Following up my ‘AUT Policy Observatory’ report on ‘Housing Prices Relative to Consumer Prices: An Analysis’.

Last week the Reserve Bank reported stress tests to assess the ability of borrowers to cope with higher mortgage interest rates. Assuming 7 percent p.a. – close to the average two-year mortgage rate over past decades – the RBNZ found that up to 5 percent of current borrowers would be put under severe stress and would not be able to meet day-to-day bills for food and power.

Stress test are an internationally used system of assessing what might happen under certain assumptions. Of course reality is more complicated, but like many measures it provides some insight into possible futures.

I guess one lesson is that the RBNZ will be cautious about raising its Official Cash Rate by the two or so percentage points which would push up mortgage interest rates to near 7 percent but it may have little option if world rates rise. It probably will increase them cautiously if it has to in, say, eight steps of a quarter of percentage point each, taking more than a couple of, or more, years. (In certain kinds of financial crises it may have to bump them up much faster.)

That means that those who are particularly vulnerable to financial stress from high interest rates may have time to adjust. (Whether they will is another matter.) In any case banks have had a signal that they should not increase advances to such potential vulnerables.

The stress-test report is yet another indicator that the housing price boom may be coming to an end (despite the ongoing optimism of some spokespeople for real estate agents). A report I prepared for the AUT Policy Observatory puts what may happen in a historical context. 

I used the longest housing price series available, starting over half a century ago in 1962, comparing it with consumer prices. For most of the period – the first 40 years – house prices rose a little faster than consumer prices, at about 1.4 percentage points a year. There is nothing special about this. You might expect them to rise a little more because land nearer city centres is limited.

However, since 2002 the rise has been much greater at 8.2 percentage points annually (12.4 percentage points if we omit the period when the Global Financial Crisis was at its most intense.) This is so much higher than the past trend that it is almost certainly due to a speculative bubble financed by offshore borrowing. (There are other lesser factors such as the failure to build enough houses and there has been housing pressure from immigration.)

The statistics suggest that our house prices are now about two-and-a-half times higher than they would have been had they risen at their pre-2002 rate. Alternately, housing prices would have to fall 60 percent to be back on track.

Typical home owners might feel poorer (speculative bubbles always make one feel wealthier than one really is – before they pop) but a lower price for their houses would not make much difference. They would still get the same value from living in them and outgoings would be much the same. Even if they have to move, on average the new house price would be proportionally lower.

There are two big groups who would be markedly affected. One are those without their own homes. They would now find it easier to find the deposit for a house and also to service the mortgage, so they might be able to buy their first house.

On the other hand, many who have been investing in housing would be worse off. For example, if housing prices were to stabilise or fall, the investor who has bought a house with as much debt as they could get away with, relying on the tenant’s payments to cover the mortgage while getting their return from the capital gain, would be faced with a zero or negative return. (They are especially vulnerable to rising interest rates.)

(A third potentially large badly-off group is home owners who lose their jobs.)

So how likely is a house price stabilisation or a price drop? The answer is ‘almost certain’, although we cannot be as certain when. Speculative bubbles are always like that. It is possible the market has already peaked; if not it will. (The sooner it peaks, the easier it is for the economy to adjust, but those exposed when it stabilises or falls hope that it wont be yet.)

It is difficult to predict the course of the adjustment. There are so many possibilities, for so many things are going on. I looked at history to make an assessment. It turns out that the typical price fall relative to inflation is about 2 percent a quarter – or 8 percent a year. So we have had not had the price crash some have predicted, presumably based on what has happened in America. My report argues that our institutional arrangements are different from those in the US and they cushion a rapid fall. (It acknowledges that sharp drops are possible in some regional markets.)  So it expects that the housing price falls will be sluggish. However the historical record is that the relative falls have never lasted for longer than five quarters. In fact it is going to take six or so years to get back to the long-run trend at the 2 percent a quarter rate fall. Who knows what might happen over that period – especially if interest rates also rise?

There will be a lot of distress among those who have over-borrowed and among investors who had not realised they were actually speculating. On the other hand, more will be able to buy their first homes.

There is another phenomenon which will add to the pain. During a speculative bubble the housing market is ‘liquid’, in the sense that there is a lot of buying and selling. Speculation adds to the ‘depth’ of a market so that people who have to change their housing – for family reasons, jobs, life style (the garden is too big) or aging (need better access) – have a big range of choices which dry up after the ‘downturn’. Those who service the buying and selling of real estate – including lawyers, valuers, and removal firms as well as realtors – will have less business.

So it will not be easy; speculative bursts never are. History reminds us they happen, especially in market economies when governments fail to take prudent measures early enough.

Comments (4)

by Andre Terzaghi on June 05, 2017
Andre Terzaghi

I've had direct experience of a few housing price busts where the price of housing has fallen by double-digit percentages. In all those cases, there was a concurrent lack of demand, due to depopulation from the area or because of speculative over-building or the GFC.

The situation we have in Auckland right now, with prices having risen way beyond any rational measure of being "affordable" yet there is a large unmet demand, is a completely new one to me. Anyone got any historical examples of what happens from here? The closest in my experience ended with a collapse of demand due to the GFC.

by Charlie on June 05, 2017

I've seen many up and a few downs over the years, here and in the UK

A significant hike in rates would force some weak hands to fold, resulting in some opportunities to pick up some stock more cheaply from mortgagee sales.

I doubt we'd see a fall of more than 10% in Auckland because there is a genuine, long term shortage of accomodation. Typically the market would be worse in a) new suburbs where debt levels are highest and b) coastal property - 2nd homes. In the so-called 'leafy suburbs' prices would remain static for a long time and turnover would drop greatly.

I believe Auckand has already topped. Investors are already absent from the market and first home buyers mostly cannot meet the lending criterea.

I expect the provinces will follow this trend in the next few months. Vendors in places like Tauranga, Napier and Nelson have been rubbing their hands expecting to get large sums from rich Aucklanders moving out but I think this will run out of steam pretty quickly.

by Rich on June 06, 2017

The two questions for people holding property are: "do I want to sell?" and "can I sell?".

Almost no properties in NZ yield a rental that will cover a (notional) 100% mortgage. Every property owner is accepting an income loss in return for the promise of a (tax free) capital gain. Owner occupiers are paying a premium for the alleged convenience of owning their own home, investors either have a block of equity earning a low yield or are making a cash loss and having to pay a regular contribution into their "investment".

Generally, in a flat market a rational investor (with equity) would only not sell because they expect an imminent improvement (in a timescale to cover the transaction costs of selling and repurchasing). As this hope declines, there will be selling pressure (especially from overseas people with a wider view on where to put their money).

Should prices fall more than maybe 15%, though, there will be a number of participants with negative equity who are unable to sell (if the sale price doesn't clear the mortgage, the transaction can't complete. It's to be noted that in some markets overseas this isn't the case - mortgage holders can hand back the keys without further recourse beyond gaining a crap credit rating).

This has traditionally put a floor on the NZ market - if prices drop, sellers go away. Possibly this isn't going to be the case this time though, given the number of overseas participants with different priorities.


by Andrew Hart on June 10, 2017
Andrew Hart

I have just been reading an article in the NZ Herald concerning private sector debt; household debt is standing at 230 billion dollars !

I hope the tax payer doesn't end up being responsible for this debt if a houseing collapse happens.

Read at



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