Your wealth: Housing boom defies realities

Neville Bennett

Friday 30th April 2004

The international property market is a threat to the health of economies. In New Zealand, many residential investments seem destined to offer meagre yields for many years.

In the US, property price-income and interest-rate ratios are high and could sharply deteriorate. In the UK, Chancellor of Exchequer Gordon Brown claims mortgage repayments, as a proportion of incomes, are lower than they were 10 years ago. But he fails to mention 10 years ago there was a terrible bubble, which exploded, and left many people with negative equity in their homes for many years.

The IMF has warned a crash is "the biggest single threat to the country's economy." Bank of England policymakers have chimed in, saying the "outlook for the housing market is one of the biggest uncertainties."

Clearly the UK authorities (and possibly the Australians, too) feel the market could crash. This defines a dilemma. Central bankers, including New Zealand's Alan Bollard, have expressed concern about appreciating asset prices.

In almost every country surveyed, there is pressure to raise interest rates to slow the boom. However, the deflation ought to be orderly and gradual. Too fast could hurt homeowners but also the banks and other lenders heavily exposed to the property market.

In New Zealand, the banks have been borrowing offshore and offer great enticements, often a mortgage worth 95% or more of a property valuation. A fall in values, even of 10%, would put pressure on loan ledgers.

Lenders strenuously deny falling property values would materially embarrass them. They depend on historical evidence that mortgagees make huge sacrifices to meet their commitments. Their cashflow is assured, for the most part.

However, there can be failures and bad debts when mortgagee sales recover less than the initial outlay. Sometimes these bad debts overwhelm a part of the financial system. The US bailed out the savings and loan organisations in the 1980s; the Japanese government bailed out banks in the 1990s.

The UK housing market is over-heated. The average price of £184,000 is a 50% increase since 2002. First-time buyers have been priced out of the market, their ratio falling to 16% of sales from 20% in 2002.

It is, however, somewhat simplistic to identify a bubble. Excellent evidence is available to understand what has happened. The Barker Report, commissioned by the Bank of England, emphasises a housing shortage.

It says supply is falling and an additional 140,000 units are needed each year. This takes the emphasis off irrational exuberance as a motive for the price rise, and re-emphasises the interplay of supply and demand.

This is corroborated by a second report commissioned by the Treasury. Professor David Miles identifies the mortgage market as a major barrier to early UK entry into euroland. The market needs alignment with its continental counterparts.

The boom and bust cycle must change. Cheaper housing is needed for key workers, yet fewer houses are being built now than in any peacetime year since 1924. Some 220,000 households are formed each year but only 165,000 homes were built in 2002.

The poor building performance is blamed on the difficulty in obtaining planning permission, which Professor Miles says, "takes an unacceptably long time." Refusals grew from 15% in1996 to 25% in 2002. There is also a labour shortage; even a modest growth in housing starts would need an additional 70,000 skilled people.

The UK is also bedevilled by an insurance scheme that went wrong. Some years ago many aspiring homeowners were told mortgages were old-fashioned and expensive. The smart thing to do was take out an endowment policy that would cover the cost of the house, and leave a bit over. But 80% of these 8.5 million policies fell short of their projected yields. Millions of homeowners have to make additional payments.

The US property market is also booming. Conservatives warn it is driven by low interest rates and is unsustainable. Yet, higher house prices have kept pace with rising incomes, and the average home budget of 22% for house purchase has been stable for a decade.

US prices are not irrational given the price-to-income and interest rate factors. Nevertheless housing is in the upper reaches of affordability, and a rise in interest rates or a fall in incomes could have a downward effect on prices.

The Economist recently highlighted Australia as one of the most vulnerable markets in the world. Households there are over-stretched and rebuilding their finances requires some cut-backs.

New Zealand is still in the throes of a property boom. There was a greater price rise in the 1970s driven by double-digit inflation associated with the external oil shocks. The present boom is unusual as the CPI has been around 2%, not the 20% of the late 1970s.

Low interest rates, high immigration and a large number of households being formed is some explanation. Moreover, a period of good economic growth and income appreciation has encouraged the middle-aged to upgrade.

Yet, fundamentals do not explain the strength of the boom. One additional factor could be overseas buyers playing an arbitrage game: they buy because property here seems relatively cheap. They buy even though they do not live here.

There is a speculative element: some are buying rental property. It seems attractive in the absence of a capital gains tax, and get-rich-quick philosophers and bankers proclaim its advantages.

The party may have gone on too long. Household debt is a record 130% of income. Some investors may find their investment souring as migration falls and interest rates rise.

Let it be assumed prices have plateaued. This brings into play powerful forces. The price cycle will turn down. Those participants who are geared will be driven out.

The new entrants into rental property will find rates and interest costs exceed yields for a long time, according to Frank Jasper, of ABN Amro Craigs. The price hike has meant the market has got out of kilter with rental realities.

Historically, the housing boom in all these societies has been important for stimulating their economies in the wake of equity market collapses. Central banks lowered interest rates to create new economic activity but an asset boom occurred as investors swapped from shares to property. That boom is at its peak and new growth areas must be discovered.

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