COMMENT: Every so often in New Zealand a property commentator or economist will argue that house prices should drop. A particularly extreme example of this would be the 2016 suggestion, by former chair of the Reserve Bank Arthur Grimes, that there should be a “managed crash” to bring down house prices by 40% - and I see that variations of that proposal are now doing the rounds once again.
I understand the argument. The price of the average Auckland home has gone from around four times the median household income in the early 2000s to over nine times the median household income in 2020 – and that multiplier is now probably even higher given the big increases in values that we saw late last year and earlier this year. House prices in the rest of New Zealand have also increased and were sitting at around 6.5 times the average household income in 2020.
So clearly houses are less affordable now than they were 20 years ago?
Well actually, no. In fact, affordability has hardly changed at all over that time. That’s because the proper measure of affordability isn’t the price of the house – it’s the proportion of your household income that is required to service your mortgage – and that figure has stayed relatively consistent because of the impact of reducing mortgage interest rates over the past 20-plus years. As interest rates have come down, the cost of servicing a mortgage has also dropped, so we’ve been able to afford bigger mortgages and house prices have gone up.
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But what does that mean in an era where there’s not much scope for further big reductions in mortgage interest rates? If anything, the forecast for those rates, over the next few years, is that they’ll be going up, so what will that mean for house price growth? In theory, it will taper off and house price increases will progress at lower levels than we’ve seen over the past 40 years, although there’s no way to know for certain because a large number of Kiwis own their homes outright, or only have small mortgages and won’t be affected by changes in interest rates; and because others will be prepared to devote more of their household income to paying a mortgage (the average Kiwi household was paying over 50% of household income to service a mortgage in the 1980s compared to around 38% today).
But what does any of this have to do with the suggestion that we could manage a drop in house prices? Quite a lot as it happens. In the current environment there’s every reason to be confident that house prices will find their own equilibrium based on logical choices made by property owners and home buyers. Higher interest rates will temper price growth and the market will find a new normal. Which is how the market should work. As economic signals change, we change our behaviour.
Ashley Church: “Crashing the market would provide some price relief for one set of Kiwis at the expense of another.” Photo / Ted Baghurst
That’s in stark contrast to an artificially controlled price drop, which isn’t just unnecessary but could actually do enormous damage to the economy. Those who had bought their first home recently would be at risk of going into “negative equity”, which simply means that they would owe more to the bank than their house was actually worth; homeowners who had used the equity in their home to buy a business, or fund business cash-flow, could lose their business or have to lay off staff in order to survive; spending on larger consumer items such as cars, renovations, travel, boats and kids’ education – all of which are often funded by loans raised against household equity - would plummet, with a knock on effect throughout the wider economy; and those approaching retirement and who had been planning on utilising household equity to fund those years in a level of comfort would be less likely to be able to do so – and may even need to work a few more years to recover their position.
And, after all of this pain had been inflicted, crashing the market wouldn’t actually fix the housing market. At best, it would provide some price relief for one set of Kiwis at the expense of another – but it would do nothing to change the overall dynamics which make the market work - which means we would inevitably see another round of house price inflation and the cycle would simply continue.
- Ashley Church is a property commentator for OneRoof.co.nz. Email him at [email protected]
