OPINION: Over the past few months I’ve written a lot about the common factors which underlie each Kiwi property boom – or, more precisely, the fact that there aren’t any common factors. It’s a strange, but true, feature of our property market that, although house prices have broadly doubled every decade over the past 40 years, each of those 10-year cycles has been underpinned by very different economic conditions.
The first boom was in the 1980s - a period of high inflation, high mortgage interest rates (they were over 20 percent) and negative net migration of around 17,000 people. The second boom, in the 1990s, was against a backdrop of lower annual inflation, falling mortgage interest rates (although still very high by today’s standards) and a continuing exodus of Kiwis overseas.
By 2006, at the height of the third boom, inflation was at just four percent, mortgage interest rates were still falling and the migration exodus had been reversed, with New Zealand gaining an additional 10,000 people per year. And finally, by around 2016, mortgage interest rates were at then low of five percent, inflation was down to an historical low of 1.6 percent and migration was running at a net gain of over 70,000. And by then we were debating a shortage of homes purported to be over 100,000.
The only common thread uniting these four booms is the downwards trend of mortgage interest rates, from more than 20 percent 35 years ago to around 2.5 percent today.
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Economists will tell you that this progressive drop in interest rates is a primary cause of the dramatic increases in house prices over the past 40 years and that it is the result of the transfer between interest rates and what they call "asset prices". Put simply, this means that when interest rates drop we can afford to "buy" more money and that additional buying power allows us to pay more for houses, thus pushing up prices.
Given the evidence of the past 40 years it’s a view which is hard to argue against, but it also begs an obvious question: What happens when mortgage interest rates can’t go any lower? If we get to a point where rates reach zero, or very close to it, will house prices stop increasing?
The short answer is partly, but not entirely, but, in any case, it will be a while before we reach that point, for several reasons:
1. Although it feels like mortgage interest rates have dropped quickly, they’ve actually only dropped by around 2.5 percent over the past five years and this has been more than enough to fuel continuing house price growth. This, coupled with the fact that the Reserve Bank has indicated a willingness to support a negative OCR, means that there’s probably still quite a bit of gas in the tank for a few years yet.
2. There’s the fact that it actually costs less to service a mortgage, today, than it did in the mid-80s when the cost reached an eye-watering 52 percent of average household income – the highest level it has reached in the modern era. Today it sits at around 37 percent of the average household income despite the fact that median house prices have increased dramatically, which means that there is still significant capacity to service additional house price growth within the average household budget.
3. Regional house prices (outside the main centres) are still much lower than metropolitan equivalents, so there’s still considerable room for price growth in these areas before they reach the levels of house prices in the bigger cities.
4. There’s a difference between new home buyers and those who are buying a second or subsequent home. This latter group often have considerable equity in the property they’re selling which means they will usually have more latitude to pay more than someone buying for the first time. This may eventually lead to a market where house prices keep going up amongst those who already own homes but where it is impossible for new home buyers to enter the market.
For all of these reasons, while it’s likely that the end of mortgage interest rate drops will slow house price inflation in the future, it’s not likely to happen any time soon. In my opinion, it could be as long as 20 years before we start to see any impact from this change in market conditions.
- Ashley Church is a property commentator for OneRoof.co.nz. Email him at [email protected]
