By Gareth Vaughan
It can take up to nine years for housing supply to catch up to demand after an unusually strong population increase, and complex and unforeseen things can happen to a housing market when credit restrictions are applied, such as through the Reserve Bank imposed loan-to-value ratio (LVR) restrictions on banks' residential mortgage lending.
These are the conclusions of a working paper from economic and public policy research institute Motu. Co-authored by Motu senior fellow and former Reserve Bank chairman Arthur Grimes and research analyst Sean Hyland, the paper looks at the impacts on the housing market of a temporary migration surge and prolonged restrictions on credit supply.
"The population simulation shows that the (housing) stock takes approximately nine years to almost fully respond to a population increase spread smoothly over five years," Grimes and Hyland write.
"The cyclicality of housing market adjustments is even more apparent in the credit shock simulation, where even after 15 years the cyclical effects remain pronounced."
The paper focuses on two key factors currently at play in the housing market. The latest migration figures show New Zealand had a net gain of 15,200 migrants in the 12 months to September. This is substantially above the average annual net gain of 11,300 migrants over the last 20 years. And, since October 1, the Reserve Bank has restricted banks' new residential mortgage lending at LVRs of over 80% to no more than 10% of the dollar value of their new housing lending flows.
The Motu paper, entitled Housing Market Dynamics and the GFC: The Complex Dynamics of a Credit Shock, looks at the former Manukau territorial local authority, which is now part of the Auckland "super-city". Grimes and Hyland specifically investigate the population growth experienced by Manukau between the 2001 and 2006 censuses. They note that between 1991 and 2006 the New Zealand population experienced an average quarterly growth rate of 0.23%. In contrast Manukau between 2001 and 2006 experienced a growth rate of 0.76% per quarter.
Grimes and Hyland say such a population shock causes housing demand, and therefore house prices, to jump, which in turn induces an increase in housing supply.
"However, the population shock also reduces land availability per person, and as such land prices increase. This increases the replacement cost of housing and results in a permanently higher number of people per dwelling. Our analysis suggests it takes nine years for the housing supply to equilibrate following the exogenous increase in demand, where the dynamics of adjustment primarily reflect supply rigidities."
They suggest the dynamics would be very similar when applied to other territorial local authorities.
Meanwhile, Grimes and Hyland also look at the impact of credit shocks on housing and house prices. Here, they note the link between credit markets and the housing market is particularly important given the recent adoption by central banks, including the Reserve Bank, of so-called macro-prudential tools designed to "affect" outcomes in the housing market. They conclude that the response of housing markets to changes in credit supply are complex and potentially very long-lived.
They argue credit restrictions place "opposite pressures" on house prices.
"Tighter credit restrictions have two effects in (our) model. First, they reduce some borrowers' access to credit, which reduces the amount that will be bid for a house, placing downward pressure on house prices. Second, they reduce developers' access to credit, which is required to construct new houses, thereby reducing the housing supply response to a given set of price signals."
"This latter effect temporarily reduces housing supply, resulting in upward pressure on house prices," say Grimes and Hyland.
The non-performing loan effect
In terms of a reduction in the supply of credit the Motu paper focuses on the impact from a prolonged increase in banks' non-performing loans. The authors say a bank will restricted its credit supply while its non-performing loan ratio is elevated. Specifically they look at the rise and then decline of non-performing loans at New Zealand banks after the onset of the global financial crisis (GFC).
They note that the average non-performing loan ratio between the first quarter of 1996 and the third quarter of 2008 was about 0.6%. Then in the fourth quarter of 2008 it jumped significantly above 0.6%, and by the first quarter of 2011 had reached a peak of 2.11%. It then dropped back to 1.36% in the fourth quarter of 2012.
Given the ratio in the fourth quarter of 2012 was similar to where it was at the start point of their study, the first quarter of 1996, Grimes and Hyland say they've used a smoothed rate of decline in the ratio of 5% per quarter from 1996 to 1999 to project forward the path for the non-performing loan ratio beyond 2012.
"The result is that the non-performing loan ratio is elevated relative to baseline for a total of 32 quarters, peaking 1.51 percentage points above baseline 10 quarters after the onset of the shock."
Grimes and Hyland go on to suggest that the reduction in credit supply to prospective house buyers leads to a significant fall in the house price level, peaking at 7.7% eight quarters after the start of the shock.
"This fall compares with an actual peak to trough fall in New Zealand real house prices after the onset of the GFC of 15.3%, implying that credit restrictions accounted for approximately half of the fall in real house prices."
"The fall in house prices reduces the profitability associated with new housing construction. As a result, housing investment is below the baseline level for 18 quarters following the start of the shock whilst the housing stock is below baseline for almost eight years, with a peak fall relative to baseline of approximately 1%," Grimes and Hyland say.
Beware of undesired price or supply effects
The paper draws the conclusion that even temporary shocks impacting the New Zealand housing market should be expected to have prolonged impact.
"Furthermore, complex and unforeseen housing market dynamics may arise through the use of macro-prudential policy tools, complicating the use of tools such as loan-to-value ratio limits," Grimes and Hyland write.
"This possibility will necessitate continued close monitoring of housing supply and price developments, and their causes, to ensure that undesired price or supply effects do not eventuate in subsequent years."
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