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Crockers Market Research April 2017
CRYSTAL BALL, PARTNERING WITH INFOMETRICS
Ten times a year, Crockers Market Research provides a summary and analysis of recent market conditions. In essence, we try to make sense of what we see in the rear view mirror. Our April Market Research edition, the first of the financial year, is different. It’s the one issue where we look ahead and predict how things are likely to be. To do that, we partner with leading independent economic forecasting and consulting company, Infometrics. Our predictions are not infallible (and as a sensible investor you should always exercise your own knowledge and judgement rather than basing investment decisions solely on another’s viewpoint). However, it does mean you can be confident that the following analysis is based on extensive research and understanding of the housing market and therein shows its value.
Upward Pressure On Rents
Nationwide rental inflation accelerated to an eight-year high of 5.8%pa in the December 2016 quarter, and was still running at 5.2%pa in the latest data to February. What has been most notable about recent figures is the outperformance of the rest of the country compared to Auckland.
Rents outside Auckland and Canterbury rose by an average of 8.9% during 2016. In contrast, rental growth in the Auckland region slipped to a two-year low of 3.3%pa in November last year and is still below the national average, at 4.0%pa. Rents in Manukau have been particularly soft (up just 0.9% over the last 12 months). However, rents in Rodney and Franklin, the outlying parts of the region, are still rising rapidly, up by 8.5% and 10% respectively over the last year. These results reflect relatively buoyant conditions across Northland and Waikato as well. Real bond rates surged more than 60 basis points in the final quarter of 2016, meaning that the gap between this benchmark rate and gross rental yields is now below its long-term average and at its smallest since 2009.
The squeeze on yields is particularly acute across much of Auckland and parts of Waikato. Coming in the wake of the tougher loan-to-value restrictions for investors that were implemented by the Reserve Bank in October last year, the soft returns (excluding any capital gains) might act as an additional deterrent preventing investors entering the market or expanding their portfolio of properties over the next two years. Recent signs of a renewed pick-up in house price growth suggest that there will be further downward pressure on rental yields during the rest of 2017, particularly outside Auckland and Canterbury, even if rental inflation accelerates further in coming months. Any significant improvement in rental yields is unlikely to take place before 2018, when a possible correction in house prices could be accompanied by steady or rising rents, enabling rental yields to recover from their current very low levels.
Weak Auckland and Expensive Property Hamper Sales Activity
Nationally, house sales volumes in February were down 14% from a year earlier. Activity in the Auckland market, in particular, continues to weaken, with seasonally adjusted sales volumes in the region now at their lowest level since October 2011.
Declines in house sales over recent months have primarily been due to the tighter loan-to-value restrictions, which appear to have affected Auckland most significantly. The Real Estate Institute noted a 20% lift in listing numbers in Auckland over the last year, but a 19% drop in listings around the rest of the country.
Infometrics’ view is that the effects of the LVR restrictions on the market will be temporary, as was the case with the changes in late 2013 and again in late 2015. Persistently strong net migration and relatively low mortgage rates will continue to be favourable drivers for the property market throughout the next 9-12 months. However, retail banks have become more cautious and selective about their lending decisions, partly in response to concerns about residential property being overvalued in New Zealand, and partly as a result of tougher regulatory requirements being imposed by the Australian Prudential Regulation Authority on the parent banks’ operations across the Tasman.
In this environment, and with the weak performance of the Auckland market, it is difficult to be confident of any significant rebound in sales activity this year. By mid-2018, rising mortgage rates and easing population growth are likely to start driving sales volumes lower. The potential introduction of debt-to-income restrictions would knock more buyers out of the market, although neither Bill English nor Steven Joyce have expressed strong support for the idea, so any changes on this front seem unlikely before next year.
Moderate Upward Pressure on Interest Rates Emerges
The Reserve Bank’s most recent Monetary Policy Statement, in February, indicated that the Bank believes it will be able to keep the official cash rate at its current record low of 1.75% until the second half of 2019. The Bank has been keen to try and dampen market expectations of an interest rate rise, with possible rate hikes being priced in from late 2017.
At 1.3%pa, inflation is now back inside the Reserve Bank’s 1-3%pa target band for the first time since 2014. The New Zealand economy strengthened considerably during the last year and, even with a softer GDP result in the December 2016 quarter, growth is expected to remain robust over the next 12 months. The economy’s performance is being underpinned by strong population growth and high net migration, rising household spending, a surging construction sector, and dairy prices that improved substantially in the second half of 2016.
The labour market has tightened across the board, and with signs of international inflation picking up a little, we anticipate that the Reserve Bank will start to lift the OCR from about mid-2018. However, 46% of respondents to the latest Crockers Property Investment Index (CPII) survey believe the Bank will increase interest rates within the next year. This measure was the most commonly expected action by respondents to slow the housing market over the next year, ahead of tighter loanto-value restrictions for investors (36% of respondents), debt-to-income restrictions (33%), tighter restrictions or bans on foreign purchases of housing (32%), and financial disincentives for foreign buyers such as a stamp duty or land tax (30% of respondents).
A surge in longer-term wholesale interest rates in late 2016 and early 2017 has put upward pressure on funding costs for the retail banks and has flowed through into fixed mortgage rates. Infometrics also notes that finance has become more difficult for borrowers to obtain as retail banks have become more cautious with their lending decisions. Infometrics expects fixed rates to gradually drift higher during the next year, with one and two-year rates climbing about 30-40 basis points to 5.0% and 5.2% respectively by April 2018.
In the near term, the effective mortgage rate (ie the average interest rate being paid by all mortgage holders) will still be falling as mortgages from two years ago or longer roll off their higher fixed rates. But this phenomenon will dissipate by late 2017 as more recent lower fixed rates come up for renewal and borrowers are forced to re-fix at higher rates.
Housing Overvaluation Still Looms Large
February data from Quotable Value showed house price growth in Auckland of 13%pa, with 14%pa price growth across the country nationally. Although recent figures have shown a pick-up in annual house price growth, the monthly changes have been less upbeat, with prices in Auckland rising just 0.5% over the last three months (seasonally adjusted). The nationwide price rise over the same three-month period was 1.7%.
Price growth in recent months has been stronger outside the main urban areas, with Wellington being the main exception. The data suggests that the effects of the Reserve Bank’s loan-to-value restrictions have been felt most strongly in Auckland, rippling out to other urban centres in the “halo” area surrounding the region. But many provincial areas are still seeing strong price growth coming through.
With sales volumes still soft, house price growth will continue to slow in the short term in response to the tighter LVR restrictions. However, as the effects of these restrictions wanes later in 2017, Infometrics sees scope for another brief rally in price growth later in 2017 and early 2018. In Auckland, despite a shortage of housing in the region of about 38,000 dwellings, further price rises will be limited by affordability, with house-price-to-income ratios at unsustainably high levels.
There has been a definite downward shift in the expectations for further house price growth in Auckland. Sixty-one percent of respondents to last year’s Crockers CPII survey expected house price inflation in the city to be running at over 5.0%pa at the end of 2017. In contrast, just 31% of respondents to the latest survey expect prices to rise by more than 5.0% over the next 12 months, while 23% of respondents expect prices to fall during that period.
Infometrics estimates that, by December 2017, real (inflation-adjusted) house prices will be about 30% above their long-term trend line. The extent of this “overvaluation” could be even greater than in 2007 in the lead-up to the Global Financial Crisis, and highlights the risk of a correction in house prices in subsequent years.
Infometrics’ forecasts allow for a 12% decline in average house prices between December 2017 and March 2020 as mortgage rates rise and population growth slows. However, a relatively good performance by the New Zealand economy over the medium term raises the risk that house prices hold up better, with few people compelled to sell for a lower price. In this scenario, property values would instead track sideways for an extended period. The large undersupply of housing in Auckland also raises the possibility that house prices in the region continue to climb during 2018 and 2019 until residential construction has increased sufficiently to keep up with underlying demand for new housing.