Widespread Expectations of Price Declines

Tuesday 26 August, 2008

This week the quarterly Housing Intentions survey by ASB indicated that more people are starting to feel it is a good time to buy a house but it seems only because they believe there could be lots of bargains out there. This survey shows that a net 9% of people feel it is a good time to buy a house which is an improvement from a net 9% feeling it was a bad time in the previous quarter and the best result since 2003. However a record net 55% of people expect house prices will fall compared with 34% in the previous quarter.

Based on the past correlation between changes in housing intentions and changes in dwelling sales annual growth there is a hint that the decline in turnover may be coming to an end. This is something we have already seen in the monthly dwelling sales numbers which have improved in seasonally adjusted terms around 15% in each of the past two months. But if we look at the correlation between house price expectations and actual house price annual changes then there would appear to be some further slight downside in prices to come.

Does this mean one should give credence to one commentator’s “forecast” that house prices will fall 30%? No. The gentleman in question makes money by getting people to click on his web site and his actions are probably best stored in the same box as that containing the freedom of speech argument by another gentleman promoting visits to his commercial site with a parade of half naked people down Queen Street. (Getting media exposure as a commentator is relatively easy in New Zealand. The reporters are simply looking to fill up some space and all you have to do is say something interesting and leave the phone on.)

To put things into context consider this. In the United States house prices so far have fallen 19% in an environment where some commentators estimate there could be between 1 million and 2 million excess numbers of houses sitting around the country as a result of the earlier construction boom largely caused by extremely lax bank lending to unworthy borrowers at interest rates around 2%. In contrast, here in New Zealand on average over the past 10 years dwelling consent numbers have been 25,000 per annum and this is where they sat between 2005 and 2007.

We have not had a recent excessive building boom and nothing remotely approaching the bad US lending practices has occurred in New Zealand. The only credit crisis in New Zealand has been for property developers whose business model depends upon easy money from finance companies whose business model in turn depends upon naive Kiwi investors either unable to understand the trade-off between risk and reward or unwilling to act on that understanding – a “willing suspension of disbelief” as they call it in the movie industry.

New Zealand's fundamental housing problem is one of an undersupply of accommodation as evidenced by the recent report from the select committee investigating housing affordability in New Zealand. The committee was not created to try and figure out how to get more people into thousands of empty houses sitting around the country or how to encourage local authorities to demolish houses to prevent neighbourhoods sinking into empty ghetto status. The outcome of that long-running investigation by the Commerce Committee was a 10 point list of, well, essentially nothing going to make any measurable impact on housing availability in the near future.

http://www.parliament.nz/en-NZ/SC/Reports/c/7/9/48DBSCH_SCR4170_1-Inquiry-into-housing-affordabilityin-New-Zealand.htm

People appear highly aware that interest rates are falling and are likely to fall further and that lower interest rates have a positive impact on the housing market. Over the coming year the likes of two year fixed housing rates currently commonly just below 9% are likely to fall below 8% and perhaps as low as 7.5% depending on competitive pressures. Household budgets are likely to be improved by two rounds of tax cuts assuming a change in government, and plummeting residential construction is likely to generate renewed debate in a years time about housing shortages.

House construction costs also continue to rise and this week we learnt for instance in the Capital Goods Price Index that the cost of residential construction rose 0.8% in the June quarter to be 4.4% ahead of a year earlier and 36% up from five years ago. Further increases appear certain with rising costs of raw materials and increasing building code requirements such as for insulation.

The big area of uncertainty however is how weak the labour market may get. We are forecasting that the unemployment rate will reach 5.2% early in 2010 from 3.9% in the June quarter of this year. The risk is the rate does not go that high because businesses appear highly aware of the structural shortage of labour in New Zealand and its possible the cash flow-driven layoffs we are seeing at the moment may not continue into general structural downsizing of businesses over 2009. Basically we will just have to take developments in the labour market as they come along acknowledging that for the immediate future weakness is the most likely outcome and that this weakness will easily cap bouts of optimism in the housing market.

Key Forecasts

Dwelling consent numbers to fall from 24,500 in the year to March 2008 to below 18,000 in the year to March 2009 with a slight recovery to March 2010 then above average activity after that as attention turns to a shortage of dwellings late in 2009.

Real estate sales falling from 77,130 in the year to April 2008 to between 55,000 and 65,000 come the end of this year then recovering back over 65,000 in calendar 2009 with further growth over 2010.

House prices down 5%-10% by the end of 2008, flat over 2009, rising slightly over 2010, possibly earlier.

Source: Tony Alexander, Chief Economist of the Bank of New Zealand.