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By Bernard Hickey, Economic commentator at the Parliamentary Press Gallery
The past two years have brought some extraordinary returns for investors, in both the New Zealand residential-property and stock markets. For investors in those sectors, that’s been welcome news. However, it’s the scale of the gains that may surprise a few.
Share market goes up, up, up
In the two years to the end of July 2016, the NZX 50 leapt 44 per cent and hit record highs. This is a spectacular rate of growth, but some say it’s not sustainable.
Our local stock market rise has been fuelled by an ever-lower, continued slide in global bond yields. Investors from all over the world are instead hoovering up New Zealand’s stocks, which are yielding comparatively high dividends.
Global investors have seen the desirability of dividends, in a world where US$13 trillion worth of bonds are now trading with negative yields. And when you compare dividends to such astonishingly low bond yields, it makes the stock market look around 35 per cent undervalued.
Stock market dwarfed by the housing market
But the NZ$37.9 billion rise in the value of the stock market – to NZ$124.9 billion – in the past two years, also needs to be put into context. Over the same period, the total value of New Zealand’s housing stock rose 30 per cent, by $220 billion, to $956 billion.
Houses have grown in value by around 50 per cent of Gross Domestic Product (GDP) each year, for the past two years. And this now makes Kiwi property worth almost four times as much as the country’s GDP. Meanwhile, New Zealand’s stock market is worth just over 50 per cent of GDP.
New Zealand is out of step with the US
Compare these figures to America. In the US, housing stock is worth US$28.7 trillion, that’s 1.6 times US GDP. And the stock market is worth around US$22 trillion, or 1.25 times GDP.
A big chunk of the US stock market’s value is held in non-listed vehicles, such as private equity funds. So it’s fair to say the US housing market and the US stock market are about on par with each other, relative to GDP.
As we’re seeing, that is not the case in New Zealand. Here the housing market is almost eight times the size of the stock market. If anything, that imbalance is about to get much larger and, some would say, even further out of whack.
Let that sink in for a moment. New Zealand housing is more than twice as expensive, relative to national income, than US housing.
At its peak in October 2006, the US housing market was worth US$29.2 trillion or 2.1 times GDP – just before it went bust. New Zealand’s housing market is now worth 4.2 times GDP. And it hasn’t stopped growing yet.
NZ housing market set to hit $1 trillion
Wellington-based economists Infometrics forecast in July that house prices would rise another 17 per cent over the next two years. And in May, Treasury said it saw prices rising another 20 per cent over the next three years.
The Reserve Bank has warned that the market ran even hotter than it expected through late June and well into July. At current inflation rates, New Zealand’s housing market is set to surpass the NZ$1 trillion mark by Christmas.
So how sustainable is a market that is twice as overvalued as the US housing market was at its peak? And one that is now eight times the value of a stock market that most people think is pricey?
These prices can’t last, according to all the traditional ways of measuring value. But conventional wisdom has not swayed the crowds of rental-property investors, who have rushed in to borrow and buy as fast as they can over the past year.
Investors keep buying
In the first six months of 2016, up to half of properties changing hands in the hottest markets – Auckland, Tauranga and Hamilton – were sold to investors.
The long-term outlook is for lower yields than these investors are currently achieving. Unlike stock market investors, property speculators can borrow to invest. What’s more, they can then claim back their losses against their personal incomes.
Nothing on the horizon resembles the pin to pierce the stretched rubber of this ballooning market. On the contrary, here are some reasons why the trend could continue:
• Interest rates are expected to be low and stable for years to come.
• Net migration remains at its highest rate in more than a century, despite predictions it would drop in 2015 and 2016.
• Auckland is building at least 5,000 fewer houses than it needs every year. The city appears unwilling or unable to grow – either out or up – to bridge that gap. Politically powerful residents in Auckland’s Eastern Suburbs and North Shore don’t want more houses built near them. And the council can’t afford to fund the infrastructure needed to build lots of houses on the fringes west, south and north of the city.
• Neither National nor Labour will campaign for a capital gains tax (CGT). And New Zealand First, which is shaping up as the ‘kingmaker’ at the next election, is opposed to CGT or any such land tax.
Restrained measures to curtail the housing boom
The Reserve Bank is about to tighten loan-to-value ratio (LVR) limits for investors. But its previous two LVR restrictions had limited impact and slowed the market for just six months and three months respectively.
The Reserve Bank’s proposals for restricting loan values to a multiple of income remain vague. And they are unlikely to happen until well into 2017. It’s worth noting that similar limits in the UK did little to stop rampant house-price inflation.
It’s an exceptional state of affairs. But it’s hard to see what could change it, short of a combination of rising interest rates, falling migration, and some sort of global economic shock – and the last time we saw that was in 2008.
Dividends: A dividend is a payment to shareholders, out of a company's profits. The value of the dividend is decided by the board of directors.
Gross Domestic Product (GDP): GDP is the monetary value of all the goods and services produced in a country in a year. It includes all spending, investments, and exports and is used as a measurement of a country’s economic health.
Loan-to-value ratio (LVR): A measure of how much a bank will lend against a residential property, compared to the value of that property.