Some thoughts on housing
I see that the latest Barfoot figures are out, and they are pointing to fairly strong sales figures in the Auckland region. That’s nice. There are also suggestions that this is indicative of a bubble or boom coming into the housing market. However, it is important to look at a broader view of what is going on, not just house sales for one agency in Auckland, in order to get an understanding of the what is really going on.
When looking at the housing market, there are a number of little points we need to keep an eye on.
- The regional split: We have commonly been told that Auckland and Canterbury have a shortage of property – all else equal this pushes up house prices in these regions. This is something we have seen happen.
- Borrowing to invest?: In 2003, households borrowed heavily and developers started building heavily. Now we have the opposite. Yes, in the year to April households borrowed 30% more (in gross terms) to buy housing. Yes, this was $45.4bn. However, the stock of mortgage debt rose by a more modest $2.4bn more – or by 1.4%, below the rate of inflation. Even as house sales and prices have climbed, households have taken the funds from sales to pay back mortgages – not to spend or build more houses. SO, while we could use the rising prices and investment in the mid-2000’s to point towards a bubble, this time we have limited investment and an underlying shortage of property driving up prices – this is not a bubble, this points to a failure somewhere in the building or credit markets.
- Credit conditions: Mortgage conditions have eased, and competition between banks (along with low wholesale funding rates) has driven down the cost for households. This sounds similar to what was going on during the boom time. But even so – we have pointed out that increases in NET borrowing have been low (or negative in real terms). On top of this, for various reasons credit conditions are tight when it comes to building houses – increasing the value of existing housing.
- Quality, income, and constraints: As the productivity commission noted, there are significant issues currently impeding activity in the building industry – and thereby pushing up prices.
When this combination of factors is taken together, it feels like we have a situation which is “supply” driven, with a shortage or property driving up values. This compares to any perceived “bubble” which would be “demand” driven, with expectations of capital gains leading to excessive investment and excessively high prices.
This distinction is important when it comes to the actions of the Reserve Bank. There are three questions they need to ask when looking where housing appears within the context of their goals of inflation targeting and financial stability:
- Are current interest rates consistent with the level of general demand in the economy? If the lift in housing market activity is supply driven, this suggests that interest rates should be lower relative to a situation where it is demand driven, with the increasing borrowing that entails.
- Is the current stock of debt, and banks attitude to risk in general, taking into account the full social risk associated with these elements? The RBNZ has introduced a range of policies to help ensure this is the case.
- Is the regulatory regime that the RBNZ implemented possibility having a greater impact on domestic demand, or the housing/construction market than was previously expected?
I have two issues with this:
(1) How do supply constraints explain a 31% rise in volumes in the last year?
(2) Where were these arguments a month ago when the Barfoot numbers were soft? Are you suggesting that that was caused by improved supply? I recall that you and your employer took it as a sign of weak demand, which is why you were predicting an OCR cut.
Hi Miguel,
Good questions – I would note down the following:
1)
How do supply constraints explain a 31% rise in volumes in the last year.
I think I worded things imprecisely – when I mentioned supply and demand towards the end I was very much discussing residential construction. So a constraint in construction supply is driving prices up, rather than the housing market experiencing a bubble which would lead to excess investment and borrowing. House sales “volume” can be an imprecise concept when viewing these, given that when borrowing levels aren’t rising buyers and sellers are on both sides of the market.
Now indeed there has been a sharp lift in volumes sold – but even at current levels sales volumes are still trucking along around 15% below their decade-long average. Relative to this time in 2003 sales are still down 34%!
I would also add in the fact that a big driver of the large lift in sales has been the low base – people weren’t really trading houses in Christchurch during the earthquake.
2)
The Barfoot numbers appear to have experienced some volatility in the last few months – but there has been an underlying trend of rising house sales volumes in Auckland, strongly rising. I agree with that. The idea behind a rate cut was premised on weak domestic demand – house sales are one indicator, but if I remember correctly my organisation changed its pick following the unemployment result while the exchange rate stayed at a very high level.
Low inflation outcomes, a significant output gap (we are not of the view that there is much structural unemployment), and a high dollar that slows the closing of the output gap appeared to give conditions where lower rates could be warranted – since the dollar has fallen our position on a rate cut has moderated significantly … although we are still kicking around that side of the fence.
Random conclusion point
I think all I was trying to add to the internet discussion on housing here is that, with building activity so low, a lift in house prices could well be necessary just to see activity pick up. We need a clearer idea of the constraints in the building industry before we can really make a call about a “bubble looming”.
Now I hold some opinions, but not opinions I’m going to put in a blog – so this is where I will let the internet sit 🙂
I don’t think appealing to construction covers it. Yes, the rate of new building is falling short of population growth, so new households are having to bid up for existing properties instead. But the rate of building is about flat on a year ago, and I don’t imagine that the shortfall has widened – more likely it’s narrowed given that population growth has slowed a lot. So we still don’t have a supply-side story for why sales are rising.
Look, it’s simple: rising prices AND rising volumes are a sign of rising DEMAND, which in turn is a sign that interest rates should RISE. Lots of smart people spent a lot of effort trying to deny that point in the last decade, and look where it got us.
Indeed, but I was appealing to the fact that there wasn’t a new boom coming in terms of prices – not saying anything about sales.
When looking sales, as I said above “House sales “volume” can be an imprecise concept when viewing these, given that when borrowing levels aren’t rising buyers and sellers are on both sides of the market.”
“Look, it’s simple: rising prices AND rising volumes are a sign of rising DEMAND, which in turn is a sign that interest rates should RISE. Lots of smart people spent a lot of effort trying to deny that point in the last decade, and look where it got us.”
We also know that building activity is ridiculously low, even with population growth slumping, and we know that net mortgage borrowing growth is very weak – that makes the current situation very different to what we experienced in the previous decade.
I don’t disagree that rates should have gone up faster in the past – but I am of the opinion that we could justify lower rates now and a steeper yield curve IMO … although of course international events are making that relatively difficult!
“We also know that building activity is ridiculously low, even with population growth slumping, and we know that net mortgage borrowing growth is very weak – that makes the current situation very different to what we experienced in the previous decade.”
Actually all of those things were true at the start of last decade. Low interest rates ensured that it didn’t stay that way for long.
In 2000 building activity slumped – but not to the same degree, or the level of persistence we are experiencing now. The view of undersupply that did develop in the early 2000s was due to the sharp lift in foreign arrivals during that period and the building industries inability to meet this sudden influx of demand (understandably).
I am loath to blame a “bubble” in the housing market on rate settings as well – in truth the RBNZ just found it had less control over domestic monetary conditions than it had presumed, leading to the eventual bubble. We did see similar “bubbles” overseas, at the same time we saw a significant lift in savings in Asia.
Also, tbh I am still of the view that any perceived bubble is irrelevant for monetary policy – we just need to ask whether the forecast track of interest rates is consistent with inflation outcomes within the target band. If expectations are well anchored then monetary conditions should be set with the goal of getting activity close to potential.
Now in the current environment we are seeing inflation outcomes persistently below the centre of the target band, and we are seeing a forecast that is “around” the centre based on growth numbers that appear too strong – if the Bank moves to lower its growth forecast and/or forecasts unemployment persistently above its natural rate it is an indication they should start looking at lowering rates.
We don’t need to think about long and variable lags as long as the Bank is credible and transparent with setting expectations right.