argues the RBNZ's 70% Auckland LVR policy is a headless chicken moment. Focusing on affordability & debt servicing would've been better

John Bolton argues the RBNZ's 70% Auckland LVR policy is a headless chicken moment. Focusing on affordability & debt servicing would've been better

By John Bolton*

The Reserve Bank has a tough predicament – hot money flooding in from offshore that is blowing up the Auckland property market at the same time as rural NZ bears the brunt of a crash in dairy prices.

The Reserve Bank’s new 70% loan-to-value ratio (LVR) policy feels like a headless chicken moment. I don’t think there is a good understanding of the impact foreign capital is having on our Auckland property market. The new policy will have unintended and possibly serious consequences. Ironically it won’t impact on foreign capital, which is often invested below the new 70% threshold.

Although the changes are supposed to take effect 1 October, the RBNZ has “encouraged” all of the major banks to implement the new rules early. To knee-jerk on rules that aren’t even official yet is symptomatic of how reactive the RBNZ has become. This is a dangerous and undemocratic way to decide on who wins and loses.

With Governments around the world printing money and interest rates near zero, and with a substantial part of our population tapped into that world, it’s not surprising we are seeing foreign capital pour into NZ.

The 70% LVR rule will not slow down foreign capital. Foreign capital wins. Instead it will have a disproportionate impact on NZ born homeowners and investors who have worked hard to build wealth through property.

So we have a policy that will favour foreign capital (in the hands of first generation NZ residents.) Is that right? And is it right that a non-democratic body like the RBNZ can make these policy decisions for the greater good?

Gen Y loses. It will be extremely difficult for a young couple to upgrade to a new home and keep their existing place as a rental. Buying a second or third property leveraging the equity growth in the first won’t work. I’m not questioning whether or not this is good investment and overall the RBNZ policy will work. I am questioning whether it is the right approach and whether there has been proper consideration of the impact.

On the other hand, someone can arrive in NZ for 5 minutes under the investor class and fill their boots with property. Say they come to NZ with $3m of investable assets. That could be easily leveraged into $10m of property at 70% LVR or $6m of property at a 50% LVR.

If the RBNZ policy works, and I think it will, then first home buyers in South Auckland will be winners. That’s a good thing, right.

But the cost will be borne by investors in South Auckland. If prices fall it will be even tougher for investors to operate within the 70% LVR rule. Many would say that’s not a bad thing.

What about Auckland investors switching to the provinces because they can no longer buy in Auckland? Foreign investment in Auckland is no different to Auckland investors piling into Hamilton or Tauranga. So the RBNZ is inadvertently exporting Auckland’s problem to the rest of the country.

First home buyers in Tauranga will be the losers. They will soon feel like those in Auckland, only this time the foreigners will be JAFAs.

On the other hand, if you’re a big property owner in either city, the Reserve Bank with the stroke of a pen is about to make you a lot richer. You’re a winner.

Open to Interpretation

When the Reserve Bank first put in place speed limits for over 80% lending, it underestimated how strongly the banks would respond. The market came to a screaming halt. It also underestimated the impact on the new-build market and was forced to backtrack and make an exemption.

With the new rule, it is still unclear how this will play out. In the absence of clarity, here are some scenarios that could play out:

Your property portfolio is at 80% LVR. You need to sell a property to free up cash. Does the bank take all of the sales proceeds to reduce your debt? If this approach is taken then investors could face a cash flow crisis.

You have bought a house or apartment ‘Off Plan’ at 80% as an investment. It doesn’t settle until late 2016 so you don’t have finance approved yet. Can you still get finance? Will new builds be exempt? You have your home and one rental with an overall LVR of 80%. Going forward, can you borrow money to renovate your house?

You want to buy a new home and have 40% equity in your current property. That won’t be enough equity to keep both properties below 70%. Can you keep it, or do you have to sell? What if you want to buy first and sell later? What if you can’t sell and need to rent it out?

You own a business and have been dabbling in property on the side. Your overall LVR is 75% but you need capital for your business. If you sell a property to extract cash will the bank let you? At 75% LVR can you borrow against your portfolio to put capital into the business? You have a subdividable rental property. Your overall portfolio is at 75% LVR. Can you borrow against it to put a second dwelling on the back?

Does the bank look at the LVR on the specific property, or do they look at your overall portfolio? Does the bank just look at properties with them, or do they look at the investor’s overall portfolio?

What should the Reserve Bank have done?

I think the Reserve Bank made the wrong call. I’d have focused on affordability and servicing. It would have been far easier to implement. The RBNZ could have mandated that banks test affordability using a standard interest rate of say 7.50%. That combined with a simple rule that any residential investment lending must stack up based on NZ taxable income. Simple and problem solved.

For example, boarder income could be used for owner-occupied property but not for a rental. It would mean that a NZ based resident couldn’t conjure up overseas income to pass servicing criteria. And as a bonus, tax avoiders and those not paying their fair share of tax would be stuffed.

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*John Bolton is the principal at Squirrel Mortgages. This item first appeared here and is used above with permission.

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The problem is, there is a problem! As the article argues, the RBNZ is really pretty powerless to do anything but a short term, knee jerk policy change. It can only react to 'what is'. The Government was supposed to regulate the overarching policy for the New Zealand property market, but it didn't. Why? Pick your favorite reason!
And that problem we have in large? It will be solved as all problems eventually are - by the market. And that....is going to be be very painful for one or more segments of the property market. The only question to be resolved is, which segments?

So a vested interest speaks out "John Bolton is the principal at Squirrel Mortgages".

Can we have an article looking from the other side?

"The 70% LVR rule will not slow down foreign capital. Foreign capital wins." except from a banking stability point of view there is no debt to worry the leverage ratio about as there is no NZ loan. On top of that it removes the greater fool component from the system ie the FHBers are highly emotional, risky and help push up prices.

Of course the same money running from NZ will cause house prices to dip or not drop a long way at some point.

A 70/80% LVR rule is dead easy to understand and harder to manipulated maybe?

Hi Steven,

I love that your first point is 'vested interest.' Yawn. I think you'll find if you read my blog that I take a very impartial view of the world. How is this one vested - https://www.squirrel.co.nz/macro-thoughts-from-san-diego/. Please do tell.

The LVR rules will work and will take the heat out of the market. I'm questioning the chosen method and the undemocratic process especially where people and businesses will be financially crippled through the process.

How is exporting Auckland's problem to Hamilton and Tauranga a good thing? First Homers lose. Affordability in these provinces loses. Restricting small businesses access to capital as we head into a weak growth environment.

The LVR is a knee-jerk policy that has been rushed through.

I'm not suggesting the RBNZ sit on their hands and have generally supported using macro-prudential tools. In this instance I think they're got it wrong. I went further and suggested a simple alternative that I think would have worked better and caused less damage.

LVR won't work, and it can't work.
And it very much won't work while (a) foreign buyers can purchase direc in NZ, (b) foreign borrowers can speculate in NZ cheaper than anywhere else, (c) the previous two can be done via recent NZ proxy

There is a compound effect in just about every direction from this stupid interfering by the RBNZ!

These rules are very anti NZ citizen/resident investment.......and as you rightly say it does push Auckland's problem into other areas!! The RBNZ's policies breach just about every human right that has been granted to NZ'ers!!! There is no authority for any Government organisation to implement policies at their discretion!!! It clearly states in 1688 Bill of Rights how Parliament is to function and how laws (which are the only thing able to used) are to be made!! The bureaucrats are like the Kings servant of a bygone era!!

One would think that the NZ law faculties would be making public statements on constitutional issues!!

and what about the tax payer who will be expected to pick up the bill to bailout the bank(s) when this bubble bursts? does the tax payer have no rights?

There is no human rights breach here I can see, just your strange view of the laws.

Now that is scare mongering Steven and you know it!! NZ has moved past the taxpayer bailout thinking and it is a depositors who would be funding any bailout in an OBR event.

You're also assuming that property prices will come back and so put blurred rights of a tax payer ahead of people who need a roof over their head..

The policies of the RBNZ show a clear preference for foreign investor dollars over NZ'ers.

The policies of the RBNZ differentiate by where a person lives!

I could go on but it is a waste of my time so won't be explaining any further!

dp

Every human right? Not sure it breaches any really, you can still buy a home, and they are doing this in the absence of any government policy.
No policies at their discretion, try telling that to the nats and their using urgency out of original context.

The RBNZ is not required to prevent house prices rising, but it is required to make sure the banking system is stable. The RBNZ thinks Auckland property is in bubble territory and has the potential to crash. By forcing the 30% equity requirement it is forcing safer lending by the banks if the crash occurs.
The RBNZ has no reason to care about overseas banks taking a haircut if the Auckland property market crashes. Foreign capitol is for your democratically elected government to (not) worry about.

The problem is that many seem to call "affordability" to being able to afford a loan, when it should mean being able to afford the total price to pay by their own means.

One matter which hasn't been mentioned - maybe it hasn't come to public attention yet, is that some Asian property purchasers are getting Asian finance declined (which is apparently very unusual) and the sale is falling over. I know this for a fact through 2 separate central real estate offices. Apparently the agents were all surprised because Asian buyers never previously got declined. This has only happened in the last month.

Unfortunately I do not know the reasoning behind this - perhaps John Bolton could shed some light?

Yep, happened to a sale in Tauranga I know of.

Interesting. I heard of 4 deals falling over in one real estate office about 2 weeks ago and 1 other at a different office last week. So that is 5 deals that I am aware of in Auckland and now Belle adds that this is also happening outside of Auckland.

Something is up and it appears the Chinese banks are tightening up on their lending to foreign property purchasers.

It would be good to know if anyone else has heard of similar occurrences?

Is that an absolute fact that Asian Finance is being declined, or is that just the easy excuse

Could be a problem in sales-at-auction which become unconditional on the fall of the hammer

Lose the deposit

Yes it is a fact. I was told first hand by both contacts - and these people work at different offices and don't know each other. I can't really be too specific without getting people potentially into trouble.

They both said that the agents in their office (as word travels fast) were surprised because their Asian buyers never get declined for finance.

Is it possible that existing overseas owners had borrowed when the NZ$ was much higher and now have less equity than when borrowed.

Not sure that's an issue

Vancouver

Chinese real estate purchases in Vancouver are not intended to produce enormous returns, but to hedge against crisis. In fact, Yan claims that the prospect of property investments losing value is not a major concern for Chinese buyers. Losses of 10 or 20 percent on foreign properties still beat losing everything at home

http://hir.harvard.edu/archives/10888

Hah, nobody is worried about a drop, if they don't believe in gravity. Wait until there is actually a drop and then tell me how unconcerned everyone is LOL. O yeah that just happened to China stocks, and China houses. Nobody was concerned about a drop before they crashed, because, well it just couldn't happen.

H Triple,

A couple of observations.

A significant number of Investors have been hurt by the major drop in the Shanghai stock exchange. In China there has been a lot of borrowing against inflated share prices and that is unravelling. At the high end of the market we are seeing some impact from this - in terms of cash flow. I wouldn't overstate it but there is an impact.

Second observation is that I think a lot of the declines you are talking about are coming from local banks. There is a general tightening up of credit criteria going on. With tighter regulations (and policing thereof) of the Responsible Lending Code and AML it has made lenders more aware of 'tight' servicing issues. There is also much more robustness around verifying paperwork. In the past it was once over lightly and credit oversight was fairly lose due to the low LVRs.

That all makes sense.
Thanks for your response JB!

I wouldn't know why/if sales to foreigners are falling over; all I know is that foreigners just aren't out there buying anymore. The rampant FDI I was observing 12 months ago recently evaporated and all the heat they were bringing to the market has gone with them.

Reason... Chinese government crackdown, Pending NZ regulatory change, falling NZD, faltering dairy industry, restricted lending, start of a cyclical downturn, fall out from the Chinese stock crash, Europe recovering... take your pick. If you had a whole world of property markets to invest in would you pile into Auckland right now?

"On the other hand, if you’re a big property owner in either city, the Reserve Bank with the stroke of a pen is about to make you a lot richer. You’re a winner."

Only a winner if you're in a position to gain off it. If your rent is limited by wages to the tenants, or you don't want to further leverage/sell - then the only things you get will be higher insurance and rates bills.

so, if you have a house that is worth 1.5m, you can still buy 2-3 houses as you have 'equity' - how stupid is that.
30% should be deposit in CASH only. that would be the only way it could work...

Exactly, because if that very same house tomorrow is worth 500k instead 1.5m, the hole in the banking system is huge.

And it might happen..

"deposit in CASH only" - that's just silly. Take your example, if I have a house worth 1.5m and I want to buy three houses total I can still do it even if a cash deposit is forced, it just requires me to sell the 1.5m house and throw a 500k cash deposit at each of my three new places. You're just adding an unnecessary step/sale to the process.