By Bernard Hickey
It's Economics 101.
When demand rises and supply does not then prices will rise.
If demand rises at the same rate as supply then prices will stay the same.
If demand is flat and supply rises than prices will fall.
So why is the Government planning to spend NZ$218 million over five years to double subsidies for first home buyers who are buying new houses?
It is adding demand to a market that is clearly supply constrained, as the Government has itself been saying repeatedly since 2012.
Economics 101 says this will push up prices. In fact, that this is exactly how the policy is designed to work.
The Government is saying this extra demand will encourage developers to bring new houses to the market, but Economics 101 says the only way this will happen is if prices generate the signal that it makes economic sense to develop more houses.
That price signal is an increase.
Critics from both the left and the right have accused the Government of adding fuel to the fire of house price inflation of 30% in Auckland since the beginning of 2012.
It's actually worse than fuel.
These subsidies for new home builds are actually rocket fuel because they can be leveraged with a 90% or even a 95% home loan.
A couple on a joint gross income of NZ$100,000 who have saved NZ$20,000 in KiwiSaver over five years would be able to get a subsidy of NZ$20,000 and withdraw their Government tax credit of NZ$5,210 as a deposit. That NZ$45,210 deposit can then be deployed with a Welcome Home Loan as a 10% deposit to borrow NZ$406,890 to buy a NZ$452,100 home.
The difference is that previously a first home buying couple could only have borrowed NZ$180,000. Suddenly, someone who could not compete with a rental property investor or another first home buyer can afford to bid NZ$200,000 more for the same house in an auction or contested situation, which is always the case in places such as Auckland.
A couple with a pumped up deposit who were able to borrow 95% from a bank would be able to bid NZ$904,200 for a house.
That is the power of leverage and it is unlimited power because the Reserve Bank has exempted new builds from its high LVR (Loan to Value Ratio) speed limit.
By targeting the doubling of first home buyers' subsides at new builds, the Government has effectively over-powered the Reserve Bank's policy, which was designed to turn down the heat on the housing market.
It was no accident through 2012 and early 2013 that high LVR (higher than 80%) lending by banks surged from 20% of all lending to almost 35% of all lending. That's because banks were encouraging first home buyers to raid their five-year-old KiwiSaver accounts and gear up to jump into the market. The banks knew how big the KiwiSaver accounts were because many were administered by the banks.
The Reserve Bank had to react with its high LVR policy in October 2013 and the Treasury rightly advised the Government last year when it was considering expanding its first home buyer subsidy that it risked over-powering the Reserve Bank and forcing it to hike interest rates earlier and higher.
Treasury also pointed out such subsidies were "low value for money and tended to be regressive." That is bureaucrat speak for wasting taxpayers' money on subsidies for richer people.
Such subsidies are actually losing popularity in Australia, where A$22.5 billion has been spent on them over the last 50 years without any improvement in affordability or home ownership rates.
The Government's policy also flies in the face of its own logic.
It has argued against the Labour and Green policy of introducing a Capital Gains Tax on the grounds it has not worked in Australia.
So if first home buyer subsidies haven't worked in Australia, why would they work in New Zealand?
Housing Minister Nick Smith has until this week been the strongest supply-sider in the Government on housing, arguing that that he wanted to increase supply faster than demand to press down on prices and improve the house price to income multiple in Auckland to four from seven currently. That would require Auckland house prices to either fall 43%, or to be flat for 19 years while wage growth of 3% nibbled away at the multiple.
The last thing the Government needed to do was pump more jet-fueled demand into to a market that the New Zealand Initiative said this week would be short of 113,800 homes by 2031, given current building rates and population growth.
Everyone likes to watch a good fireworks display or a hotly contested auction, but it is madness to ignore the laws of supply and demand when spending taxpayers money and trying to improve housing affordability.
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A version of this article first appeared in the Herald on Sunday. It is here with permission.
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Here is a review of the housing policy failures in Australia, by Saul Eslake. The following two images are from that review.
42 Comments
So Bernard given Wheeler has previously aggressively attacked the housing bubble by introducing macroprudential LVR limits what do you think his reponse will be if National is re-elected?
Remove the LVR new build exception?
A rapid increase in the OCR?
A Greenspan hand wave at irrational excuberance?
Well it won't be the later Greenspan hand wave.
There's a good chance there will be another OCR rise this year. Especially if banks keep cutting interest rate offers and National win the election. Probably also means the LVR rules will stay in place much longer, years maybe.
Probably Bernard because "Mr Market" is getting ready to purge the housing market excess with a reduction in the current ludicrous multiples of income needed to buy event a modest home. This would be bad for the bankers for whom the dream must surely be impossible debt multiples, inter-generational liabilities, and government subsidy on command. As Lord Acton famously reminded us the war we will ultimately have to fight will be: "the people versus the banks". Who rules NZ? I would suggest it is essentially the banks. The country is a slave to usury.
The answer to our housing crisis is to allow the market to purge the excess - politicians will only make matters worse. Indeed, this proposal from National suggests they are terrified said market is planning to do just that. Time for a dose of Austrian economics?
Things do appear to be getting a litlle desperate in housing bubble land. Increases in housing debt are back to levels from 2 years ago.
And the forecast 'surplus' requires a 7% increase in house values to March 2015 but instead they have quietly deflated over the first 4 months of the year.
Housing is central to TSY's forecast surplus. The PREFU sees 2015 with a 20.7% increase in residential investment (down from 22.6% at Budget Update).
House prices are supposed to increase in 2015 (PREFU 4.4% - down from 7.3% at Budget Update).
TSY logic goes:
Lower dairy prices impact terms of trade
Lower terms of trade => lower private consumption
Lower private consumption => weaker house price growth
Weaker house price growth => lower residential investment
In a forecast where:
1. A mix of inflation and GDP growth is supposedly driving a hefty increase in tax take, and
2. Private consumption growth is 4.1% against public consumption growth of 0.1%, and
3. Dairy prices have already fallen below PREFU forecast
4. House prices are static or deflating, then
Tax revenue (GST, source deductions and corporate) are all going to continue to come in well under forecast and deficits continue.
I am not aware of IRD or TSY separately accounting for capital gains tax in PREFU or Budget Updates.
Bernard I think you need to go on-line and check out where the next Economics 101 class is being held, for all our sakes.
The Governments policy of assisting first home buyers into newly built homes will increase the supply of housing stock and lower the demand for housing. New buyers make up current demand for either rental stock or existing houses, demand will be reduced by taking them out of the market. Thus reduceing demand for housing stock in the long term.
The government have been working to free up land for new housing, this policy will ensure that these new houses go to those in most need.
To suggest the creating a mechanism for new home buyers to get into new housing will increase overall demand is just plain wrong, they won't effect the demand for existing houses.
To suggest that creating more housing supply will somehow increase prices is just to mindboggling to deal with on a Sunday morning
Good luck at the classes, look foward to a more reasoned debate in the future.
TAPO
Interest7 .. You might be right .. you might be wrong
On a couple of occasions Bernard has referred to the experience of the First Home Owner Grants (FOHG) schemes undertaken in Australia
Immedialtely after the beginning of the GFC, the Australian Federal Government (Labour) introduced a Federal scheme which was additional to pre-existing State-Based FHOG schemes
Within months the prices of house and land packages provided by ALL the production builders increased by the amount of the additional Grants
Last year, just after the 2013 Federal Elections, the incoming National governent cut FHO Grants back by 50% and the States reduced the level of their grants also.
The production builders immediately reduced the prices of new-build house and land packages by the same amount
That's the experience.
That's what Bernard's referring to.
He's not referring to the prices of existing houses.
Interest7 you are wrong. Iconoclast has given you a reason why based on experience. I can give you the Econ 101 theory reason for why it happens.
The Homestart program is a subsidy to subdivision developers and homebuilders. Subsidies always cause prices to rise, even if it is given to the buyer.
The elasticity of the supply curve determines how much prices rise. When supply is very inelastic i.e. when there are supply constraints then most of subsidy is captured by the seller in price rises.
So National's Homestart policy is incredibly cynical politics given National has spent 6 years saying the cause of unaffordable housing is supply constraints caused by local government.
It is quite simply gifting taxpayers money, young folks kiwisaver money and mortgage debt to the big end of town.
Go on then, make all newly build houses in an entire development only available to first home buyers. No exceptions, only those who have never before owned property anywhere in the world. Where they are a couple, neither may have owned. There is your "most in need" unicorn right there.
Only that would be a test of the truth behind the "First home buyer" driven mantra. I suspect the developers would simply not turn up to work unless they were paid some form of guaruntee.
Developers are not altruistic, they are capitilists, they will sell for greatest gain and the customers credentials matter not one jot.
There is another issue. Economists and students of finance know that the core principle of investment is diversification. It is the only "free lunch". I am yet to meet a financial advisor who would recommend taking all of your retirement eggs and putting them in a single investment (a highly volatile, illiquid one at that), at the peak of the market, and then lever it 400% and hope for the best.
Economics historians understand that the exponential house price growth seen in western economies over the past 30 years has been due to a structural reduction in the cost of finance as central banks figured out how to tame inflation. So our parents and grandparents bought $20k houses but suffered 20-30% interest rates. As interest rates structurally fell and their incomes grew, their asset prices grew strongly (buyers could borrow more at lower rates, so they could pay more for a house). This sort of structural reduction in interest rates cannot be repeated (you can't reduce rates by 15% from here - the bank would be paying you to borrow!).
The sad reality is that NZ house prices are a house of cards. With household debt levels >90% of GDP and >145% of disposable income we are now beyond where the USA was in 2008 when it imploded under the weight of its own housing debt (they were at 95% and 128% respectively).
The only thing currently saving us is artificially low interest rates here and abroad. We know as a fact that when interest rates here normalise back to 8%, our debt service will be >14% of disposable income (this is where we were in 2008 - the data is all on the RBNZ website). We also know that the US hit the wall when their debt service hit 13.2%.
So let's make a prediction, one we can be very confident of, based on the following known facts:
- We know for a fact that the US is reducing its artificial QE policy and will start raising its rates next year
- We know for a fact that higher US rates flow directly through to our fixed mortgage rates which will therefore also go up (despite the current volatility and minor cuts)
- We know for a fact that higher US rates cause the USD to rise relative to other currencies (other things being equal), so the NZD should fall
- We know for a fact that a lower NZD causes price inflation because most of the stuff we consume and use is imported from overseas (so these things will all cost more in NZD)
- We know for a fact that the RBNZ raises rates when inflation rears its head, so our floating rates will rise
- We know for a fact that rising interest rates cause asset prices to decline (whether they are shares, property, infrastructure) because they reduce the amount of net cashflow that goes back to the leveraged asset owner; or in other words, an asset can support less debt, so a buyer can borrow less, so they are forced to pay less and asset prices fall.
So what can we confidently predict? House prices are due for a quite large correction as interest rates rise from here.
I certainly wouldn't recommend to anyone to take all of their savings and plough them into a house purchase today.
I can't argue with any of that Mr Bear, the only issue is timing. Based upon your scenario, and a current market expectation that US rates towill start rising from mid-2015, maybe its late 2015 or more likely early 2016. But theres still alot of debate about US rates timing and nothings certain on timing. But youre right, even if inflation stays under control central bankers have been quite vocal in acknowledging that theyre blowing financial bubbles all over the world, including here, and they will move to normalise rates as soon as they feel they can - and they wont be waiting forever to do that because they know the longer they do, the bigger the burst.
We don't know "for a fact" the that the US Fed will start raising rates next year. Current best bets seem to be mid 2016 . It is just as likely that deflationary forces will more than counter inflationary forces for the next several years. Take a look at 5 year futures contract for crude oil. 20% lower than spot prices. If you can point out where the inflation to justify what would amount to a several hundred percent rent increase on QE'd money, ie Fed Funds rates up from 0.25 to even 2% will come from I will be appreciative of the information.
The Bear... I would qualify your underlying premise that :
"Economics historians understand that the exponential house price growth seen in western economies over the past 30 years has been due to a structural reduction in the cost of finance as central banks figured out how to tame inflation."
The exponential growth in house prices has been caused by the exponential growth in Money supply.... ie.. In reality is is essentially the purchasing power of money that has devalued.
It just so happens that Central Banks in thier great wisdommmm or maybe it is ignorance.... decided to manage the demand for credit ( money ) thru the interest rate mechanism...and decided to measure the declinge value of money ( inflation ) thru and artifical index called the CPI....
NZ house prices are not a house of cards.... NZ house prices are a better proxy for measuring what happens when Money supply is exponentially expanded... ie. purchasing power of money decline... We have all been hypnotized into believing inflation is simply changes in the CPI and as long as the CPI is within its range ...we can print as much money as we like....
U are right thou... we are reaching the limits of this game.... but it could last another 10 yrs...... We are probably only 1 cycle awya form our own version of QE...????
So.... I disagree with the timing your prediction..... current interest rate rises won't trigger a crash .... we will make it thru another business cycle.... ie.. recession and then a boom..
Central Banks and Politicians are still very keen on money supply growth...
just my view.....
Maybe Caleb, my thoughts are either cheaper houses or higher incomes, possibly a bit of both over a longer period which would be the preferred scenario rather than suddenly cheaper houses. But I do think it will be somewhat higher rates that at the very least halt the rise, but hopefully not mortgagee sales, but higher rates are designed to create some pain and a change in incentives.
We are irrelevant as a market in the global scheme of things.
US households have used the window of abnormally low interest rates to delever, with HH debt:GDP down to c80% (from the mid 90%s).
UK households have also used the window to reduce HH debt:GDP to c90% (from 103%).
We are moving the other way, under some false belief that low interest rates are here to stay.
There is a significant possibility that US rates rise more quickly than expected as their economy keeps expanding and the Fed has to play catch up. They will also be hit less hard at home as rates rise because they have delevered.
Unfortunately, as a nation, we are our own worst enemies on housing. We believe price rises make us wealthy when in fact they don't. They make old people wealthy when they sell up and downsize into a retirement unit, but everyone else just grows their mortgage debt every time they "move up the ladder".
Mathematically, a falling market is better for upgrading your house and growing your total net wealth, as a percentage loss is bigger in absolute $ for an expensive home (so stretch and upgrade at the bottom, not the top). That is why the best investors play counter-cyclically (sell into a rising market, buy in the troughs). It's tried and true, and we all watch and admire the likes of Buffet and Soros, but when it comes to our own money, for some reason we completely ignore their examples and believe we should keep piling in at the peak because we "feel" wealthy due to some irrelevant paper value. And because we rely on leverage to do it, we end up getting burned badly when prices fall. Which they do, even in housing, and even in Auckland.
Housing is a big part of why we are now quite poor as a country relative to where we used to rank globally and where we could rank if we were smarter about what we did with our money.
My head is beginning to hurt with all this argument going back and forth.
All I know is that with Auckland in particular the percentages of investors is far too high and of owner-occupiers is far too low. Government policy should target this.
Start with something similar to the Hong Kong tax on buyers and not just foreign ones. A purchase tax at 15% on buyers unless it is for an owner occupied home and for upgrading charged but remittable once the previous home is sold. Holding on to a first home as an investment while buying another or second home needs to be discouraged. This would even up the investment scene to give a boost to owning your own home.
Owning a bach is discretionary and a tax on holiday homes is no big deal. The price on this type is decided by the market anyway as many owners have found with major falls in value on the Northland coast for example.
There is a much lower shortage of accommodation in Auckland than many believe and this is evidenced by the low pressure on rent increases. Obvious really.
Its just another clumsy attempt at market manipulation by gubbermint.
With LVR the FHB couldn't enter the market.
By excluding new builds and giving away free money they hoping that FHB will go into new builds and tadda...there's your 10,000 new residentals in Auckland.
except that not how it works in real life.
i love it how half the people on this website hassle the people that buy property for other people to live in...if only they knew how much risk you take on every day, month, year...auckland storms, broken window, mold in the bathroom, there goes the kitchen insinkerator, back room needs replacement toilet, rates up 10% (again), insurance costs $1000 (up 10%) a year and now because of an earthquake your house only has 75% coverage down from 100% if it burns down, just before the tenant does the dirty and runs off with $800 dollars, and then as half of you want; lets put up the interest rates like 6 years ago to 10% (again), ...so that means if that happens again a $1.25 Million property in central auckland that gives you $50k rent at best is now costing you $125k in interest....oh yeah, us greedy property guys...taking the easy money....naahh...we definitely need a CGT on top of that plus a WOF, and higher tax rates just to make it a little bit fairer to the renters or people living with mommy...
one of my tenants didn't just try to stick me with the 500 phone and power bills...they also ran off with all my internal doors. The tribunal guy wouldn't believe us, and the guy had no money or assets so after the bond went to clean their mess it was all on me :( Property managers just said "his references seemed ok, and that's all they had to check"
It's a business, do your sums and price it accordingly, but don't cry about it if your gamble loses due to lack of insight. If you treat this as a hobby then of course all these things will annoy you as they appear as extras you did not account for in the initial business plan and when you paid too much for your "investment".
Exactly. And what about a house in which I have an interest, that was secretly turned into a gigantic P lab?.
Now it has to be demolished to ground level, and the neighbours each side may also have to be decontaminated or even partially demolished.
Cost around $400K.
Who said being an investor was easy.
Sad but sooo true, notec. Buying votes by redistributing munny from the wealth generators, creates swathes of perverse incentives (e.g. high EMTR's), energises John Galt, and generally foobars the economy. For a working example, see the UK outside London: e.g. Wales is a 72% Gubmint spend 'economy'. But the foobar happens so slowly and quietly (generationally, in fact) that it's the boil-the-frog deal, and nice and warm and comfy in the early stages......
You mention "the wealth generators"
There is another segment called "the wealthy" who dont generate
But, by crikey, if you have been paying attention lately, they have been fighting back, making sure they keep a bigger slice of the pie. It's been in ya face so much it's boring. They dont even bother to disguise it anymore. Lobbyists. Influencers. Influence-Buyers. Peddlers. You name it. Then there's those who employ them to do their bidding, keeping their hands clean.
However among the "wealthy" of both stripes, there are some who at least realise they have to recycle some of that "green carpet" back down to the minions so the "carpet layers" can take it back up again, and the greater the frequency, the more they get to keep
It's called recycling
It is Lobbying on any front that is the issue......remove that and what would happen?
Lobbying only takes place because someone/group has a cause.....
It doesn't matter whether you're the minion or the big-booted wealthy if you're lobbying for a cause then you are part of the problem........there is a complete lack of discipline by Politicians and the populace to adhere to the basic constitutional rights of freedom and liberty!!
The trickle down effect is an illusion so why would any reasonable thinking person think this is beneficial? It reminds me of a young dog running around in circles trying to catch its tail. You can change direction but the tail is attached.
Progress must happen, productivity must increase :
http://www.smbc-comics.com/index.php?id=3465#comic
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