If you earn more per annum sitting in your home than you do from your job, then something is probably going very wrong.
Both Australia and New Zealand have residential real estate markets that are on fire and are amongst the countries with the highest growth rates in the world, according to the Knight Frank Global Index. The same report flags that the high rates in New Zealand and Australia accompany worldwide rapid inflation in house prices. This is from the normally sober Bloomberg:
Around the world, property markets are going bananas.
Global valuations are soaring at the fastest pace since 2006, with annual price increases in double digits. Frothy markets are flashing the kind of bubble warnings that haven’t been seen since the run up to the financial crisis.
From the U.S. to the U.K. and Australia, the drivers of the frenzy are remarkably consistent: cheap mortgages, a post-pandemic desire for more space, newly remote workers taking city cash to regional locations — and, crucially, a pervasive fear that if you don’t buy now you may never be able to.
Regular readers will have read my previous concerns about inflation being pumped into the world economy; central banks are printing mountains of money to fund unprecedented government borrowing. As I have said, this is the biggest economic experiment in history, and thus should be viewed as something to cause significant worry. The rapid house price inflation may be one of the early symptoms that big problems are brewing.
In a recent discussion, I highlighted that big institutional investors are investing heavily in residential real estate, and this is being done as a hedge against rising inflation. How much this new money is inflating house prices is an open question, even in the US, where the activity is being reported. Here in New Zealand, there has been no reporting of large-scale institutional investors putting money into residential real estate, but poor reporting here might mean we are just not hearing about it. In all events, we should be very, very concerned about house price inflation in New Zealand. Bloomberg Economics has a country rating system for real estate that considers; price-to-rent ratio, price-to-income ratio, real price growth, nominal price growth and annual credit growth. A Bloomberg economist painted a worrying picture, as follows (emphasis added):
“Record low interest rates, unparalleled fiscal stimulus, lockdown savings ready to be used as deposits, limited housing stock, and expectations of a robust recovery in the global economy are all contributing.”
If things are looking bad in the OECD, they’re abysmal in New Zealand.
A poor performance across the five indicators saw us top the rankings, ahead of other ‘frothy’ housing markets like those in Canada, Sweden, Norway, the UK, Denmark and the US.
Similar concerns are being expressed by the S&P credit rating agency if house prices continue their upwards rise:
It said there was a “one-in-three possibility” that New Zealand financial institutions could face a greater risk of a “disorderly correction” in house prices in the next two years, which could potentially result in higher credit losses.
“If the current trend persists, we expect to assess our economic risk score for the New Zealand banking industry as having worsened.”
Action to Address the Problem?
The Reserve Bank has recently sought to address the issue, with powers for the imposition of debt to income ratios for mortgages. In principle, this would constrain house price inflation through limiting access to finance for private buyers but would be difficult to apply to investors, a concern if institutional investors are active in the New Zealand residential market. This comes in addition to previous ideas which have sought to work against investors and in favour of private buyers:
– A $3.8 billion fund will be used to help green light tens of thousands of house builds.
– The Government will assist Kāinga Ora to borrow an additional $2 billion to boost strategic land purchases.
– Income caps for the Government’s scheme meaning first-home buyers only need a 5 percent deposit will be lifted from April so more people can access it.
– The bright-line test – the tax on investment property – will be increased from five years to 10 years, but it will be kept at five for new-build investment properties. The family home will still be exempt.
– The Government will remove the ability for property investors to offset their interest expenses against their rental income when they are calculating their tax.
It does not take a very wise person to see that there are perhaps some policies that might be working in opposite directions when seeing these policy responses together. However, there has been a small slowing in the rate of house price growth recently. Whether this is meaningful or will endure is a question mark. I suspect not.
The reason is that the underlying problem is the one I identified in my previous discussion. It is the problem of printing money to fund government borrowing. That fresh off the press money has to go somewhere. In a scenario of record-low interest rates and rising general inflation, bricks and mortar are unsurprisingly attractive. However, if inflation does get out of hand, and interest rates rise, this could spell deep, deep trouble. That goes for institutions with exposure to mortgages, institutional investors, private investors, and those people with retail mortgages. And the wider economy.
Are you wearing a bathing suit?
I forget who said this, and I paraphrase, but it was a wise comment on frothy markets; it is only when the tide goes out that you see who is not wearing a bathing suit. When people are earning more income from just living in their house than their actual work, it is likely that many people will be found to not have been wearing a bathing suit.