What are the possibilities for the future housing prices? What can we do?

Two eminent but retired Reserve Bankers, Don Brash and Arthur Grimes, have argued that house prices should halve. I am not sure whether they actually mean it or are just vividly pointing out that house prices are about double the sustainable level. I probably use a different method of calculation but have come to a similar assessment. (See here for an earlier attempt at the exercise when the imbalance was not as great.)

But while housing prices may be too high, will they crash? My 2007 exercise thought they might stabilise until consumer inflation caught up with them. Nine years later, inflation is negligible and house prices are even further out of line. A reconciliation through this inflationary mechanism is unlikely.

Could house prices collapse to half their current level in the way that some people have interpreted Brash and Grimes? If they did, the impact on the financial sector would be disastrous. For the vast majority of owner-occupiers, a halving of house prices would have little effect. They would get up each morning in the same house, pay the same rates, insurance, maintenance and mortgage and live much the same life with the same cash flow. Things might be a little trickier if they decided to change houses, but that difficulty would not compare with those faced by the minority of house owners – occupiers and investors – whose mortgages now exceeded half the current value of their houses.

If house prices were to halve, they would be, in the American jargon, ‘under water’, with the temptation to walk away from house and mortgage. Many owner-occupiers might not, but the pressure on investors would be to get out, dumping the house and mortgage onto the bank which lent the cash. Very quickly the banks would find themselves with a portfolio of houses they owned whose value was not matched by what they had borrowed to fund them.

In the well-oiled world of simple economic theory, this would not matter but in advanced economics and the real world it does for at least two reasons. First, the transaction costs of dealing with the investor bankruptcy are large. Second, the balance sheets of the banks would likely be so screwed up that, in order to prevent their failing, the government would inject large quantities of taxpayers’ money into them – effectively nationalising them.

However, I do not think a rapid fall in housing prices is likely. I am not ruling out a 10 percent fall or even a 20 percent fall for distressed selling. But I think a 50 percent fall is unlikely (although the Reserve Bank is prudent to take that possibility into account in its settings).

The reason for my scepticism is that there is a phenomenon called ‘nominal price rigidity’ in which general price levels do not fall even though economic analysis says they need to in order to clear the market. It arises because where people’s attitudes about monetary values are such that they are reluctant to reduce their offer prices.

That makes zero or negative inflation so difficult to handle, because so prices have to fall. But it is best studied in ‘nominal wage rigidity’; when workers refuse to cut their remuneration as unemployment rises. I am anticipating that home owners will be similarly unwilling to lower the price they want for their houses markedly and would not put them on the market. (Investors have to, when their mortgage is costly.) The net effect would be that the housing market would have few houses for sale, which would be tough on those who want to purchase or need to move; that seems to be already happening in some localities.

At this point we reach an impasse. Houses prices are markedly out of balance with the rest of the economy’s prices and wages. Consumer price inflation is unlikely to resolve the imbalance, while a slow decline in house prices will take ages and ages with the damage from the imbalance continuing. A major house crash will cause financial chaos. So how does the mess unwind?

I do not know, but my intuition is that any resolution is going to involve taxpayer money. Ouch! Exactly how that will happen depends on contingent events and political decisions. (I would hope that if taxpayer money was to be used, a good chunk would go to enable the purchase of first homes; although that would reflect a different political ideology from the one which has dominated the last three decades of ‘the boats are for the well-off’.)

We have got into this muddle because there has not been the political foresight to see it coming or to take action to prevent it. As too often it has been ‘full speed ahead and damn the torpedoes’. When they strike many will find themselves under water. 

An AUT Policy Briefing paper I wrote, Over-investing in Housing, which looks at the impact of taxation concessions on housing is here.

Comments (13)

by Graham Adams on August 30, 2016
Graham Adams

"If house prices were to halve, they would be, in the American jargon, ‘under water’, with the temptation to walk away from house and mortgage. Many owner-occupiers might not, but the pressure on investors would be to get out, dumping the house and mortgage onto the bank which lent the cash. Very quickly the banks would find themselves with a portfolio of houses they owned whose value was not matched by what they had borrowed to fund them."

My understanding is that all mortgages in NZ are full recourse loans and an owner (investor or otherwise) cannot walk away from their debt (as is possible in some US states). The bank will follow you, with all its legal might...

by Raymond A Francis on August 30, 2016
Raymond A Francis

Brian, check the changes of farm land in the 80s if you think there is resistance to falling prices.

As an exampole I bought a farm for $350,000 in 1981, by 1984 it was valued at $650,000.Then came the mid 80s crash and it fell to well below $250,000.

We hung on because our mortgage remained the same and we had some guard against the  high interest rates of the time.


by Antoine on August 30, 2016


was Brian referring to insolvency?


are you not illustrating Brian's point? The farm did not change hands at below $250,000, because you were resistant to selling it at that price. (PS sympathies for your bad crash experience)

by Murray Grimwood on August 30, 2016
Murray Grimwood

We got into this 'muddle' because we all lost sight of simple facts.And aren't discussing them yet.

There was a Listener article recently - Listener, Bauer, Macfie, about as good as media gets - which got close but failed to join the dots (or is that the role of media, to put both truths and falsehoods up to let the reader decide?) or to ask the 'is growth over, if not when? question.

On Page 17, it claims that 'Auckland prices rose in June by an average of $1358 a day, or $57 an hour - almost twice New Zealand's average hourly earnings'.

Actually, there are 7 days in a week - 7x1358 is 9506, divide that by the 40 hours a week worked (we do not work 24/7) and it's actually $237.65 an hour. 8 times the average. Am I missing something there? Then factor in the fact that the average wage is also the upper limit for landlord return, via tenants wages.

Who said that can carry on? That's not just a bubble, thats an overinflated balloon atop a very sharp pin. Who says it stops at 50% depleted? Given that much of the 'average income' is dependent on people paying which depends on the 'value' still being there, I see no reason why the who shebang doesn't drop to 1:1 underwriteable levels.

Where's that? 1975 valuations?

by Alan Johnstone on August 30, 2016
Alan Johnstone

Obviously all bubbles burst, this one will be no different. If something isn't sustainable then it will end. It's out of sync with local wage levels and driven by cheap money from offshore.

50% fall? Sure why not. The Germans have a saying that I think is particularly apt here

"Better an end with horror than a horror without end"

by barry on August 30, 2016

In 2007 house prices peaked and then dropped about 10% (NZ recession then GFC combined with low migration).

If they had stayed at 2008/2009 levels then wages would have caught up by now.

Houses are much more overvalued now, so 10% is the minimum you can expect them to fall off the peak, but when will the peak be and at what level?  At the moment there is still support for current prices and more with cheap money, immigration and probably overseas buyers.  If one of those stops then the slide will start.

What is that value of land anyway?  A new house can be valued by what it cost to build, plus land value. An existing house can be valued compared to a new build, minus the newness value if the land is similar.

Presumably the average million dollar house in Auckland has less than $300 000 worth of improvements.  I can understand a section in Freemans Bay or Remuera being worth 10 times the median wage, but not Henderson or Albany.  

In business/investment an asset is only worth buying if you can get a better return on value than any other investment with similar risks.  If you are renting a million dollar property for $600 per week then the return (minus rates and maintenance) is at most 2.5%, which is less than bank term deposit rates.  So people are investing for capital gains.  While house prices are increasing the risk is very low, and the returns are high.  As soon as the peak is hit, the equation changes.  The risk goes up and the return goes down.

As always the best advice is to ride the bubbles but panic just before everybody else does.

by Murray Grimwood on August 30, 2016
Murray Grimwood

"If they had stayed at 2008/2009 levels then wages would have caught up by now"

Um, no, they wouldn't have. Which barrow are you pushing, Barry - the blue one?

Is anyone going to ask why we have zero and below-zero interest rates globally, and something called 'quantitive easing' (which is like pushing on a piece of string). Have we ever needed them before? If not, why not? What's different this time?

And who is going to then relate the pending bubble in 'existing items' to what's going on?

by mikesh on August 31, 2016

I think inflation, which implies increases in wage and income levels, is unlikely to catch up with house prices since these will tend to push house prices even further northwards.

by Murray Grimwood on August 31, 2016
Murray Grimwood

You have to factor in rising debt - which was essentially the book-keeping indication we were starting to live beyond our means, and doing so at an accelerating rate.

But measuring the physical world - housing, farming, infrstructure, trade, pollution, depletion and energy - cannot be done via a system which avoids the inconvenient by calling it 'externalities'.

Those who study the real stuff, will tell you that 'Auckland housing prices' are the same as 'Libyan refugee crisis' and 'frackers file for bankruptcy': symptoms.

Zero interest rates, quantative easing and the so-called GFC, were/are, I suggest, symptoms too.




by Donald Ellis on August 31, 2016
Donald Ellis

I find it helpful to think of residential property as two markets: (i) shelter (consumption good) and (ii) house (asset). They overlap, and, crucially, the owner-occupier has a central role in both. Long story short the owner-occupier will pay an irrational price for a roof over their head if they believe that the asset value will rise in the future.

Asset prices are largely influenced by future expectations.And, given that all the inflation in residential property is in the land price, a fall in residential property prices will only start when there is a general belief that all land prices around Auckland, say, will fall in the future.

Again, long story short, that will only happen when there is a credible plan from both central government and Auckland Council to make it easy to develop any piece of farmland within the new RUB at any time. That would encourage land-owners to sell for any reasonable offer and not hold out for higher.

In the absence of that credible plan (hint: the AUP is not that credible plan) sentiment is unlikely to change.

Yes it will take taxpayer money: most likely in the form of transport infrastructure investment well over and above what is happening now. Or a massive lift in government house building. Or both.

by Ross on August 31, 2016

I wouldn't like the idea of prices halving. In many parts of the country, house values are below their pre-2007 levels. There's the Auckland market, then there's the rest of the country.

Click on “Since 2007 market peak change (%)”. It shows that large increases in property prices have been confined to Auckland and Canterbury. But for many regions, property values are below their 2007 values and some are more than 20% below. (These data were published 12 months ago.)


by Brian Easton on September 01, 2016
Brian Easton

Raymond: The analysis I was doing was for housing. You are quite right that farmland is different, because it is about generating a stream of income for the farmer; owner-occupier housing does not. If there was only rental housing, the parallels would be closer.

Barry: You are quite right that housing prices dropped about 10 percent in a year after the GFC, but they recovered quite quickly. I should have been more explicit that I was concerned about the prospects of long term falls.

Donald: Don’t disagree with the two dimensions of house demand of shelter and investment. But I would add conspicuous consumption. When I was looking at new houses a few years back I was struck by how many of the housing features I saw were for appearances but were hardly functional.

Ross: That different regions have had different house price inflation illustrates the difficult the Reserve Bank has of running a national monetary policy since, in principle, settings ought to reflect local circumstances. An even greater illustration of the difficulty is the European Central Bank has a single monetary policy for a diversity of EMU countries.

by Andrew Hart on September 09, 2016
Andrew Hart

>>I do not know, but my intuition is that any resolution is going to involve taxpayer money. Ouch!

It's  hard to gauge how vulnerable banks are to a property downturn. The major banks are sitting on price earnings ratios of 12 , yielding about 7%, a much lower valuation than two years ago.

I would be aggrieved if tax payer money was used to recapitalise banks in a crash; their lending hasn't been a public good, more a gift to speculators and property developers.

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