By Geoff Simmons*
The Reserve Bank, faced with soaring Auckland house prices and low inflation, is getting creative.
They are looking at making it harder for investors to borrow the money needed to buy rental properties.
So at least the RB accepts the problem is a demand one, unlike Bill English who remains deluded thinking that all we have to do is build more houses all over the Bombay hills.
But this RB response will do little to halt what’s distorting our property market: The toxic duo New Zealand has sponsored for years via a Reserve Bank that insists that lending to housing is less risky than any other type of loan a bank can make, combined with the loophole in the taxation regime that enables home owners to dodge their fair share of tax.
These two structural distortions amplify the pressure from the population growth of Auckland on house prices, into a raging brush fire of house price inflation. Until they are dealt to, we are whistling in the wind.
John Key highlights the dilemma
The Prime Minister can clearly see the dilemma facing the Reserve Bank; inflation is below the 1-3% target zone, and heading south (at least in the short term). Meanwhile, Auckland house prices continue to rise at a rate that threatens our entire financial system.
If the Reserve Bank drops interest rates to boost inflation, the Auckland housing market will go stratospheric. If it raises interest rates to dampen the flames in Auckland, the rest of the country will suffer, and potentially topple the whole country into deflation. If you are wondering why falling prices is a bad thing – would you bother buying anything if you knew it would be cheaper tomorrow? No, nobody would, so the economy would freeze in its tracks.
But refuses to help out
John Key understands financial markets, but isn’t interested in making any of the changes that would really make a difference.
We have been criticising for years the Reserve Bank’s instruction to banks that they must favour lending on housing over lending against other types of assets.
The Reserve Bank argues that the default risk for mortgages is lower, but has no comprehension of, or respect for the impact such a policy rule is having on behaviour. It’s self-fulfilling, borrowers gear up where they can get the cheapest money and eventually that leverage leads to a speculative bubble. We have seen this play out in recent years overseas, and it’s just a matter of time before it bites here.
In fact, the music has played longer here because we have a second factor conspiring to inflate the bubble. Housing investment is also a one-way bet, thanks to the loopholes in the tax regime.
This is much bigger than the lack of a capital gains tax – we fail to tax any of the non-cash benefits a homeowner gets from their property. With the deck stacked in this way, it’s been a total no-brainer that investors have leveraged every ounce of equity they have to buy more houses.
So the Reserve Bank has to get creative
Recall the Reserve Bank’s last move was to create loan-to-value restrictions, which created political fallout over the impact on first homebuyers – the very people who they shouldn’t be punishing.
That made it inevitable that their next target would be property investors. And they have international evidence on their side that suggests that these investors are far more likely to walk away from their mortgage when the going gets tough.
The Reserve Bank’s latest idea to address the symptoms of the house price crisis is to target investors. The proportion of the housing stock in Auckland owned by investors – up to 40% – is now being identified as a threat to the stability of our financial system. By contrast, the RB argues that people who own their own house are far more likely to keep paying the mortgage, even when it doesn’t make sense for them to do so.
Will it work?
The devil is in the administrative detail for the Reserve Bank here. Any policy which targets one type of borrower over another creates an incentive to change how that borrower appears in the eyes of the law.
The market will no doubt get creative with finding ways around it – we might soon see partners or even children of wealthy families buying their own house. Trusts and companies could also be helpful in shrouding investors from the watchful eyes of the banks.
If they conquer those demons, the Reserve Bank still has to worry about all the other places that investors can borrow from. We have already seen first homebuyers turn to their parents in the face of loan to value restrictions. Could this push more investor borrowing into the hand of finance companies?
There is also a big question mark over whether this will capture foreign buyers, who may not be dependent on our banks to make their purchase. This might put increased pressure on calls for a register of foreign buyers (which itself could be possible to get around).
Is this good news for first homebuyers?
Taking some of the investors out of the market will theoretically leave more room for first homebuyers.
But this is unlikely to send investors to the wall and spark a housing fire sale, so will do little for historically high house prices.
All we expect to see is a slowing in the speed with which they rise.
Do we really want to see the next generation of house buyers leverage themselves to the eyeballs to get their first house?
A far more durable solution would be to treat housing like we do other assets, both in the eyes of banking policy and in our tax regime. House prices would soon fall to affordable levels and end our obsession with this unproductive national investment pastime.
Who knows – we might even start investing in things that make money.
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Geoff Simmons is a senior economist at the Morgan Foundation. This article was first published on the blog garethsworld.com and is re-published here with permission.
36 Comments
Do any others get tired of hearing this broken record about Auckland house prices? I wouldn't say that it should be fully ignored, but in comparison to other major cities in the world Auckland is still absolutely dirt cheap, which could be why it is so attractive for immigrants and investors alike.
All this talk about first home buyers is a joke as well, it seems that based on all these reports that every first home buyer should look to buy in central Auckland and is disadvantaged, that is rubbish! Most first homebuyers have no reason to be looking to buy in the most expensive hub within a country/city/state, just as a graduate shouldn't expect to be put into the role of CEO of a company just because he/she passed school courses.
If you want to look at housing like any other asset then maybe focus on those other assets realistically and in context (your first car wasn't a maserati, and your first time in the ocean wasn't on a luxury yacht) where these first homebuyers who are made out to be the victims have to make do with first homebuyer properties.
My wife and I are under 30 and purchased our first home 5 years ago, purchased another property overseas 3 years ago by leveraging the house here and have now just purchased another home and have the other 2 as profitable rentals. Both being students (myself still studying) and starting a family. It sure as heck wasn't in the Auckland CBD though, because that would have been a very silly as the deposit alone would have taken us over that 5 year mark.
Cheers
Hats off to you KC. To acheve what you have under the age of 30 is great work (especially starting a family). It must be difficult however with student loans and no outside family help to get you into your first home? How did you acheive it..some FHB would appreciate the advice?
I grew up in the US and moved here in 2008 about 12 months after graduating HS. I was fortunate enough to save money from the time I started work at 15 (while still living with my father at home, this is a big advantage that I think a lot of the younger generation - my generation and today's as well - throw away because they want to move out once they can work and get a car!! Big Mistake when rent is free while you are at home, and most meals too :). Summer and evening work helped me save about $10K USD while also buying a very cheap truck to use to and fro. I then went to Uni close to home and worked full time as an inbound telemarketer (hated this but it paid good for a uni student ($10/hr + commissions) and provided evening work so I could study in the mornings) since I still had next to no rent costs and only travel costs I didnt take out student debt but paid for study out of wages and saved an additional $6-7K USD over that 12months. Decided I didn't want to continue studying for awhile so I travelled to NZ (with residual funds, not my savings!) and met a girl after 18months of travel. Married and decided to take her father up on the option of staying with him together until we found our feet (work for me/finish study for my wife) which was cheap as we only paid utilities and bought groceries - my wife had about $5K of CC debt here when we got married unknown to me so I transferred my savings here and cut that thing out of our lives and bought a $1600 Honda Rafaga which left us with ~$25KNZD in savings both working fulltime with little in the way of bills. We stayed with her father for about 7 months saving over 50% of our income (this allowed me to visit my family twice in 2011 in the US) and we ended up having savings of ~$43K NZD. We found a very very humble home for sale at a great price (97m3) which only actually took a deposit of less than $10K once we negoiated the final price. Small mortgage meant we could do some renos with cash instead of debt and within 12 months we spent $20K cash on renos and increase the value of the house by over $40K. With over 40% equity in the home and a great ROE I decided to purchase a home freehold - leveraged with some equity from the house here - at the end of the GFC for my dad in the US to live in mortgage free (as he is retired and getting on) until he passes. We kept this cash style life up only taking small interest free consumer options that made sense and in 2012 had our first child. I am still studying, now on my 2nd degree (no student debts as yet) and my wife is now finished (she has ~$5k NZD student loan) and works part time. We purchased another home late last year - leveraged with our first again to gain tax benefits this time and it now serves as a rental with over 8% returns. I guess to sum up how I/we have done it boils down to a few key factors - 1) we didn't buy a mansion as a first home 2) we didn't buy a car/vehicle/toy that was worth 20% of a home on debt of 11-19% interest 3) we used cash as much as we possibly could have on everything outside of mortgages on our home 4) we took opportunities that others would look at as silly or 'not cool' by staying at home with parents until a better opportunity presented itself or not owning a new car because we had enough to pay for it out right 5) We looked at the environment we were in (GFC, DINK (double income no kids), unmaintained home, position to negoiate). These have been tough at times - we would have loved to travel a bit more but that takes time and money that we can spend once we get to that point and besides we have travelled alot more than most anyways. That just about sums HOW I DID IT UP - with no real handouts, just 'sacrifices' in my opinion.
That's a great success story and you deserve congratulations.
The problem with Auckland property that I and others harp on about is not to detract from hard-working FHBs, it is to commentate on the social destruction caused by any property value inflation whatsoever.
You only have to think about your own children to see the issue; please as an exercise calculate 8% p.a. compound growth on your own house for 25 years, and see if you think your 1st child will be reasonably likely to be able to repeat what you have done at the same age, even with all the same financial care and hard work.
Since you are American, I also encourage you to look up the Case-Shiller property price index work. There is a chart of US house prices since the late 1800's. Find it and study it.
Well done.
You do realise most of us don't get free room and board.
Nor the option of convenient after school job (mine ended up being like the pizza delivery guys...where if you're lucky you get enough to cover your car repairs)
So yess you made some good choices, please also realise you struck it very lucky as well.
Auckland property is dirt cheap when compared to Hong Kong , Tokyo , Taipei , Shanghai and even Sydney .
There is so much cheap money avaiable to overseas borrowers to come here chasing yields and buy secure(ish) assets like our houses
So we have a long way to go to the top in terms of property prices .
A long way to go ...
Suck it up and get used to it , becuase the Government has no appetite to stop it and the RBNZ is just blocking its own Kiwi Citizens from entering the market ( LTVR and now penalty interest for domestic investors)
Auckland property is not "dirt cheap" by any measure. Name me one city of comparable population to Auckland whose house prices are more expensive (maybe some in the UK??). Now take a look at prices in almost any US city. What gets you a shack in Auckland would get you something superb in most US cities bar California and New York. We are a tiny city by world standards and yet compare our house prices to New York and London - drives me nuts! Remove the artificial restrictions on land and you will both improve the environment (by decreasing commutes from Hamilton and lifestyle block proliferation) and make property prices sane again.
>>> Do any others get tired of hearing this broken record about Auckland house prices?
You are going to hear more and more of it, the worse it gets.
>>> in comparison to other major cities in the world Auckland is still absolutely dirt cheap
Rubbish.
>>> Most first homebuyers have no reason to be looking to buy in the most expensive hub within a country
Well in principle that may be true, but many careers start in the Auckland CBD and the commuting transport options from outer suburbs/fringes are unbelievably bad, even if you live along the motorways or railways. On top of that there is the U of A and other schools, a bunch all within the central suburbs. Do you think maybe it made more sense to locate them centrally when they were built, and that something might have changed since?
>>> My wife and I are under 30 and purchased our first home 5 years ago
Congratulations. Comparisons of external help from family notwithstanding, you have elbowed out those who by misfortune happen to be 5 yrs younger than you, and taken from them a wealth transfer of approx 30-40% of your property's purchase price. That is not by any skill or productive work on your part. And that is nothing compared to what older generations have managed.
"If the Reserve Bank drops interest rates to boost inflation, the Auckland housing market will go stratospheric. "
I don't think interest rates, up or down, are having/going to have much effect on the Auckland housing market anymore Why is the UK property market not highly stratospheric with mortgages of 1 or 2%? Many Auckland houses are being bought with no borrowing from NZ Aus banks.
It will be interesting whether nz inflation does pick up to 2+% in 12 months time as predicted by banks and RBNZ. They have been over optimistic before (actually for the last 7 years).
Try not to see NZ through a UK filter. Not only is that cultural cringe, our economy has virtually nothing to do with theirs and virtually no influence from there. True, in the past we adopted some regulatory styles from there but almost all of that has turned out to be a mistake. We've moved on.
I think not.
So Hayden here is not the most diplomatic person in the world. He is trying to tell Merkel and everyone else who is outside the [Five Eyes intelligence alliance] - the UK, the US, Canada, Australia, and New Zealand - that they are secondary citizens and they will remain so as long as they don’t spring to obedience the way the other four do. Read more
British foreign secretary Philip Hammond's message to Kiwis was as blunt as it gets in the diplomatic world.
"Frankly we've got used to New Zealand being there alongside us - alongside the US, the UK, Australia, as part of the family," the British foreign secretary said yesterday on New Zealand joining the anti-Islamic State coalition.
But were his comments insensitive? Certainly, they have got many bristling.
Hammond was in Wellington for talks with Prime Minister John Key and Foreign Minister Murray McCully. It was not a courtesy call - it became clear at a media conference that Hammond was here to lean on New Zealand.
It's hardly a co-incidence that Britain's Chief of the Defence Staff, General Sir Nicholas Houghton, is in Auckland today for meetings with defence chief Lieutenant General Tim Keating.
Britain, an influential player in the international coalition, wants Key to send 100 troops to Iraq. The Government has signalled it will offer training to Iraqi forces, but Cabinet is still grappling with the details. Read more
I am still cringing with embarassment on behalf of the families of those about to embark upon this unnecessary adventure demanded by the UK .
I am not sure that is what he said though. Another country has very low rates and yet doesn't have rapid house price growth.
The point that foreign investors are unlikely to use a NZ/Ossie bank is correct. But we don't know the full affect as the govt refuse to make any type of measurement to see if it is a problem and how big.
Mainly because the Russian oligarch collective has largely dispensed with London and the English country side as a property plaything since the UK upheld sanctions against Russia.
Hong Kong has endured the brunt of the consequent capital flows and has pressured the authorities to defend the currency peg along with other measures to deter property speculators. Read more and more
I was taught in economics class that we have three needs, food, clothing, and shelter. Surprisingly a 15% increase in the price of shelter doesn't even register as inflation. Instead people are freaking out about how we are having deflation, because the price of a 14" TV has fallen by 90%. What else can I say?
Banks should be treated just like any business and assess thie risks in the property market accordingly .
They cannot come crying to the taxpayer for a bailout if they lend recklessly .
Quite simply , they need to tighten up their lending criteria in this over heated market
What are you talking about? Bank depositors are there to underwrite the banks in times of hardship. OBR was put in place to turn depositor's savings into extinguishable capital in the event of financial instability morphing into systemic insolvency. I am guessing every working person is both a retail bank funding agent and a taxpayer. A cohort in desparate need of a guild to represent them against the ill- founded enterprise of those wanting money for nothing to speculate in the residential housing market.
I still have not had a sensible answer to this question yet. In the event of an OBR event, what happens to the bank shareholders equity? Is it preserved? If not who ends up owning the bank? If it is preserved how can there be any justice in that? Shouldn't these matters be made crystal clear to the public?
The relatively miniscule sum that constitutes so called bank shareholder equity will be vaporised along with a portion or more of depositor's savings and the principal of other unsecured lenders. What's left of depositor's funds, if anything, given they also underwite the losses on bank assets financed by covered bonds and foreign wholesale lending, wiil be made available to recapitalise the shell bank and a government guarantee is to be issued to lure in fresh retail funding victims. And yet you can bet those liquidated depositors will have no claims of ownership. A very public investigation is called for.
With the election in Northland, this is something that the opposition parties should be screaming from the roof tops.
Given the experience of the crooked sale of the rural bank back in the 80's you can bet that the bad debt provisions will grossly over exagerated and the new owners will be given the depositors funds for nothing. They will in effect be paid to take the bank with the depositors funds.
Housing is a one way bet, thanks to tax loopholes? While I agree that property should be treated like any other asset, I don't think the tax loopholes are what makes housing a one way bet. I think it has more to do with the fact that simply owning a house is giving people a gross income of over 1k pw. With that kind of return, who cares about the tax? Seriously.
Interesting to hear an economist seperate supply from demand. The best thing to do is increase supply, more jobs, more houses, hopefully better houses with insulation. What is not to like? A tax is going to have very little impact on demand, at least for the half awake part of the population, tax it at 30% and your still making a pretty tidy income for sitting on your arse.
I can guarantee that house prices in Orcs will come back down to trend, and it wont be pretty.
Maybe John Key might act if all the homeless Auckland people and families living in cars and vans parked overnight outside his mansion at 107 Stephens Ave, Parnell. (With a TV crew)
They are having to live on the streets somewhere, they may as well make it obvious to him and his neighbours. What have they got to loose, they could be locked up in a nice warm police cell with a bed or thrust into the arms of social welfare to do? With immigrants pouring into the country and supply probably not even keeping up with natural demand it is going to get one hell of a lot worse yet.
I just had a look at his place on Google Street View - nice place! Interesting that if you virtually "walk" along the street it moves in small steps, until you get to John's house then it moves in one giant leap so you can't see in!
Mr Key enjoys a bit more privacy than the rest of us!
What a mix up of contradictory ideas. I guess that's economists for you.
Presumably house prices going up has something to do with supply and demand, not just one or the other. We appear to have an unlimited supply of cheap money and a serious constriction of supply of houses.
Demand for houses is pushed up by record immigration and the RBNZ manipulating rates below the natural rate (ie taking money from the elderly in Nelson and giving it to those with good jobs in Auckland).
Supply of houses is constrained by the endless and senseless outpouring of regulations from the do gooders.
Here we have a wonderful example of a chap who ought to know better warping his analysis to justify more stupidity.
I think most people in business especially those in the export markets would agree with Geoff's following statement.....
"We have been criticising for years the Reserve Bank’s instruction to banks that they must favour lending on housing over lending against other types of assets".
It is such a shame that the RBNZ doesn't recognise that without business there is no housing market.....ah the brain cells or is it the neurons firing the wrong way.
The RBNZ have just found another way to milk a bit more out of a class of assets.....what is the gain/benefit to them?????????? I
It gets a little tiring hearing that it is a lack of tax that is contributing to the house price rise issue......Do we not learn anything from history and Winston Churchill when he quoted:
"We contend that for a nation to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle."
So Geoff why would you want to make a whole lotta people stand in a bucket and try and lift themselves up??
"You don't make the poor richer by making the rich poorer."
And Geoff why would you want to steal someone elses stuff and redistribute it??? It is a serious mistake to make an assumption that the difference between rich and poor is money......you have to recognise the HOW and the ATTITUDE cos that is all that is different!!!!!
It is hard to say whether a Trust or Company will be helpful.....they are entities so can they be viewed as Owner/Occupiers? I would have thought not...but the devil will be in the detail......and it is usual for bureaucrats to leave gaping holes!!!!
Houses can be valuable because they an asset that provides for a direct need, for minimum 50 years.
We can start treating "other assets" the same when your car lasts minimum 50years on the road, preferrably 120yrs. When your electronics, whiteware, TV, and cellphone have minimum 50years full functional life span. When you can live in or eat your share or bonds document.
Or your groceries or movie visit or batteries or clothes will last at least 50 years, preferrably 100. I hope they put in lots of intermissions in those 100yr movies.
does that degree that you paid you fees to get, need taxing? Not just the income made from using the knowledge and selling your time, but the actual ownership of having the degree - shouldn't it be like a trade registration where you have to pay fees/extra tax on it, or they wipe it from your brain.
Please notice these two points
If you are wondering why falling prices is a bad thing – would you bother buying anything if you knew it would be cheaper tomorrow? No, nobody would, so the economy would freeze in its tracks. - Geoff Simmons
AND
I was taught in economics class that we have three needs, food, clothing, and shelter. Surprisingly a 15% increase in the price of shelter doesn't even register as inflation. Instead people are freaking out about how we are having deflation, because the price of a 14" TV has fallen by 90%. - Skudiv
Can someone please have a hard look at the claim that deflation is bad for demand? As skudiv points out, we have had effective deflation in consumer electronics for a long time now, and no one thinks demand has suffered in that industry. And I think the claim could be expanded to most manufactured goods, as cheaper imports have replaced locally manufactured items for the last 30 years. And there is theory that supports this: Jevon's paradox takes as a given that as prices decrease, increased demand more than compensates.
Also, to a naive observer, it seems that both views of inflation are rising: we have a much larger money supply (=debt) than 10 years ago, and we have much higher prices in housing and energy than 10 years ago. How can anyone claim that inflation is low other than by defining housing and energy out of the calculation?
May I kindly ask for articles from interest.co.nz on these two topics? :)
"articles from interest.co.nz on these two topics" This is education, you can educate yourself on line lots of places like youtube etc. So what you want to look at is, there is what economists call inflation and how define it and what they use it for, and then there is the wooly definitions of joe public who see the price of tomatoes go up seasonally so complain yet ignore the price drops when tomatoes are "in season". It comes down to job public having no understanding of these terms and what economists are trying to achieve and getting confused, your post clearly shows this but its common. All I can say is I am learning like you but just a bit ahead!
"The toxic duo New Zealand has sponsored for years via a Reserve Bank that insists that lending to housing is less risky than any other type of loan a bank can make, combined with the loophole in the taxation regime that enables home owners to dodge their fair share of tax."
Load of b...dy cobblers.
House loan is _demonstratably_ less risky than all other loans. eg vs unsecured?? vs car which depreciates and is at high risk when on the road and is non-income generating asset? vs business loans based on theoretical business gains?? vs Quangoes such as Stolid Energy?
home owners aren't doging any tax. again demostratively.
Geoff Simmons you speak rubbish.
True. Once again what is this 'loophole'? Investors pay tax just like every other business on net income. How do they 'dodge' tax? That would be illegal surely - I know at least one who tried to 'dodge' tax who got fined and spent time in prison for trying it.
CGT is payed by speculators and property dealers - if they don't they are breaking the law. It is rubbish to say all property dealers 'dodge' tax because some choose to break the law risking penalties and jail time in doing so. Some people choose to burgle houses - does that make everyone a burgler?
Go to the top-of-the-class
And thanks for the validation - it has taken a long time - I've been telling everybody exactly that for the last 3 years - not that anybody takes any notice - evidenced by the fact everyone wants the RBNZ to cut rates when in fact it should be hiking rates to counter-balance Government's (lack of) Fiscal policy - even John Key is telling the Governor to cut rates when it's not a monetary problem - it's a fiscal problem
February 2013
Monetary Policy and Fiscal Policy should oppose one-another. If government fiscal policy (or lack of it) is being profligate or stimulatory then the central bank should pull the monetary policy lever into the up-position. One lever should not be fanning the flames of the other. Equilibrium should be where the two balance one-another.
http://www.interest.co.nz/bonds/62967/opinion-what-are-4-macro-prudenti…
June 2014
Monetary Policy and Fiscal Policy are (supposedly) two opposing forces that should be in equilibrium What you are seeing is an example where Fiscal Policies should be being implemented by Govt to overcome fiscal problems. If Govt doesn't act, that puts pressure on the RB to take monetary policy action that it shouldn't have to, in order to counteract distortions arising from "inert" passive fiscal policy
http://www.interest.co.nz/personal-finance/70370/despite-borrowers-rush…
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