By Alex Tarrant
As the rest of us argue which supply-side factors need to change to make housing more affordable, Westpac economists reckon demand factors like tax settings, interest rates and inflation expectations are the dominant drivers of house prices in New Zealand.
Last week the government released its response to the Productivity Commission's report on housing affordability, backing calls for the release of more land on city outskirts and changes to planning regulations to make it cheaper and faster for houses to be consented and built.
Finance Minister Bill English said the government wanted to address the problem by focussing on the early stages of house building to make it easier for cheaper housing to come on stream.
That was instead of the government waiting for the market to build - or not build - houses and then offering demand-side assistance like cheap government loans or rent supplements.
But Westpac economists said the solution was not as straightforward as the belief that 'dealing to' red tape presented a win-win scenario in which more houses would be built more cheaply. Recent jumps in building consents in supply constrained Auckland and Canterbury actually showed market forces at work, they said.
Market forces at work
Building consent data last week provided some reassurance that housing construction was warming up, at a time when there was a growing amount of soul-searching about the housing market in New Zealand, the Westpac economists said in their Monday morning weekly commentary.
"The Government is focusing its attentions on the supply side, but we need to keep our expectations modest as to how much can be achieved on this front. We have long emphasised that demand-side financial factors have been the dominant drivers of New Zealand’s house prices," they said.
Residential building consents were up 7.8% for the September month, and 22% on a year earlier. However, the headline improvement was overstated by an above-average month for apartment unit consents, which tended to be lumpy.
"And of the 5.6% rise in ex-apartment consents, about half was driven by an unusually strong month for the Waikato region, which suggests we could see an offsetting below-par report for October," the economists said.
"These issues aside, the details were in line with our impression of the housing market: consents are gradually lifting from very low levels, led by the Auckland and Canterbury regions where supply shortages are most apparent," they said.
"It’s worth noting that the rise in consents in the Canterbury region has been quicker in the outer regions than in Christchurch City itself, reflecting the fact that it’s been easier to get the process going there. It’s another demonstration of the long timeline for post-quake recovery; the vast majority of the work in the city still lies ahead of us.
"We’re clearly seeing ‘market forces at work’ in the Auckland and Canterbury regions: a shortfall of supply relative to demand is pushing up prices, providing an inducement to build more. But it’s also clear that this is a slow process, and the effect on house prices has sharpened calls for a government solution to housing affordability," the economists said.
"Last week the Government responded to the Productivity Commission’s recent recommendations on housing affordability, adopting several measures to improve the responsiveness of housing supply such as freeing up more land and streamlining the consenting process. The public response has generally been one of disappointment; our view is that there are limits to what can be achieved down this track anyway," they said.
"We acknowledge that the supply side matters a lot in some instances; it’s clearly a factor in the Auckland market’s outperformance in the last two years, and probably also in the mid-1990s housing boom. But an Auckland-centric diagnosis falls apart when applied more broadly to the New Zealand housing market, particularly in light of the previous decade’s boom."
Tax, interest rates, inflation expectations
Westpac economists made two points about the 2002-07 housing upturn:
- Regional performance: Almost every region saw house price gains of 90% or more, with a few exceeding 200%; Auckland’s 93% increase was actually one of the slowest rates of growth in the country. The rate of house price growth did not correlate with population growth or the rate of building in each region, with some regions losing population even as house prices rose sharply.
- Owning vs renting: While house prices soared in the 2000s, rents only trickled higher, and actually fell as a percentage of household income. If there was an outright shortage of dwellings, it should be expected to see rents rising as much as prices. Christchurch today is a prime example of this.
"So if not physical constraints on the housing supply, then what? For several years we’ve been successfully applying a model of housing valuation that incorporates key financial factors: interest rates, expected inflation, and the tax treatment of investment properties," the economists said.
What was notable was that all three of these factors moved in tandem during last decade’s housing boom: fixed-term mortgage rates were substantially lower, actual and expected inflation drifted higher as the result of a looser target for the RBNZ, and an increase in the top tax rate made property investment more valuable as a way to reduce taxable income.
"Together, these factors can explain a sharp rise in the ‘fair value’ of property as an investment, which by 2007 had become baked-in to market prices," the economists said.
"We suspect the amount of attention paid to supply-side factors partly reflects a hope that a win-win solution must lie within our grasp – that we could have more houses, and cheaper, if only we got rid of the red tape," they said.
The financial drivers of the housing market were not so straightforward.
"The tax system is clearly within our control, but the winners and losers and the disruption that comes with tax reform make it a much harder sell," the economists said.
"Interest rates and inflation obviously fall within the Reserve Bank’s mandate, but over longer timeframes they become increasingly subject to global rather than local forces. Remember that the low fixed-term mortgage rates that fuelled the last boom, particularly during its final years, were often in defiance of the RBNZ’s policy stance."
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