I never believe experts who cry wolf over the housing market, but could it be true now that even the Reserve Bank is sounding the alarm?

Speaking on TVNZ’s Breakfast programme yesterday, Reserve Bank Governor Adrian Orr said he was encouraged by the state of the country’s economy. He also offered some advice to people preparing to invest in the property market:

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“House prices have indeed risen, and homeowners certainly feel wealthier than before. First-home buyers can wait a little longer and see what happens to interest rates,” the Governor said. “If I do not raise interest rates, houses will become more expensive. If I do my job well, you [first-home buyers] may be able to afford a home in future.”

Asked whether New Zealanders should pay attention to OCR movements, his answer was an emphatic “Yes!” People taking out loans should “always pay attention” to interest rates, particularly when buying a home. “This is a long-term repayment commitment. Low interest rates may have attracted you initially, but you must understand that rates rise and fall over time. We have long advocated ensuring banks adequately stress-test their customers.”

Orr went on to explain that the Reserve Bank expected New Zealand’s inflation rate to peak at around 5.6% or 5.7%. It had already seen price pressures across the board from factors including global oil prices and rising shipping costs. “Our concern is that these pressures will lead to broader inflation, and the conditions for that are already in place. That is why the Reserve Bank is acting early [by raising the OCR].” Orr also predicted that house prices would “moderate”, with the biggest positive being the rapid increase in housing supply. His advice to first-home buyers was that highly leveraged borrowing would create long-term repayment challenges, while property values could fall as well as rise.

The Governor’s message is clear: he wants buyers with a genuine need for housing—first-home buyers—to wait rather than rush into the market. If only property speculators enter and there are no buyers to take properties off their hands, how can prices keep rising? In its latest Monetary Policy Statement, the Reserve Bank of New Zealand forecasts falling house prices from 2022 to 2024. It says current house prices are unsustainable and provides extensive data and reasoning to support its view. Recently, many financial experts and prominent figures in finance and politics, including former Prime Minister John Key, have expressed the same view, although many experts’ previous forecasts have repeatedly been proved wrong. Are the experts and the Reserve Bank right this time? Could house prices fall over the coming years?

 

Falling demand

In analysing the detailed data behind its forecast, the Reserve Bank of New Zealand says underlying housing demand driven by population growth has fallen substantially since the pandemic began. Most New Zealand citizens who returned from overseas before the pandemic stayed, and many others returned in its early stages, but this inflow was temporary. Since then, border restrictions have limited overseas immigration, while a small, steady number of residents have left New Zealand. This means net arrivals have trended negative since early 2020: people are leaving New Zealand. In other words, more people are departing than arriving, which clearly reduces housing demand.

 

Construction boom

A large number of housing projects are currently under construction. Data cited by the Reserve Bank of New Zealand suggests that by mid-2022, the total housing stock will be growing at its fastest rate since records began in the 1960s. Government policies supporting new builds and medium- and high-density housing mean the nationwide rush to buy land, subdivide and develop will continue for some time. Large numbers of completed homes across New Zealand will then come onto the market and face the test of buyer demand.

 

Mortgage rates and DTI

Recently, we have seen extensive news coverage and discussion of rising interest rates and debt-to-income (DTI) lending restrictions, sending a clear signal to the market. Mortgage interest is a major cost of property investment. If rates are too high and borrowing too heavily leveraged, sharply rising costs will suppress demand and dramatically increase borrowers’ repayment pressure. Although some commentators say property investors will be affected first, first-home buyers could suffer more severely. They typically carry more debt relative to their incomes and have less capacity to adjust their finances to meet higher repayments, constraining homebuying demand. Property investors have more income and assets, giving them more options when facing larger repayments.

 

How rising landlord costs affect the housing market

The removal of existing tax relief for rental properties, government measures affecting council rates, income tax and mortgage interest, and the increased cost of upgrading rentals to meet new regulatory standards under Healthy Homes legislation could all prompt more owners to sell their investment properties.

For years, experts have repeatedly predicted falling house prices. Yet across most of New Zealand, prices have risen “unsustainably” for 10 years—and are still rising. Has the Reserve Bank of New Zealand never been wrong?

 

The Reserve Bank of New Zealand once made this forecast:

In May 2020, the RBNZ predicted that New Zealand house prices would fall by around 10% because of the widespread outbreak of Covid-19. The opposite happened: prices rose by around 30% over the past year. In other words, its forecast was out by as much as 40%. We are not saying its forecast will be wrong by 40% again, merely that any individual or organisation forecasting the future can make mistakes, particularly during the exceptional circumstances of a pandemic.

We believe that to analyse the age-old mystery of whether house prices will fall, we need to understand the underlying issues.

 

Construction costs

The cost of building new homes remains high and will continue rising, setting a “floor” under how far house prices can fall. We must also acknowledge shortages of building materials, construction workers and other construction professionals.

 

Interest rates will not rise that far

Given the pandemic and global economic conditions, despite constant reports of further interest rate rises, nobody is predicting a return to historical averages. This means mortgage rates will remain relatively “low”. Furthermore, if New Zealand’s pandemic situation fails to improve or economic conditions continue deteriorating, rates could return to their previous levels or fall further.

 

Overseas immigration will resume

The New Zealand Government recently announced its border reopening timetable. New Zealand is expected to attract more overseas migrants. If immigration returns to pre-pandemic levels, this will again put pressure on both local housing supply and house prices.

 

Can we trust what the Reserve Bank of New Zealand says?

In theory, the Reserve Bank of New Zealand should operate independently of the government. However, several developments call that independence into question. The government has repeatedly asked the Bank to consider housing affordability when making decisions. Over the past year or more, the Bank’s actions have become increasingly politicised, attracting fierce criticism from various quarters, particularly over its prolonged low interest rates, which fuelled abnormally rapid growth in the property market. As housing affordability becomes a social problem and a political hot potato, it is easy to understand why the Bank might forecast falling house prices to deflect blame for poor affordability. In short, pressure on the Reserve Bank over housing affordability will, to some extent, affect its ability to forecast future house prices accurately.

 

A cautious forecast for future house prices

Taken together, our analysis suggests the current housing oversupply is temporary, so any fall in house prices will also be temporary. This may be a brief cyclical correction, implying that prices will largely maintain a steady upward trend. YIJU recommends that investment decisions in any circumstances be made as rationally as possible, based on investors’ personal circumstances, future plans, goals, risk tolerance and timeframes.

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Disclaimer: The views above are for reference only. YIJU accepts no legal liability.