The Reserve Bank (RBNZ) thinks house prices are nearing sustainable levels, despite remaining out of reach for many New Zealanders, and it's therefore easing lending restrictions.
The national house price to income multiple is 7.2, and Auckland's 8.9. These are high by historic standards but down from peaks of 9.3 and 12.6, respectively, in November 2021. (See interest.co.nz's house price to income multiple chart at the foot of this story).
“Our current assessment is that, given recent falls, New Zealand house prices are closer to being at sustainable levels than has been the case in recent years,” the RBNZ said in its May Financial Stability Report.
“Current prices are within the range of fundamental values suggested by some of the metrics we monitor, but the overall balance across indicators suggests prices remain somewhat overvalued”.
Affordability v sustainability
The national average residential property price was $928,656 in CoreLogic’s House Price Index data released for April. This may not feel particularly sustainable to would-be first home buyers unable to get into the property market, and is still about $200,000 higher than the pre-Covid March 2020 level.
But Reserve Bank governor Adrian Orr said there was a difference between affordability and sustainability, with the central bank only targeting the latter.
“Sustainable is something that you can explain with the underlying economics and settings of supply and demand. That may mean that something is sustainable but not necessarily affordable to all”.
“Affordable is a very loaded concept. Affordable to who? A first home buyer, a low income, a high net worth — what does it mean?”.
The bank assesses whether house prices are at risk of causing financial stress by considering metrics such as whether it was cheaper to rent, build, or buy a house. As well as mortgage to income ratios and rental yields relative to other investments.
“In Aotearoa, ‘sustainable’ has been outweighing ‘affordable’ for a long time now because of the underlying economic constructs,” Orr said.
Underwater houses
The RBNZ thinks the proportion of home buyers that are in negative equity—when a mortgage is bigger than the value of the property—is likely somewhere between 2% and 4%.
Around 25% of the current stock of mortgage lending originated during 2021, when house prices were abnormally high, with about a fifth of this being to first home buyers.
The rapid rise in debt servicing costs has been testing households that borrowed at high debt-to-income multiples during the past three years.
Many of these borrowers are facing interest rates above those at which their servicing capacity was assessed by the lenders.
A strong labour market and wage growth has been helping keep heavily indebted households from falling into default, but a larger-than-expected increase in unemployment is a key risk to financial stability.
RBNZ Deputy Governor Christian Hawkesby said loan-to-value ratio (LVR) restrictions had protected most households from falling into negative equity when house prices were elevated in 2021.
LVR restrictions were raised to their tightest settings and are now being rolled back to more middling settings.
“This reflects our assessment that current lending activity presents fewer risks to financial stability and household resilience than those of the past couple of years,” the RBNZ’s report said.
The central bank has recently been given the ability to impose debt-to-income ratios as another way to control risky borrowing. This restriction will be ready in about April next year, but is unlikely to be deployed.
“At the moment, the trend is for us to be easing those macroprudential tools. They are tools you want to be putting on when those vulnerabilities are building,” Hawkesby said.
In this stage of the economic cycle, the RBNZ wanted to be easing restrictions so as to be able to put them back on later if risk levels rise.
Some economists have predicted that house prices have already found a floor, which could be reinforced by looser lending restrictions.
The central bank said there was a risk that house prices could actually fall below its assessment of sustainable levels.
Lower house prices meant there was less risk of a sudden correction, and lending conditions remained tight regardless of the RBNZ’s rules.
Additionally, there had been little demand from investors due to the phasing out of tax deductibility on mortgages and low yields on rental properties.
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