Your mortgage and the banks

 

What caused the recent rise in property prices, and should we be worried about the corresponding increase in household debt? Jack Powell, of Private Wealth Advisers, looks at the data.

Directly held property is a favourite investment for many Kiwis, who have a large percentage of their wealth in both residential and commercial properties.

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Why is there a love affair with property?

Over the past 40 years, residential property has offered excellent performance after inflation, with limited risk.

The New Zealand property market has benefited from strong support over the past 30 years with falling interest rates. The banks have helped with their lending policies.

In mid-2016, household borrowing from the local banks accelerated, while funds held on deposit slowed. This slowdown was due to lower interest rates forcing investors to look at investments other than bank deposits. This, in turn, led to a funding gap for the banks, which had to seek money from overseas. The reaction from banks was to slow lending and compete more aggressively for deposits.

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In September 2016, the Reserve Bank also brought in lending restrictions to slow down growth in property prices, which were mainly rising in Auckland.

Interestingly, this slowdown in property prices happened even as immigration numbers stayed close to record levels. The slowdown in prices was centred mostly in Auckland, which tells us that affordability was a huge factor slowing the market.

So, are the current price levels supply-and-demand driven, or something else?

Supply-and-demand pressures certainly influence property prices, but this data would suggest that credit conditions might also have a big part to play in the high prices.

Household debt on the rise

Auckland house prices are now 8.5 times the average income in Auckland. The average for New Zealand (excluding Auckland) is sitting at 5.2 times, and rising.

With mortgage interest rates at record low levels, we’ve seen the levels borrowed by New Zealanders increase, with household debts now at 167 per cent of people’s earnings. This includes residential and credit card debt, and student loans.

Interestingly we’ve seen the percentage of disposable income required to service this debt drop since 2008, as the Official Cash Rate (the wholesale price of borrowing or lending money) and global interest rates fell, reducing the cost of funding higher debt levels.

But how will people be able to service these loans if interest rates rise?

Why did mortgage rates fall?

Mortgage interest rates fell due to two major factors.

Firstly, the Reserve Bank has reduced the Official Cash Rate to record low levels. Setting this rate allows the Reserve Bank to ensure price stability.

The second factor is the Quantitative Easing (QE) programmes introduced by global central banks after the Global Financial Crisis.

These measures keep longer-term interest rates artificially low. The Reserve Bank has signalled that increases to the Official Cash Rate in New Zealand are on hold until 2019 at the earliest, meaning that short-term mortgage rates will likely stay low until then.

Because we are now seeing global growth and inflation pressures picking up, some central banks are slowing or reducing quantitative easing and lifting interest rates. This is resulting in offshore interest rates rising, and may mean increases for longer-term mortgage rates here.

What does this mean for property prices?

New Zealand property prices have seen significant growth over the past decade, supported by cheaper borrowing costs, relaxed lending practices by the banks, record immigration levels, and high foreign investment.

At the time of writing this article, inflationary pressures are building throughout the world. This suggests we could see global rates move 1 to 2 per cent higher overseas, as the central banks move to limit rising inflation.

In a world where debt levels are high and technological innovation is dampening inflation pressures, we are unlikely to see interest rate increases get out of control.

However, if rates rise by even 1 per cent, this will filter through to mortgage costs, which could have a significant impact on households’ ability to service their debt. 

I believe, based on these factors, we could potentially see New Zealand property prices remaining flat, or even declining for the next few years.

First published 28 May, 2018

Story by Jack Powell, Private Wealth Advisers

JUNO does not contain financial advice as defined by the Financial Advisers Act 2008. Consult a suitably qualified financial adviser before making investment decisions. This story reflects the views of the contributor only. Content comes from sources that JUNO considers accurate, but we do not guarantee that the content is accurate.


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