The Minister of Housing’s ambition is to reduce markedly the ratio of house prices to household incomes. If his strategy works it would transform the housing market, dramatically changing the prospects of housing as an investment.
Leaving aside the Minister’s metaphor of ‘flooding the market’ I do not see how the announced strategy is going to quickly resolve New Zealand’s housing problems.
His strategy seems to have evolved over the last five years following the establishment of the Ministry of Housing and Urban Development and is much the same as a Labour Government would have proposed, point-scoring and minor differences aside.
Supply-side initiatives take time. It is not like the Reserve Bank changing the Official Cash Rate, with an immediate impact on financial markets which works its way quickly into the new mortgages and mortgage renewal markets.
We are currently adding about 30,000-40,000 dwellings a year to the housing stock. (There will be more new ones since some will replace demolished dwellings.) Suppose we add an extra 10,000 a year. That would not only be a strain on the building industry but the Reserve Bank might feel it necessary to further restrain the economy. Given there are over 2 million houses the additions to the total stock would be about 0.5% a year. Is demand so elastic to such a small change in supply? (For a review of the changes in the intercensal housing stock see here.)
In any case, it is unlikely that the announced changes will produce a sharp increase in the supply of new buildings. It is not just a matter of putting up a shed on new piece of land. There is the accompanying infrastructure including water and roading. That in will take time to be installed, even if the local authority is enthusiastic. So the strategy is about the long term and not ‘flooding the market’.
The Minister’s strategy includes a long-term target of the price of houses costing ‘three to five’ times (annual) household incomes. ‘What I want is for house prices to moderate over time, so that in 10 to 20 years’ time, we have essentially gone a long way towards solving our housing affordability problem.’ Currently the multiple is 6.6 nationwide. In Auckland it is 8.1, Wellington 6.1, Christchurch 5.8, Hamilton 6.6, Dunedin 5.7 and Queenstown-Lakes almost 15.
So the Minister wants a cut in the relative price of housing of between 25 percent and 55 percent. That does not mean he expects the nominal price of houses to fall 25 to 55 percent, a reduction which would cause widespread financial distress (particularly if it was to happen rapidly). Rather, the Minister is hoping that nominal incomes will rise faster than housing prices over the long term.
To make rough sense of it all, suppose he envisages a 40 percent relative cut in house prices in fifteen years (the Minister’s midpoints). Allow inflation at 2 percent per annum and real incomes to rise their long term average of 1.5 percent p.a.. Now suppose the average price of a house is $1m. (Quotable Value thinks it is about $900,000 but the million keeps it simple.) The 6.6 ratio would mean an average household income about $150,000 p.a. (Which is also a bit high – this is an illustration). In fifteen years’ time, under those moderate inflation and growth assumptions the household is likely to be earning about $250,000 p.a. The ministerial ambition for the ‘four’ ratio means the price of housing will still be $1m (i.e. four times $250,000). So the Minister’s target means that there will be no nominal capital gains in house prices for a long time to come.
You can fiddle around with these assumptions, but realistic alternatives suggest that, under the Minister’s ambition, capital gains on housing will be negligible and house ownership will be a poor investment prospect. For most people home ownership will make still make sense, even though they will make no capital gain when they sell (for neither will the next house they buy have gone up in price). However, treating your house as a financial investment or investing in property may not make as much sense.
Of course, it is only the Minister’s ambition. He won’t be the Minister of Housing in fifteen years. But he can be held to account while he is. Will housing prices be stagnant on his watch? In my judgement the proposed measures will not be sufficient to attain the ambition. My guess is that a serious effort to restrain house price rises will also require further fiscal and monetary measures.
Since the cost of building houses and providing infrastructure will go up with inflation, the value of land will fall under the Minister’s scenario. That seems very unlikely. In the more stable past, house prices have rise a few percent annually faster than consumer prices. What the reverse would mean is difficult to analyse but there would be a very different housing and investing world from the one we are, or were, used to.
So will housing prices stagnate to the extent of the Minster’s ambition or will they rise much like they did in the quieter past. Your guess is as good as mine, but I shall be surprised if they stagnate. I am not holding my breath waiting for the flood.