The recent uptick in the property market is due to housing shortages in Canterbury and Auckland as demand rises but supply does not respond, Treasury says.
And high construction costs could hold back new builds, especially of lower quartile housing, Treasury said in its latest monthly economic indicators for July.
Structural factors such as land availability and low productivity had contributed to elevated section prices and building costs. A preference for high-specification housing and the relatively higher cost of building materials in New Zealand also led to high construction costs, Treasury said.
"These issues were raised in the Productivity Commission Inquiry into housing affordability and the government is currently considering its response," it said.
Recent developments in the housing market meant Treasury now expected annual growth in house prices in the year to December to exceed its Budget 2012 forecast of 1.6%, it said.
"The recent uplift in the housing market can be attributed to the shortages in Canterbury and a more general shortage in Auckland with housing markets elsewhere in the country relatively subdued. Median house prices in Auckland and Christchurch both posted record highs, up 7.1% and 8.7% respectively over June last year," Treasury said.
It also took three to four fewer days to sell a property on average in the Canterbury and Auckland regions compared to the national average.
"Although there are pockets of weakness in other regions, median house prices have generally risen between 1% and 4%. The Auckland market is facing considerable demand pressure as the growth in new listings fails to keep pace with rising house sale volumes. This dynamic has been reflected in rising house prices," Treasury said.
"The shortage in Christchurch, as a result of the earthquakes, is seeing heightened competition for undamaged dwellings. Not only are Red Zone buyers entering the market, but first home buyers and investors are also actively seeking properties. Since the earthquake last year, rents in Canterbury have been growing at an annual rate of 6% on average, double the national rate of 3%," it said.
House prices and rents had been rising at a similar pace but low mortgage rates were encouraging more buyers to enter the market.
"Although median house prices (expressed as a percentage of gross annual income) are still a barrier to some, debt-servicing costs have fallen significantly," Treasury said.
"The BNZ-REINZ Residential Market Survey showed a net 44% of agents reporting more first home buyers in the market in July, 14% higher than the same time last year. Property investors have also been seeking higher-yielding properties given subdued rental yields, but according to QVNZ they are being increasingly outbid by first home buyers," it said.
However, the growth in new housing loans remaineds weak even though mortgage approval rates had been strong.
"Data from the RBNZ show that total household credit claims in July grew at an annual rate of 1.8%, well below the growth rate of house prices, and is indicative of the subdued level of residential investment," Treasury said.
"Since 2007, residential investment has grown more rapidly than the value of housing loans which means household equity has been rising. Equity injection or the share of residential investment not funded by mortgages, has risen by NZ$13 billion between 2007 and 2012. This is helped by falling mortgage interest rates which boost the pay down of loans," it said.
Supply response subdued
Despite forward indicators of activity such as the National Bank Business Outlook and the NZIER Quarterly Survey of Business Opinion showed that the building industry continued to be the most optimistic, the pace of residential dwelling construction and consents had fallen short of expectations.
Listings of existing homes had also been slow to rise. Several reasons had been advanced to explain the low market turnover and building activity, Treasury said.
"New listings have been constrained, with existing homeowners unable to trade up owing to the poor quality of listings, some may be holding out for higher capital gains or unwilling to take on more debt. New housing construction continues to be skewed towards the upper end of the market as inexpensive houses are under-capitalised in the face of elevated section prices," it said.
A shortage of new low cost housing in the last decade had seen lower quartile house prices increasing by more than upper quartile houses in all major regions.
"New construction could be held back due to the high cost of construction relative to existing house prices. Structural factors such as land availability and low productivity currently underlie elevated section prices and building costs," Treasury said.
"A preference for high-specification housing and the relatively higher cost of building materials in New Zealand also lead to high construction costs. These issues were raised in the Productivity Commission Inquiry into housing affordability and the government is currently considering its response," it said.
Banks reluctant to fund uncertain projects, especially those needing new infrastructure
The shake-out of the non-bank finance sector had reduced the availability of finance, and could be limiting the supply response.
"Banks are reluctant to fund projects with a high degree of uncertainty, particularly those that require new infrastructure. Alternative investment vehicles such as equity based partnerships, for example, may be required," Treasury said.
"The annual running total for new dwelling consents in Canterbury has now returned to prequake levels but the consents data has yet to signal a clear ramp-up. Activity so far has been centred on small repairs but larger value repairs are now getting underway," it said.
"The difficulty around settling insurance claims also remains a bottleneck to progress. Some areas have been earmarked for new subdivisions but uptake from investors and residents is slow. Certainty and clarification around technical building requirements will also be required for investment decisions.
"However, the new CBD recovery plan will provide some confidence to investors," Treasury said.
Prices to rise further than expected
Given the tight market, Treasury said it now expected house prices to exceed its Budget forecast of 1.6% annual growth in the year to December.
"However, house price growth is expected to moderate over the medium term as residential construction expands and new listings rise. Weak population growth outside of Auckland, rising interest rates and a cautious household sector over the forecast horizon will provide additional offsets to house price growth," it said.
"In the short-term, rising house prices will provide some support for consumption growth but are unlikely to add much."