Factors behind the house price reset

Average house prices have fallen 7.7% so far nationwide, though with Auckland peaking in November and the rest of the country mainly February. We are probably about half-way through the pullback from absurdly high prices reached last year when a FOMO-gripped public bought anything they could get their hands on.

As house prices fall further, we are going to see some optimistic predictions that affordability will go back to levels of earlier years. We might even see the old view that house prices should be three times incomes because that is where they were in the modern dark ages up to the late-1980s.

Prices are not going to go back so far that we get anywhere near close to that ratio and forces are already in play to strongly limit the extent to which prices fall this cycle and the duration of the period over which these declines will occur. As noted here recently, we are seeing an acceleration of many things currently as central banks scramble to unwind the effects of their incompetent implementation of monetary policy last year.

The period of falling prices is likely to be over quite quickly.

But why is it not reasonable to expect a reversion to the three ratio of prices to incomes? To help understand this here is a run-through of factors I have been discussing since 2008 which explain why we have seen a permanent change in this ratio. There are others, but this list should suffice to curb the enthusiasm of those yet to buy.

Planning rules

The rise in the urban planning profession from four decades ago, and the derision attached to development of new suburbs on city fringes encapsulated in the term “urban sprawl” has meant soaring prices for land to build on. Councils have restricted urban boundaries to try and create better “planned” urban environments.

But at the same time as new land supply was restricted, intensification on existing already developed land was made near impossible. The government has now wiped away those restrictions through some rule changes so the impact of this factor will diminish over time.

Falling interest rates

Around the world interest rates were structurally falling for over three and a half decades from the late-1980s. As mortgage rates went down more people qualified for debt funding of a house purchase.

Lower mortgage rates have been factored into higher house prices, share prices, commercial property prices and so on. Lower deposit rates and returns on other assets meant investors were incentivised to purchase houses for their yield.

Save for retirement

From the late-1980s we saw government campaigns aimed at encouraging Kiwis to save. The message was that retirement would be a miserable affair if one did not have assets from which to supplement superannuation, especially as the pension might disappear because of tight fiscal circumstances.

These scare tactics have encouraged people to save and with the 1987 sharemarket crash fresh in the minds of many they naturally looked towards an asset that did not fall 60% in prices as shares did back then. Many investors opted for housing, purchasing properties and renting them to people who missed out at the auctions.

Higher net immigration

Migration rules were changed in the late-1980s away from a focus on source country towards skills. This has led to many people coming from countries with a far greater focus on building lifetime wealth through property ownership than those who tended to come here under the previous rules.

Rising construction costs

Governments and local council have piled more and more costs on anyone building a new house through the likes of more frequent inspections, consent fees, developers levies on sections, and much higher standards for materials and construction methods. The latter includes tougher rules on earthquake resilience and energy efficiency. Extra costs come from the likes of stringent health and safety rules.

More "luxurious" houses

The average size of a newly built house is far greater these days than in earlier decades, toilets are on the inside and there is usually more than one of them, and fittings tend to be of higher quality.

Credit supply

The availability of mortgages was often constrained for extended periods up until financial deregulation of the mid-1980s.

Aging population

As a population ages the average number of people per house goes down. You need more houses for the same population as more people live alone.

Higher divorce rate

Marriage breakdowns have meant more households with just one parent instead of two. Similarly for the rise in solo parenting.

Tourism growth

Many houses have been taken out of the rental and owner-occupancy pool by investors making them solely available for tourists to use through the likes of Airbnb.

No new cities

People like to live where other people live, where jobs and business customers are, and where cultural and recreational activities are located. There has been an absence for many decades of a new town sprouting up in a new location where land prices are low and people are happy to live, perhaps embracing a pioneering spirit. Twizel maybe.

In the early-1970s most of the three million Kiwis living here wanted to live not far from CBDs and in or close to suburbs long considered desirable. Now there are 5.1 million of us trying to do the same thing.

Lack of productivity growth

Growth in output per person in the construction sector (productivity growth) has lagged well behind virtually every other sector. Houses are still to a large extent hand-crafted. Lack of scale limits the widespread use of off-site construction techniques in New Zealand.

The current period of house price declines is likely to end sooner than many people are thinking. I’ll be able to see when through my monthly surveys. My latest survey of real estate agents undertaken with REINZ will be released next week and I can note here that we are nowhere near that turning point yet.

When the turning point in the cycle comes it will not remotely involve a massive correction in the ratio of average house prices to average household incomes. But things will be more sane than they were last year.