Westpac economists say expectation of future profits - not a supply shortage - is main reason for soaring Auckland house prices

Westpac economists say expectation of future profits - not a supply shortage - is main reason for soaring Auckland house prices

The rapidly heating Auckland housing market is being driven primarily by buyers' expectation of capital gains - not a housing shortage, according to Westpac economists.

Latest figures from the Real Estate Institute show that Auckland's annual house price inflation is running at just under 20%.

Last week Auckland's biggest real estate firm Barfoot & Thompson, which is said to account for around 40% of Auckland house sales, reported that its house listings were at historic lows. It also reported that the median price for its house sales in June rose by 3.5% to a new record high of NZ$590,000, although the REINZ figures for the same month, in contrast, showed a NZ$10,000 drop from a record high for Auckland in the previous month to NZ$555,000.

The Reserve Bank is becoming increasingly concerned about, particularly the Auckland market, and is talking up its prospects of introducing "speed limits" on high loan to value lending as a way ensuring continued financial stability and potentially of taking some heat out of the housing market.

The central bank's concerned that a sudden sharp fall in property values could cause financial stability problems. Interest.co.nz analysis of past household credit figures suggests households might be more vulnerable to the effects of a bursting housing bubble this time around than they were in the run-up to the last housing boom in the early 2000s.

The Government and Auckland Council have agreed in principle to an Auckland Housing Accord that would enable the fast-tracking of housing development, with a target of 39,000 new houses in three years to rectify a perceived shortage of around 30,000 homes in the region.

Westpac chief economist Dominick Stephens said in the bank's monthly analysis of the housing market, "Home Truths" that it has become "fashionable" to talk about a physical shortage of houses and slow building activity driving prices higher in Auckland. 

"But physical housing shortages cannot explain the fact that rents are falling in Auckland," he said. 

"House prices in Auckland are now rising at almost 20% per annum, while rents actually fell 1% in the year to May 2013, according to the Ministry of Business, Innovation and Employment.

"If physical supply was desperately falling short of demand, rents would be rising alongside house prices like they are in Canterbury. Physical supply shortages simply do not fully explain the Auckland housing market."

Stephens suggested that a better explanation for the characteristics of Auckland's housing market - these being low turnover, rapid sales, rising prices and falling rents - was widespread expectation of future capital gain. 

"Owners are reluctant to sell because they expect better prices in the future, hence low turnover. Buyers are desperate to get in and enjoy capital gains, hence rapid sales and rising prices. Investors are keen to acquire properties despite low rental returns, hence falling rents. Tenants would rather own, again pointing in the direction of falling rents and rising prices."

BNZ chief economist Tony Alexander in his weekly newsletter last week noted that in Auckland there was a growing tendency for people moving up the scale to their second home to keep their first home as an investment property.

"Hence further aggravation of the listings shortage,"  he said.

"Reinforcing that, one [real estate] agent noted that of 93 people through an Open Home recently only three had houses which they wanted to sell! The listings shortage is getting worse," Alexander said.  

Westpac's Stephens said that in trying to explain why there existed a widespread expectation of capital gain in Auckland, three "candidate explanations" sprang to mind:

  • People believe that Auckland's population and incomes will grow rapidly while insufficient houses will be permitted, creating a future sharp increase in rents that restores balance;
  • People believe that today's low interest rates will last forever, thus allowing future generations to pay more for houses despite low rental yields;
  • The expectation is irrational (a bubble).

"If physical shortages are not the main explanation for the behaviour of Auckland's housing market, then building more houses will not necessarily change the market," Stephens said.

"I seriously doubt that the supply measures recently enacted by the Government will really change much. Prices are being driven by buyer expectations of future capital gain - we know this because prices have become divorced from rents.

"The key to changing the trajectory of prices is to change buyer expectations."

 

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54 Comments

went to an auction across the road from us here in devonport on sunday. 100yr old villa, owned since 1950s and not looked after at all. massive do-up - a total sh*t hole, really, with nothing not needing replacing except the original villa has to be kept due to heritage listing. 501m section. i knew of three families at the auction looking to live in the squalor and slowly do up as they could afford. they were quickly left behind by a bidding war between chinese guy with heavy chinese accent so i'm guessing a recent immigrant maybe or overseas buyer, and a pakeha property developer. developer won, paying just over $1m. he is going to do-up and flick. don't know how he'll make money but hey, no-one there including me thought it would go for a mill so what do i know? all i can say was it was surreal and depressing.

Going to put yours on the market?

nope. we're still using it.

$1m for a villa in devonport, that is really really cheap!  There was a 3 bedroom house probably in similar condition to that a bit more land sold for $1m - but in Mt Roskill in a street full of state houses!  The median house price in Mt Roskill last month was $680k, its an area full of state houses and no where near a beach. Avondale and Mangere Bridge are just as mad too.  These are areas first home buyers used to turn their noses up at, now they they are all struggling to get a foot in the door.

i see what you mean with your mt roskill comparison but calling it really really cheap is like saying that i smell delightful after i've stepped in dog poo just because there's a guy over there who smeared sardines all over himself and then fell down a longdrop! a house directly across the road that was twenty percent bigger on a slightly better section and while still a do-up was in twice as good condition went for 767000 a year and a half before. there were two families bidding to live in it not big swinging money d**ks coming in and slapping their financial schlongs across everyone's face there.

I'm surprised no one has mentioned that the year on year growth rate for june of 19.8% was in fact a greater rate of growth experienced in: 2012, 2011, 2010, 2009, 2008, 2007, 2006, and 2005 - some pretty hefty growth years!  Not only is it faster than any of the couple years pre GFC in 2008 but you have to go back to February 2004 to find a growth rate that approximates us.
 
Kiwi's are a funny people.  They believe so firmly in property, and well, errr Xero - and that downside doesn't exist.  Awww - bless !

"Owners are reluctant to sell because they expect better prices in the future, hence low turnover. Buyers are desperate to get in and enjoy capital gains, hence rapid sales and rising prices. Investors are keen to acquire properties despite low rental returns, hence falling rents. Tenants would rather own, again pointing in the direction of falling rents and rising prices."
The most logical reasoning I have seen lately regarding Auckland's house prices

Owners are reluctant to sell because they expect better prices in the future, hence low turnover.
I don't want to sell but it has nothing to do with future prices - it is because there is no way I could afford to go to the 'next rung' in the ladder in Auckland and there is no other city in NZ big enough and warm enough to consider moving too.

I think it depends where in Auckland you are talking about. I know in the more affordable centralish suburbs there is massive demand from first home buyers and recent immigrants, and barely a for sale sign to be seen. Anyone who thinks there is enough supply of even slightly affordable housing within 10km of the city is fooling themselves. 

Prices up.  But rents stable or decreasing.  Says it all.

Interesting, "bigdaddy" seems to think his $500 a week rentals will fetch him $800+ "shortly" yet rents are going  no where...
Long may rents going no where, continue.
regards

".........a sudden sharp fall in property values could cause financial stability problems."
And a sudden sharp rise in property values hasn't -apparently.

So we have greed.....OK fair enough why shouldnt ppl make a profit when the banksters are also making lots fo $s for naff all...
Come the correction, when everyone wants to get out, it will be bigger and messier.
@KH, its only a problem when it goes wrong.....its like driving down the wrong side of the road, its fine til something is coming teh other way....
;]
regards

Funny how a lot of the things I've said a few months ago are now winding up in economic reports...

Thus proving 2 things,
a) Its very easy to claim something...even if it was obvious or lucky. ie show us your model as to why you were right.
b) its even easier to spot the ones that claim "because I was right last time you should listen to me from now on".
and not.
regards
 

I was being a bit facetious.

dp

Well, here are the adjusted REINZ statistics graphically presented for  May 13 and June 13
 
Take your choices. 2004-2007 was a housing boom. June 2012- March 2013
saw some movement in prices, but that seems to have died with average
prices at June 2013 below march 2013.
 
Sales have to some extent moved back to the lower deciles - balanced
averages are up - but this month my monthly medians have fallen for the
first time in a while. Rolling 3,4 and 5 medians are still up but they
are still showing the effects from the earlier months.
 
When will higher interest rates impact?
 
CPI adjustments next week, may negatively impact real price returns expectations.
 
Graphs courtesy of Colin Riden.

Hi Steven, me again.  I was right last boom, I was right again 2 years ago and I'm right again now.  I guess I'm in your "b" category. 
 
But what about category c that you fit into - wrong last boom, wrong 2 years ago and (probably) wrong again.  Who, exactly, should be listening to you?

Absolutely no one, I dont have concrete answers to the problems I see (along with some others) coming. Hopefully the ppl out there will go read up for themselves and make their own call on what they should do and as a society we'll move forward.
Right now it seems to be tulip time, Ksoze said 20% rise per annum, a doubling in prices every 3.5 years, no housing market has gone past 9 to 1 for long let alone 12 to 1 that 20% implies.  The Q is when to sell, ppl just made a fat 20% but are going to hang in there....most will be too late, like the US bond market.
Self-education I think is one of the best ways to learn.
I expect you'll go the same way as the gold bugs who used to be on here with their promise of $3000 and even $5000 an ounce of gold, they saw a 30% loss this year, so far, good luck.
regards
 
 

Steven you wonk - I'm one of the harshest critics here on what house prices will look like in 3 years time!  You've taken the things I've said and reversed them in haste because you are so emotionally zealous over the topic.
 
About two years ago all the editors for interest.co.nz kept repeating the sounds of gloom and doom that had been occurring.  However the were cherry picking statistics and probably wrongly interpreting them anyway.  It became very clear that prices had stopped declining, volumes were increasing, and I made very loud and vocal calls that the situation was in fact improving and there would be a sustained increase in volumes and prices.
 
That has happened.
 
Over the last 6 months I've now been saying that the residential cycle is entering familiar bubble territory.  I've been arguing that the growth is not sustainable long term, that prices will in fact be lower in 3 years time than they are today, and that there will continue to be some short term growth in prices even if it peels backwards later.  I noted that the issues in Auckland have nothing to do with supply issues, and on and on.
 
Get your facts right Steven - don't let your emotional attachment to the issue cloud your thoughts and the facts.

LOL, wonk....
"emotionally zealous over the topic." no I dont believe so...
"the residential cycle is entering familiar bubble territory"  I would say its never left a bubble, the norm would seem to be 3 to 1, we are at 5~6 to 1 and it seems heading higher...
I too argue growth cant be sustained.....
Im not sure what "facts" we disagree on here....we seem to be more agreeing than not.
regards

steven: you need to
(a) stop trying to divine from a distance what is happening in auckland
(b) traditional statistical mathematical economics doesnt apply
(c) applying behavioural economics on a global stage might help
(d) take some time and spend a few days up in auckland and peel your eyes back
(e) spend a day in the arrivals lounge at auckland international airport and observe
(f) wander around a few suburbs - northcote, highbury, beachlands, dannemora
(g) what is happening is a global re-location of population - akl is the nz destination
(h) now try and work out who wears the collateral damage

It's all down to expectations of future capital gains...and has nothing to do with our bank creating as much credit out of thin air as we can get away with and flogging it into the bubble...got that Mr Wheeler...nothing to do with bank behaviour.

 
True but what’s funding the markets profit. Wealth created within NZ or cheap overseas credit?

Buy your tulips now, ready for spring planting!!!!
regards

Yes a bubble; yet Government sit like stoned mullets gazing at the distortion.

"stoned Mullets" indeed...but you can bet the pollies are into the property game boots and all...no way will English lift a finger to stop it...oh we must be about due for another blather from the govt, concerned over first home buyers...a blather that will continue right up to the election...they are so concerned...not

if it all goes tits up after the profit is taken.  Which it will be by some.
The funding will have come from bank depositors, who will loose all.

The Westpac economists epitomise either the incompetence of mainstream economists who have not actually studied land economics under an authoritative expert, or the crookedness of economists who work for a vested interest in keeping economic land rent high. Why would anyone believe economists who work for the very institution that profits the most from artificially inflated housing prices?
Before you can have the "expectations of future profits", you need an inelastic supply of housing.
In the paper "The Role of Speculation in Real Estate Cycles", Stephen Malpezzi and Susan Wachter (2002), find that it is necessary to include a major part of "speculative demand" in their model ENDOGENOUSLY to "supply inelasticity". Otherwise it is impossible to explain the presence in the data set, of cities with no house price appreciation at all in spite of high fundamental demand.
http://www.economics.smu.edu.sg/events/Paper/sw_malpezzi.pdf
And another more recent one that finds the same thing:
Glaeser, E.L., J. Gyourko and A. Saiz (2008) "Housing Supply and Housing Bubbles"
http://dash.harvard.edu/bitstream/handle/1/2962640/housing%20supply.pdf?sequence=2
Even this paper was not recent enough to incorporate the data from the ridiculous recent bubble - the results would be even more obvious in any newer study still. 
 

Before you can have the "expectations of future profits", you need an inelastic supply of housing
Exactly!
Zoro has no clue

Who is right?
David "strangles" Chaston?
Dominick "bubbles" Stephens?
Peter "blind-man" Thompson?
Tony "it-just-aint-so" Alexander?

Tony Alexander in NZHerald today
http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=10895526
Grant Montgomery in NZHerald today
http://www.nzherald.co.nz/nz/news/article.cfm?c_id=1&objectid=10895580
 

Remember the dark art of deception and mis-direction
Tony Alexander has been busy lately - has published a number of articles
If you read Tony Alexander's report in todays Herald it will be noticed his survey's make one fundamental assumption that is there is a one-for-one relationship among buyers, one-buyer, one property.
 
Last week Gareth Morgan "categorically stated" that all of the attendees at Barfoots auctions were multiple buyers, ie a one-for-many relationship, in fact 1:4. Wonder where he got that from? because it makes a mockery of  "one-for-one" Tony's survey.

yes, havent forgotten, the fly-in-fly-out who bought 27 houses in two days, and just last month, one person who bought 65 houses in one month

I have seen numbers that support the fly in fly out scenario, with 50% of sales in Whangarei for the last month to cashed up Aucklanders.
 
What the dopey Aucklander don't realise is that Whangarei has very little industry to underwrite the housing market, post 2008 they experiences a fall off in value lf 30%+ in houses and they will go back down that fast again, or more, when all is reconciled.

FYI: The Herald story was based on a Tony Alexander newsletter from nearly two weeks ago. Interest.co.nz had this earlier cut at it

David "strangles" Chaston?
Dominick "bubbles" Stephens?
Peter "blind-man" Thompson?
Tony "it-just-aint-so" Alexander?
 
Aye?  
 
you forgot Bernard "30% drop" Hickey

As I said on another topic "Auckland's Scorching ..." - greed and self-interest is the only reason - whatever spin you want to put on it.  Human nature - and I'm including myself in that scenario as well.  We just can't help ourselves can we.  Tears when it all goes bad though.  And when you get burnt you hardly ever recover.  I remember my grandparents (now long gone) who told me they lost their house in the great depression because my grandfather lost his job - literally put on the street in Newtown Wellington with their suitcases and three kids in tow.  They never owned another house because they never ever wanted to be beholden to a bank again.  My grandmother cleaned factories until her 60's to help out.  They lived a relatively good life until their mid-80's.  Don't be greedy people - we all have short memories.

At least Stephens is honest in attributing most of it to human behaviour, the animal sprits, rather than the usual economic clap trap most economists try to use as an explanation. As soon as the expectation of big capital gains is gone the mania will end. Hopefully those foreign buyers also have a nice fat exposure to a depreciating NZD too.
 
The only thing Stephens and the other bank economists leave out is the willingness of the banks to fuel the mania and the unwillingness of the RBNZ, the National or the Labour parties to reduce the torrent of cheap credit and crimp the banks profits. Given their employers I guess that's to be expected.
 
They should all read Kindleberger
 
http://www.untag-smd.ac.id/files/Perpustakaan_Digital_1/FINANCE%20Manias,%20panics,%20and%20crashes%20a%20history%20of%20financial%20crises.pdf

No capital gains tax (if you demonstrate you are not trading) and you can use other people's money (largely) to fund the purchase. It's little wonder the odd speculative buyer is out there driving up prices.
Whilst the NZ environment is so property investment friendly it's hard to see demand drying up.

Another thing I forgot to mention earlier, about how incompetent or dishonest these "economists" are - rents being strangely static at the same time as house prices being crazily high, is classic evidence that there is a price bubble, not evidence that "there is no supply shortage". 
Would they argue that a crazily high P/E ratio on the sharemarket  was evidence that there was NOT a bubble?

I think Dominick is honest and right here. I've said previously that this Auck frenzy has little to do with supply, in fact to increase housing supply will just enlarge the size and risk of the Ponzi Game. The frenzy is only in the inner suburbs and it will die quickly once/if any material interest rate increases or some other spoiling factor  comes to pass. In the meantime let the participants stew in their own juice.
Ergophobia    

Investments such as equities and houses have two values. There is the Current Market Perceived Value and the Cost Price Value.
It works like this.

Imagine 10 unique cars are built and sold for $100k ($10k each)

The Cost Price Value of the cars are $100k, because that is what people were willing to pay, and did pay.

One of the cars on-sells for $12k. We now assume, that all of the cars, are now worth $12k each ($120k total). This is the Current Market Perceived Value

But actual money paid for the 10 cars = 9 x $10k + 1 x $12k = $102k. So the new Cost Price Value is $102k ($10.2k each) because that is what was actualy paid for all of the cars.

Now assume, after several on-sales, that

The Current Market Perceived Value is $200k ($20k each) while the Cost Price Value = say, $150k ($15k each)

If the market now crashes, then the new price of the cars will settle at the Cost Price Value of $150k. If prices fall below this then people will see a bargain and buy in, pushing the price back up to the Cost Price Value of $15k each.

Exceptions to these rules are

If the cars could only be sold at these prices because people get into debt to buy them. Then any price collapse will fall below the Cost Price Value

If the value of money changes due to inflation/deflation Then the Cost Price Value of the cars/houses/equities change to reflect this change in money value. The Cost Price Value has to be inflation/deflation adjusted.

I say house prices follow the same pattern.

Why the Mighty River Power Shares fell below the Cost Price Value

So why did Mighty River Power Shares fall in value (below the Cost Price Value) after the IPO?

Going back to the unique cars

Imagine 10 unique cars are built and offered for sale at $10k each
But only 7 sell at opening so the manufacturer sells the last 3 at $9k.
Now the real Cost Price Value of the cars is

7 x $10k + 3 x $9k = $97k ($9,700 each)

And if there is no change in money value (inflation/deflation) then the cars are worth $9,700 each.

Based upon all of the above it is clear to me that the Government "Did NOT sell all of the shares at opening"
To avoid egg on its face the government sold what was left at a lower price

This also fits in with the Supply & Demand rules

There was a lack of demand for MRP shares so the price fell AND this  lack of demand was also the reason the government was unable to sell all of its shares at the opening price.

Observation of House/Equity Prices

My idea is that

Low buy/sell volumes increase the gap between Current Market Perceived Value and the Cost Price Value which makes this investment risky

High buy/sell volumes, across the range of properties/equities decrease the gap between Current Market Perceived Value and the Cost Price Value which makes this investment more safe.

It would be possible, but a big job, to monitor prices of houses in a given area to determine these values. As for equities it would be a massive job unless you selected a single company. You would have to follow every single share in that one company, still a big job.

That is how i see it, you may disagree.

USA Housing Crash

Looking at the USA housing crash and putting debt to one side. Many house values fell below what people had paid. Assuming there had been large, across the board sales, then the Cost Price Value should have been close to the Current Market Perceived Value and so the collapse in values should have been small. On the other hand the Recession would have increased the value of cash and so reduced the price of houses (buy more for you buck). Then there was the QE which should have caused inflation and pushed up house prices. Also prices would have, initially, fallen below the Cost Price Value, and bargain hunters would move in pushing the price back to the Cost Price Value. Maybe there was a high volume of house sales but it was not across the board and so distorted overall prices. Clearly there are many forces acting here and it is beyond my capability to sort it out.
 

"USA Housing Crash".
I thnk its beyond many experts ability to sort out as well...
Indeed, throw in another variable, its likely that some housing  simply wasnt sold out from under the defalter, or the banks kept it on their books when the got the keys in the post, ie the drop in prices wasnt as big as it should have been in a true clearing out. 
QE doesnt cause inflation...not while in the zero bound trap, this was totally expected by the Keynesian economitss like Paul Krugman.
regards
 
 

Seeing you admire Krugman, what do you think of his observation in his article "That Hissing Sound", in August 2005, about the difference in price inflation between "the zoned zone" and "flatland"?
http://www.nytimes.com/2005/08/08/opinion/08krugman.html?_r=0
"........Many bubble deniers point to average prices for the country as a whole, which look worrisome but not totally crazy. When it comes to housing, however, the United States is really two countries, Flatland and the Zoned Zone.
In Flatland, which occupies the middle of the country, it's easy to build houses. When the demand for houses rises, Flatland metropolitan areas, which don't really have traditional downtowns, just sprawl some more. As a result, housing prices are basically determined by the cost of construction. In Flatland, a housing bubble can't even get started.
But in the Zoned Zone, which lies along the coasts, a combination of high population density and land-use restrictions - hence "zoned" - makes it hard to build new houses. So when people become willing to spend more on houses, say because of a fall in mortgage rates, some houses get built, but the prices of existing houses also go up. And if people think that prices will continue to rise, they become willing to spend even more, driving prices still higher, and so on. In other words, the Zoned Zone is prone to housing bubbles.
And Zoned Zone housing prices, which have risen much faster than the national average, clearly point to a bubble.
In the nation as a whole, housing prices rose about 50 percent between the first quarter of 2000 and the first quarter of 2005. But that average blends results from Flatland metropolitan areas like Houston and Atlanta, where prices rose 26 and 29 percent respectively, with results from Zoned Zone areas like New York, Miami and San Diego, where prices rose 77, 96 and 118 percent....."
 

37 Stanmore Rd, Grey Lynn $720,000 March 2010 - sold today at Barfoot auction $1,200,000

5 Grange Rd sold today at Barfoot auction $2,387,000 last sold $1,493,000 Feb 2010

Rent prices will not go above what economy can afford and if they do......payments will start to get behind......the tennant kicked out and nobody to replace them........no the tennant wont get kicked out the rent will remain affordable, because who else is going to get a payrise?
 

I could see the Auckland property market as safe if the country was booming from export growth etc, but I don't see it at the moment. I think it's the last growth phase before stagnation and eventual decline......If incomes were rising I would see it as a good move, but they're not.......its a two-way relationship between house prices and the economy at the end of the day.....only other scenario is more people living in one house to cover the rising rents? possible I guess

Over 70,000 home loan approvals have been granted since the 1st of May. No wonder there is pressure on prices - probably only 3,000, or 4,000 homes listed for sale since 1st of May or are most of these loan approvals for new cars, boats and holidays etc - house being used as cash register again?

A great analysis in NZ Herald today by Brian Fallow giving some analysis and ideas on how to deal with the housing market. (Not yet on the Herald website)
Business p B5 "Courting of Home Buyers Tawdry"

The drums are beating .. tap, tap, tap, tap

Something to read while you wait maybe,
www.earth-policy.org/images/uploads/book_files/wotebook.pdf
Overly optimistic....