ANZ's economists see "growth headwinds" intensifying for the supply of new Auckland dwellings as escalating costs and capital constraints start to squeeze the market.
"The supply side is responding to considerable housing pressures in Auckland, but barely sufficiently to keep up with demand," the economists say in their weekly Market Focus publication.
They say the twin challenges of cost escalation and capital constraints (especially in the multi-dwelling space) "risk curtailing the supply side response further".
"It all points to growth headwinds intensifying for dwelling supply. In fact, there is a risk that the above pressures actually result in a slower rate of dwelling construction over coming months.
"...Finding skilled labour is an additional issue. While there are some natural ways the ‘market’ could offset demand-side strength (increased inter-regional migration and larger household sizes), headwinds to supply growth reinforce how correcting Auckland’s housing imbalances and affordability challenges is a multi-decade undertaking."
The economists say that while Auckland house prices have cooled over recent months, with the REINZ Stratified House Price Index actually falling 6.2% month-on-month in January, this can all be seen in the context of recent LVR restrictions, lifts in mortgage rates, affordability headwinds and possibly the impact of stricter Chinese capital controls.
'Hard to see Auckland price weakness extending'
"However, it is hard to see weakness, especially in prices, extending too far, when the demand/supply picture doesn’t look set to normalise any time soon."
Another complicating factor for the supply of new housing is the difficulties the construction sector is having in finding skilled staff at present, which is also constraining its ability to respond to demand, the economists say.
"At a time when net migration inflows are showing few signs of turning, a weaker supply story certainly doesn’t paint a picture of Auckland housing imbalances and affordability challenges being corrected any time soon. We’ve already seen some construction cost inflation. However, in the words of Bachman-Turner Overdrive, 'You ain’t seen nothing yet'."
The economists say current annual net international migrant inflows into Auckland are equivalent to 2½% of the resident population. That compares with 1½% for the country as a whole.
"Statistics NZ project that under its “medium” assumptions for fertility, mortality and net migration, Auckland’s population will grow by a further 600k people (37%) by 2043.
"Right now, the region’s population is not only tracking north of that projection, but is actually north of Statistics NZ’s “high” scenario (where the population is projected to grow by a further 50%)."
The economists say there is "little denying" the strong fundamental outlook for Auckland housing demand. "And that is before you even consider whether or not there is a shortage of dwellings to begin with (we believe there is, perhaps around 20k, but the exact figure is open to plenty of conjecture)."
They note that the supply side is responding, with Auckland dwelling consents totalling close to 10k in 2016, which is the highest since 2004. Consents for multi-dwelling units made up 43% of that (the highest share since 2005), so there is increased evidence of intensification, "which is what the region needs to see, although we are yet to reach prior peaks". (NOTE: All the graphs in this article are sourced from ANZ/Statistics New Zealand information)
"But of course, part of this growth just reflects catch-up after a material period of underinvestment since around the middle of last decade."
Given the growth picture, chinks in the supply response is the "last thing needed right now, but that’s precisely what is happening", the economists say.
"There are increasing reports of residential development projects being delayed or canned. In fact, you can see this in the data to some extent, with our estimates of seasonally adjusted Auckland consent issuance actually falling in four of the past six months, to be down around 20% since June 2016. That’s a big drop."
The economists say some of this will be "noise versus signal", with regional monthly consents figures volatile and requiring plenty of caution about making strong conclusions. Moreover, the reasons for project cancellations can be numerous and in many cases unrelated.
"But we do believe the overall message of a weakening in the supply picture is consistent with some key challenges the construction sector is facing right now."
The economists note that credit is now being "rationed".
"That’s prudent at the top of the cycle and also necessary to rein in a bank wide ‘funding gap’, with deposit growth still trailing credit growth. It’s not in New Zealand’s long-term interests to let such a gap persist.
"The current account deficit (and external debt levels) would blow-out, New Zealand’s credit rating would likely get reviewed, and inflation would turn up necessitating tighter monetary policy.
"Credit driven booms invariably end in busts. In playing the long-game though, less credit makes it more difficult for pro-cyclical components of the economy such as housing and construction.
"A net 32% of respondents to our Business Outlook survey reported it being more difficult obtaining credit in December, the highest since we began asking this question in 2009. So it’s having an impact."
The economists said another "canary in the coalmine" is costs, which have "exploded", making the viability of projects (and also obtaining credit) more challenging.
"You can see this in the difference in consent value per square metre in Auckland versus the rest of the country. It has always been a little more expensive to build in Auckland, but the gap is now historically wide, with Auckland around $2,400/m2 and the rest of the country less than $1,900/m2 (note these are consented figures and not actual costs so it is not the final word, but a useful gauge). It certainly fits with the Q4 CPI figures that showed implied construction costs rising 8.2% y/y in Auckland versus 5.5% y/y over the rest of the country.
"The majority of this cost escalation is in the multi-dwelling space. Compared with ‘houses’, which have seen costs rise steadily over time in Auckland (to about $1,900/m2), the value of consents per square metre for multi-dwelling units has surged to over $3,500/m2. Now to be fair, with many developments (apartment developments especially) occurring in the CBD or city fringe, elevated land values means it just doesn’t make sense to build low-value dwellings. You need to earn a return somehow. Yet costs still appear to have reached the point where these projects are becoming increasingly difficult to make “work” from a risk-return perspective. And the “spike” in the series of late looks telling."