If house prices fall, will the sky fall too?

House prices were supposed to fall last year. Everybody said they would: almost all the economists and property people, the politicians and the business writers. Even while prices were rising faster than they had for decades, the commentators kept on saying it would soon come to an end.

For a moment, they were almost right. In May, the median house price fell 8.8 per cent: the largest fall in a single month for decades. But then prices surged again. By September they were rushing past the April peak and they just didn’t stop.

In the year to February 2021, data from the Real Estate Institute (REINZ) shows house prices in New Zealand rose 22 per cent. Since then the Government has changed the tax rules and borrowing rules for investors, but nothing has changed.

The latest QV House Price Index, with data up to April, shows a national rate of 21.4 per cent. Auckland prices are still growing at 19 per cent. In the Hawke’s Bay town of Wairoa, which struggles economically at the best of times, it’s 21.8 per cent.

Only seven months ago we reeled to the news that the median Auckland house price had reached $1 million. Now, that figure is predicted for the whole country by the end of the year.

It has not always been like this. Prior to 2019, housing inflation was in single-digit figures for every year since 2007, except 2009 and 2011, when prices actually fell. Thank the Global Financial Crisis for that.

By February this year, though, the commentators had agreed there was a new trend: runaway housing inflation.

The Government has made it clear it wants runaway housing inflation to stop. The electoral risk, apart from anything else, is immense. But is that enough?

What if house prices really did fall?

What if we regarded the trend of 2020 and the first part of 2021 as an abhorrent spike that must be reversed, for the greater good of everyone?

Would it be the greater good of everyone, or would it cause too much pain? It would be painful, but would that pain be less than what so many people experience now?

The new rules announced in March were intended to slow the growth, not provoke a fall. Economists at ANZ and Kiwibank said at the time a fall was unlikely, although at Westpac they warned of a “chilling effect on investor demand”.

“We estimate that house prices could settle around 10 per cent lower over the long term,” Westpac’s acting chief economist Michael Gordon said.

Nothing like that has shown up yet in the data, although QV general manager David Nagel says it may be a couple of months before the impact is clear.

Besides, is a 10 per cent fall over time really “chilling”? In March, Prime Minister Jacinda Ardern herself noted it would “only takes us back four months”.

BRINGING DOWN the price of housing, especially if it’s done in a managed way, is not a whacky idea. In previous times when house prices have fallen, the sky has not collapsed around them.

The BNZ’s chief economist, Paul Conway, says he would welcome it. “Personally I would like to have house prices coming down.” His reason: basic social equity. What’s happening now is just not fair.

In December last year, ANZ’s Property Focus report said lower house prices were “absolutely necessary” because they were the only way to reintroduce affordability.

And, said the report, “Not only would this help affordability, but a managed supply-induced decline in house prices is a much better outcome than a painful correction, which is a risk under the current market structure.”

How far should they fall? REINZ’s most recent figures are for March this year, when the median price for a house was $826,300. Ten years ago it was $365,000. That’s a rise of 126 per cent.

Two-thirds of that rise has happened in the past 5 years. One-third of it in the past 10 months, from May 2020 to March 2021. That’s what runaway means.

What if we set prices back to where they were before runaway inflation kicked in? Back to the recent past, to January 2020, when the median house price was $628,000.

That’s a fall of almost 24 per cent. What would happen?

TO START with, the banks would be fine.

“New Zealand’s banks are well-capitalised and stress tests have shown that they can survive a large fall in house prices,” says Arthur Grimes, former chief economist at the Reserve Bank.

Homeowners would be okay too. Most of them have owned their home for many years, so they have a lot of equity in the property. The Reserve Bank estimates that fewer than 10 per cent of homeowners would see their equity disappear.

Even this would be a problem only for those who needed to sell straight away.

OneRoof property owners’ advocate Ashley Church points out the risk of negative equity would be most acute for first-home buyers, especially if they’ve borrowed to the max to buy.

But they are also likely to hold on to their homes for many years, so the negative equity risk isn’t such an issue.

First-home buyers would also benefit from having to save $40,000 less for a 20 per cent deposit on a median house. And assuming no change to interest rates, mortgage payments would be lower.

Properties would still, in all likelihood, continue to gain in value, although perhaps at a slower pace.

ANZ economists also point out that for existing homeowners, upsizing would become more affordable.

Falling house prices could lead to less spending elsewhere in the economy. “Private consumption in New Zealand follows house price growth quite closely,” says Treasury.

As the Herald’s Hamish Rutherford has written, “If you believe the value of your home … is going up, you are more likely to spend. If it is dropping, households are much less likely to go out for dinner, go on holiday or renovate.”

Church says this isn’t just about subjective feelings: people who borrow against their house for a new car or a holiday, he says, would be less able to do so.

And, he suggests, some people approaching retirement would have to keep working, because their equity was no longer big enough to fund their retirement.

Perhaps the biggest risk relates to small businesses, especially those where the owner has secured bank loans against their own home or other residential property.

When businesses find it harder to borrow, economic activity contracts and jobs disappear. When business confidence falls, the same things happen.

As ANZ chief economist Sharon Zollner says, “The problem is no one wants housing to be unaffordable but if house prices fall, people pull their heads in and stop spending and we don’t want that either.”

But having more people able to buy a home is also good for business, because it grows consumer confidence. And that, in turn, should grow business confidence too.

PERHAPS WE need a little perspective. If house prices fall, there will be some harm done. But a great deal of harm is being done now. And remember, although the fall we’re talking about might sound big – 24 per cent – it would restore prices only back to their level 16 months ago.

Besides, we don’t really know how it would play out. In a Covid environment, and amid the devastation caused by the runaway housing inflation we have now, we’re in uncharted territory.

The New Zealand property market is just not performing the way the experts keep expecting it to.

It’s not even performing the way overseas markets are right now. In Britain, the US and Ireland, measures such as high loan-to-value ratios (LVRs) for investors have cooled investor interest. But not here.

It’s like, gulp, no one knows what to do.

AS REPORTED above, many economists believe that house prices should fall. Some of them say 24 per cent is not enough.

Arthur Grimes at Motu has been calling for a 40 per cent reduction for the past five years. Recently, he said, “Policy-makers should strive to cause a 40 per cent collapse in house prices, to bring the median back to around $500,000.”

Infometrics economist Brad Olsen also says if the aim is true affordability, house prices should fall 30 to 40 per cent.

A 40 per cent fall, from the March 2021 median price of $826,300, would take us back to March 2016, when the median house price was $493,000.

According to the Reserve Bank, two-thirds of mortgages would be plunged into negative equity.

That would hurt everyone hoping to sell in the near future and business owners who no longer had security to borrow against. Business confidence would take a hit and unemployment would almost certainly spike.

On the other hand, first-home buyers would need $67,000 less for the 20 per cent deposit on a median-priced home.

It’s happened before, although you have to go back 50 years to find the last time. In the four years from 1971, as MRCagney economist Peter Nunns has shown, house prices rose by 60 per cent, before falling by 40 per cent over the rest of the decade.

But as Nunns pointed out, there’s an important difference between then and now. In the 1970s New Zealand had double-digit inflation. In real terms, house prices didn’t fall after 1974. They stood still while wages and prices for everything else rose around them. There wasn’t much pain.

WILL THE boom will correct itself anyway?

CoreLogic head of research Nick Goodall predicted this in January. His argument was that steep price rises were making houses of any kind unaffordable for more people all the time, thus reducing the number of buyers. Sooner or later, according to the theory, that would create a glut of unsold houses and prices would tumble.

So far, the market has failed to take a blind bit of notice.

ANZ chief economist Sharon Zollner says the thing most likely to force buyers out of the market and therefore end the boom will be rising interest rates.

“There are more ducks lining up globally for upwards pressure on inflation than in a long time,” she said in January. “It won’t necessarily happen but history suggests post-pandemic euphoria.”

It’s May now and it hasn’t happened yet.

Perhaps the biggest problem with a fall in house prices is one identified by Ashley Church at OneRoof.

With lower prices, many more people will want to buy. But unless this is accompanied by rapid growth in new housing, it will cause house price inflation to surge all over again.

This means that while the Government and the Reserve Bank can keep fiddling with the monetary and fiscal levers at their disposal, and those things might help, they won’t be the key to bringing housing inflation under control. To do that we need to build a lot more houses, more cheaply, and make them cheaper to buy.

And to do that, we need a whole lot of things, including better building regulations, faster and smarter construction techniques, a larger construction workforce, more equitable access to finance and a far greater commitment from local authorities to increase urban density.

THE CURRENT situation isn’t neutral.

It’s tempting to argue we can’t let house prices fall because of the pain it will cause. The Prime Minister herself says as much: in December she argued the Government had a moral duty not to threaten the nest eggs of New Zealanders. For the two\-thirds of us who are homeowners, that means, she believes she cannot undermine the value of our own homes.

But there is great and growing pain for everyone else, caused by the runaway housing inflation that homeowners gain so much from. The record number of people in emergency housing, with all the attendant social problems it creates, is a direct consequence of rising rents, which in turn is caused by rising property values.

We’ll be lucky to solve those problems without much greater equity throughout the housing market.

And yet, as interest.co.nz has reported, house prices have risen five times faster than wages for typical first-home buyers over the past three years. Homeowners benefit from the fast-rising market and record low interest rates on their mortgages, even though for everyone else, as the website puts it, those things are “a savage kick in the guts”.

It’s understandable the Government doesn’t want to cause pain by trying to bring down house prices. But another way of putting that is to say there will be no redistribution of the pain that currently makes life so hard for so many. Is that fair?

Gareth Vaughan at interest.co.nz wonders if making homeowners feel some pain might be a good thing. “We might actually learn, the hard way, that house prices can actually fall. Doubtless those impacted would remember for the rest of their lives. And stories of the Great House Price Crash would be passed down through generations like tales from the Great Depression have been.”

40 years of sky-high house prices

Follow our interactive timeline which traces how and why house price rises have risen so sharply from 1981 to 2021

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