House prices are now “sustainable” according to the Reserve Bank of New Zealand. But why aren’t they affordable? The answer is they’re two different things, says Kelvin Davidson, chief economist at CoreLogic.
Confusion reigns among homeowners about what the difference is between the two concepts. In its July Monetary Policy Statement, the RBNZ announced that after recent house price falls, that house prices had returned to “more sustainable levels”.
Yet CoreLogic’s affordability measure relating to typical debt servicing as a percentage of average household income is still above 50% – very close to a record high, driven by the increases in mortgage rates since mid-2021.
The difference is that sustainable house prices relate to the financial stability of New Zealand’s housing market, and housing affordability is, as it sounds, about what homeowners can afford to pay when they buy a house.
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In November 2021, when the nationwide median sale price hit a peak of $925,000, having risen 49% from a post-Covid low of $620,000 in May 2020, the RBNZ noted that house prices in New Zealand had “become more unsustainable over the past 12 months. As households are having to borrow more debt relative to their income to purchase a property, household incomes may become stretched when interest rates normalise”.
The RBNZ report noted that sustainable house prices did not “necessarily mean they are affordable”.
“The housing market can be sustainable from an economic perspective, but still create social outcomes that are seen as undesirable. For example, restricted land supply can cause prolonged upward pressure on house prices as demand increases. This in turn can lead to historically high house prices that are sustainable due to persistent land restrictions, whilst at the same time becoming less affordable to many New Zealanders.”
The report defined sustainable house prices as “the level that house prices will reach over several years given the outlook for supply and demand” and that affordable house prices meant "adequate and decent housing accommodation should not cost the worker more than a reasonable proportion of income (e.g. 30% of their income), whether by way of rent for, or by way of payments towards the purchase of, such accommodation”.
For Davidson, the key difference between sustainable and affordable is that “sustainable can be justified on the basis of current mortgage rates, rental yields etc”.
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“But that doesn’t mean the average person can necessarily afford it, given prevailing conditions, including the LVR rules and serviceability tests. It’s very easy to say in a binary sense that housing is either affordable or not. It’s more of a continuum, and needs to be assessed across areas and through time. ‘Affordable’ for one person is not affordable for another.”
Affordability is determined by comparing the cost of purchasing a home against the income levels of potential buyers. Key factors that influence affordability include income levels, mortgage interest rates, deposits, and housing supply. Whilst house prices have dropped, interest rates have risen considerably in the past year.
CoreLogic chief economist Kelvin Davidson: "Affordable for one person is not affordable for another.” Photo / Peter Meecham
Davidson says affordability is still stretched, with interest rates unlikely to fall anytime soon. He adds that debt-to-income ratio limits, which the RBNZ can introduce as early as March next year, could act as a brake on the next upswing in the housing market cycle.
ANZ’s economists wrote earlier this month that the RBNZ’s comments about house price sustainability on July 12, when it held the Official Cash Rate at 5.5%, were “a bit vague”.
“With real house prices adjusted for income growth back around 2019 levels, that statement seems a little inconsistent with the debate that was raging back then. But what ‘sustainable’ means is a bit vague, providing some wriggle room,” they wrote.
This was a question the RBNZ grappled with when in 2021 the government first sprung the requirement that in its monetary policy decisions it “assess the effect of monetary policy on the Government’s policy to support more sustainable house prices”.
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