The new Labour-NZ First-Green government has promised to make large scale changes to the housing market. There is a long list of policies. Some will be put in place quickly, others will take years to take effect.

Right now, the biggest risk for the housing market is a slowdown in lending. Banks have become cautious and are not lending much. The LVR restrictions from the RBNZ have also limited how much of that lending can go to investors, first home buyers and buyers who want to have a small deposit.

The housing market is already slowing. The new policies will reduce demand, increase supply (slowly) and ask more of landlords. Everything is pointing to one direction: the super cycle in house prices since 2001 is over. A correction in house prices seems likely in the next 1-2 years, and longer-term increases will be more modest than seen in the last two decades.

1. Backdrop of a slowing market

The housing market has been slowing over the past year, well before the general elections.  The housing market has recovered strongly following a steep downturn from 2007 to 2010. Sales volumes and prices have picked up strongly since then.

The latest cycle has been led by Auckland, but other regions have followed with a lag. Over the past year, sales in Auckland have slowed sharply. Sales in other regions are also slowing, but are following with a lag.

Figure 1: House sales have been slowing for a year, led by Auckland

Source: REINZ, Sense Partners

There have been many drivers of the upswing in the housing market. We aren’t building enough houses. Demand from population growth and investors has been strong. Credit has been cheap and easily available.

Indeed,  New Zealand households now have more debt than ever before. It is unclear how far the virtuous cycle of more debt and increasing house prices can keep going. There is no historical precedent to guide us.

Figure 2: New Zealand households have more debt today than ever before

Source: RBNZ, Statistics New Zealand, Sense Partners

While all other drivers remain in place, borrowing has become much harder. Banks are lending less, and they are pickier about who they lend to. This combo has meant that there is less money chasing the housing market.

There are three big reasons why banks are being more cautious.

First, Australian regulations have become much stricter. This has flowed through to the New Zealand operations of the Australian owned banks, and the parents also need capital back from New Zealand. This means New Zealand banks are trying to lend less and only to low risk clients, so that they meet both the new risk criteria and increase their likelihood of profits they now will have to send to their parents.

Second, the RBNZ has progressively increased the LVR restrictions. While this has not affected how much the banks lend, it has affected who they lend to. The regulations pulled credit from high LVR lending, to first home buyers, then to investors and then from Auckland. These rules have reduced the pool of potential borrowers.

Third, banks are not confident that house prices will keep rising at recent rates. Banks lend confidently when house prices are likely to rise, as even if the borrower faces difficulty, the debt is becoming smaller relative to the price of the asset. The risk of default and loss is very low. But if prices are not rising, banks only want to lend to the most creditworthy borrowers – this is a much smaller group.

Bank lending looks to have peaked. Without increasing amounts of money to bid up house prices, the housing market has slowed. Fewer houses are selling and prices have stalled or are falling in previously investor driven markets. If the banking sector caution lasts, we can expect house sales to stay low and prices to edge lower. We could expect this cyclical slowdown to last another 1-2 years, with house price declines of 10% to 20% from the peak, based on historical experience.

2. New government

The new government has promised to increase housing supply, clamp down on foreign investors, reduce immigration and reduce the incentives for housing investment. If successful, these policies will clearly reduce the current supply-demand imbalances that have driven house prices higher.

But there are uncertainties around what the policies will actually look like and when they will be implemented. Further, there is uncertainty if all these changes will remain in place permanently, or if a future government would undo some or all of these changes.

Assuming all the policies will be put in place, we can expect house prices to increase at a more modest pace in the future, than we have seen in the super-cycle of the past two decades.

2.1       Reducing demand

There are a number of policies in the pipeline to reduce demand. There is little current analysis on exactly how much of an impact these policies will have. These demand management policies seem marginal, but cumulatively could have a large impact.

2.1.1         Foreign buyers

Foreign buyers will be banned from buying existing houses. This will reduce demand, but it is not clear how much. There is no officially collected information on foreign buyers. Using partial data, we believe less than 10% of house sales were to foreign buyers in recent years. So, a ban on foreign buyers will help at the margin, but will not be the major driver of a housing cycle.

2.1.2         Immigration

The government has pledged to reduce net migration. Record population growth in recent years has undoubtedly increased demand for housing. Reducing net migration will reduce demand for housing. Because house building in recent years has not kept pace with population growth, current shortages in housing supply will take many years to clear even with lower immigration.

Figure 3: Record net migration in recent years

Source: RBNZ, Statistics New Zealand, Sense Partners

2.1.3         Negative gearing

Negative gearing is a practice in which an investor borrows lots of money against their rental investment, which lifts their mortgage payments sufficiently so that their outgoings exceed their rental income. This creates a tax loss, which they offset against their other income, thus reducing their tax bill.

This practice is most lucrative for those on high incomes, who get a bigger tax benefit because the income they have ‘removed’ from the system would have been taxed at the top marginal tax rate.

While we do not have figures for New Zealand, we know that in Australia nearly half of the benefits of negative gearing go to the top 10% of income earners.

There are of course legitimate reasons to count the costs of running a business, such as renting out property, for taxable income purposes.

Under new policy, the returns from an investment property will be quarantined or ring-fenced, so that they can be offset only against the same investment. So, if an investment property makes a loss one year, this is carried forward until the property does make a profit, or is offset against the capital gain (if the property was bought with an intent to benefit from capital gains) when the property is sold. This will ensure that residential investment properties stand on their own merits – as either genuinely profitable or unprofitable exercises – rather than hiding behind a tax shield.

This policy will affect regions where rental yields are very low. Gross rental yields by territorial authority is shown in the following table (Auckland is shown in the pre-amalgamation forms). Removing this policy is only likely to affect around 10% of owners (who may own many properties). The impact on prices is likely to be small. For example, when depreciation was removed for investment properties, there was no appreciable impact on house prices or rents.

Figure 4: Rental yields are very low in many areas

 Source: QVNZ, MBIE, Sense Partners

2.1.4         Longer taxable investment timeframe

The government has proposed that any investment property sold within five years of purchase (except the family home, transferred by bequest or for family reasons) will be liable for tax. The capital gain will be treated as investment income. This extends the current two-year rule that was introduced in 2015.

Historically, only modest numbers of houses have sold frequently, and usually only during period of a strongly rising market. The new rule will reduce the rate of turnover in the market – which is only likely to affect Auckland in any meaningful way. Other regions tend to see long ‘hold’ periods.

2.1.5         Expecting more from landlords

Rental policies on insulation, heating source, and eventually reasons for evictions are likely to move more in favour of renters. This will require landlords to become more professional, perhaps using agencies to manage on their behalf. This is likely to increase the cost and responsibilities of owning investment properties.

Many current landlords are ‘accidental landlords’ – their main purpose is to profit from accumulated savings and capital gains. Most landlords do not even know if their tenants wanted or needed different features. But this is likely to change and could see the rental ownership become more corporatised in coming years.

Internationally, corporate owners tend to favour higher yields (which they can bank) over capital gains. This could change the motivation and driving force of the investor market. Any changes in this area will take many years to take effect.

2.1.6         New governor

The RBNZ will appoint a new governor in 2018. If the new governor comes with experience from the UK or Australia, we may see a significant change in the way the RBNZ regulates the banking sector. In both those jurisdictions, banking regulation has moved aggressively to reduce the amount of credit banks create, not just who they lend to (as NZ has done).

While the shape and timing of any such risk is unknown, this could have a more pronounced impact on the housing market, than all other government policies in a very short timeframe.

2.2       Increasing supply

There are a number of policies to build more houses. The current shortages are so severe, and the shortages of labour so intense, that any house building programme will take time. Over time, a more responsive housing supply will mean that house prices should keep pace with incomes, rather than increasing faster than incomes as they have done since 2001.

Figure 5: House prices have risen much faster than income in recent years

Source: QVNZ, RBNZ, Statistics NZ, Sense Partners

2.2.1         KiwiBuild

The KiwiBuild programme intends to supply 100,000 houses over 10 years. The programme is ambitious, but it is not clear how much of the increase will displace houses that would have been built anyway, or if they will be additional.

International and historical experience suggests that houses built for poor people, through social housing and affordable housing that cannot be sold in the open market, do not compete with the houses the private sector would have built anyway.

The UK experience is particularly vivid. When the public supply of housing slowed, it was not replaced by the private sector. Rather the private sector continued to build as it did before the change in policy.

As such, we can expect the KiwiBuild programme to only increase total housing supply modestly. As only a portion of the programme will be social and affordable housing.

Figure 6: UK experience shows government provision of housing doesn’t crowd out private housing supply

Source: QVNZ, RBNZ, Statistics NZ, Sense Partners

2.2.2         Planning regulations and infrastructure funding

The government also plans to reduce regulatory and funding barriers to housing supply.

Current planning rules and regulations limit where houses can be built and with what features. This can slow the supply of housing and also require larger or more expensive houses to be built.

There aren’t enough higher density options being built at the 1 to 2 bedroom level. Most property developers focus on 3 to 4 bedroom standalone houses. This tends to be most profitable for them because building higher density is more expensive or not permitted, mainly due to government regulations. As a result, nearly three-quarters of the new supply in recent years has been in homes with four or more bedrooms, even though much of the growth in the population is from singles and couples

The government wants to reduce density limits. This will allow more housing to be built in existing areas. Currently many areas with density potential have not yet done so, because it is expensive to develop in built up areas and often infrastructure connections do not have sufficient capacity to add more houses.

The government wants to further reduce these limits. Removing the regulatory boundary in places like Auckland will mean that previously un-zoned but contiguous land will now all become eligible for housing (currently much of this is rural land).

It will increase the demand for infrastructure – particularly for things like transport, water, storm, sewerage and basic services like schools and doctors.

All of these issues are yet to be worked through. If addressed, these policies will significantly increase housing supply over decades to come.

Figure 7: We are building too many large houses

Source: Statistics NZ, Sense Partners

3. Conclusion

The myriad of new government policies will together make housing less of an attractive investment option. But these policies will take time to bear fruit.

The immediate focus should be on banks. Their reduction in lending has slowed the market and depressed confidence.

In the next 1-2 years, bank behaviour will dictate the performance of the housing market. Current cautiousness in banks suggest house sale volumes will remain low and prices are likely to fall by 10%-20% from their peak.

Longer term, if all the announced government policies are in effect, then we can expect the current supply-demand imbalances to fade gradually. Future house price gains are more likely to mirror increases in incomes, rather than the very strong house prices we have seen in the last two decades.

Written by Shamubeel Eaqub for NZHL

The information contained in this article is of a general nature and should not be taken as advice. It reflects the opinions of the writer only and does not necessarily reflect the opinions of New Zealand Home Loans (NZHL).