The Auckland “Solution” 1

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Thursday, October 20th, 2016
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The entire country of New Zealand is being made to pay for Auckland’s housing inflation problems. This ‘super city’ has an average house price of circa $1 million and has seen inflation in excess of 300 per cent over the last four years.

The problem is a basic supply and demand imbalance that has grown over the years and which has recently become an issue that necessitates government intervention.

Western governments typically eschew interference in ‘the market’ other than at a macro-economic or fiscal level. But when circumstances combine, as has happened in Auckland’s case, to create a perfect inflationary storm, electoral prudence demands that something be done.

That reaction has occurred in several ways.

The first attempt to remedy the situation was to ensure that overseas buyers who were not registered as residents could not purchase a home. Since that demographic accounted for less than three per cent of all purchases, it didn’t make a great deal of difference.

The second attempt was to introduce the ‘bright line’ test. Properties purchased, held for capital gain, and then sold would be subject to income tax in a fiscal regime that does not have a capital gains tax per se.

The third key measure was to tinker with the loan-to-value ratios (LVR) that govern bank lending. For the last five or so years, this LVR has sat at 80 per cent or even higher in some instances. At first, the maximum LVR banks could go to in Auckland was 70 per cent while the rest of the country was at 80 per cent.

That was lowered, then lowered yet again to the now (some might say ludicrous) 60 per cent. If one doesn’t have either 40 per cent of the equation in cash or equity, borrowing is now out of the question, and the banks are enforcing this policy rigidly. This applies only to those seeking to build or purchase a house that is for some purpose other than owner occupation.

The Reserve Bank has stated that existing lending and construction finance/funding is exempt, though that is not how banks are interpreting this policy.

To fully understand the problem, both in Auckland and in other areas, it is important to look at the problem in context.

Auckland has a growing population; it the largest city in New Zealand by far and has enjoyed the benefit of investment in infrastructure to the tune of billions of dollars. As is the case in most places in the post-GFC world, NZ  interest rates are at record lows. The GDP for NZ continues to grow and inflation (sans housing) is modest along with historically low unemployment.

There is also a ‘ripple’ inflationary effect on areas that are outside, but within commuting distance of Auckland. Hamilton (within a two-hour drive) has seen a 25 per cent increase in house prices in the last year and other areas are now being affected by those whose ability to borrow is being outstripped by the Auckland market inflation rate. With average annual wage inflation at less than two per cent, it doesn’t take long.

By far, though, the major problem can be traced to the basics of Keynesian economics: demand outstripping supply. That fundamental imbalance has been exacerbated by several things:

  • an influx of speculators buying off plan and re-selling on completion for a virtually effortless profit
  • landowners sitting on land and enjoying double digit compound gains with no incentive to release it to the market
  • real estate and land agents effectively doing ‘back of the envelope’ residual appraisals to maximise land value.

This latter issue has a knock-on effect in that developers are driven to attempt to make a return on high land values by the only means possible – a greater level of density and a greater number of apartments and small townhouses. This is not a bad thing in and of itself, but is the government achieving its goals? For that matter, what in fact are its goals?

Some suggest the government is looking to dampen the rampant inflation occurring in Auckland and make available more affordable stock for first time buyers (FTBs) who are still relatively unconstrained by what some would consider a more sensible LVR of 80 per cent.

So, do these measures achieve the goals?

Well, a 60 per cent LVR for anyone who has built a portfolio over the last eight or so years is now an impossible target to hit. A lot at are or above this, meaning that existing equity can’t be recycled and they are therefore at a standstill. Large developers aren’t as affected by this other than at the margins – namely very large schemes.

In terms of policy goals, making more stock available to the first-time buyer seems like a useful step, but is that stock really out there and available?

Most small developers are building anywhere between four and perhaps 20 units. So developer A, faced with the 60 per cent LVR, now can’t buy the land and progress his or her 10-unit development. Does that shortfall get made up by FTBs? Of course not; they are on the demand side of the equation, not the supply side. Limiting the one does not benefit the other. In fact, it does the opposite.

Limit the supply and the cost of the ‘good’ goes up, suggesting that this policy simply fuels exactly what it was introduced to avoid – inflation.

The same basic scenario applies to investors who purchase developers’ stock. These investors are now also constrained and they too will ensure the stock they do secure reflects (in rent) the increased price of procuring it. They too are now fishing from a smaller pool.

How then does this in reality, dampen inflation? It’s hard to see how this might work, and if dampening inflation is not the intent, what other reason might there be behind it?

As far as I can see, only one reason seems to make sense: concern over the banks’ exposure to the market.

However, banks have the wherewithal to control their own destiny; they set their lending rules as they see fit and therefore control their own risk. It is not unusual for them to ‘make hay’ while they can and worry about the future when it arrives. Granted, in the wake of the GFC, a bit more prudence is no bad thing and whilst a cynic may suggest this could be a policy behind which they are hiding to limit their exposure at no or little risk of criticism, this too is counter-productive.

Take, for example, a developer who is denied lending for a scheme of say $5 million at a 70 per cent LVR (a reasonable figure)  because the stated limit is 60 per cent. The bank is not therefore exposed to that risk which would have otherwise sat at $3.5 million.

However, that same bank is more than happy to lend the money to a number of FTBs , let’s say 10 each borrowing $400,000 at a LVR of 80 per cent. The bank’s level of exposure is now $4 million (though no one party is more $400,000 in debt to the bank and that spread of lending does mitigate the risk somewhat).

That said, the risk profile in terms of pure exposure has changed; it has gone up from $3.5 million to $4 million, an increase of 14 per cent. Extrapolate that across the residential lending portfolio of the banks’ collectively (2016 housing debt in NZ is a gross $218 billion) and the increased exposure is huge.

I know which side of that fence I’d rather be on!

It’s difficult to see who this policy benefits other than it will undoubtedly, at least initially, dampen down the volume of property and construction in the Auckland market and other areas. But as has been said, Auckland is being driven by a different dynamic than the rest of the country.

What of those areas where house price inflation is flat at best, or at worst negative? Well, arguably it will help inflate them both. Whilst generally modest house price increases do no harm to the economy, this is a by-product of the policies, not the purpose.

One has to question the wisdom not only of the policy and its outcomes, but also of the creators. Beating the rest of the country with the Auckland stick makes little sense.

Auckland has major traffic issues, so the government spent $1.4 billion on a piece of road infrastructure to help alleviate the problem. Did they spend more than a billion dollars on the same in every city? No, because it didn’t need it. So why burden the rest of the country with a supposed solution to a problem that exists primarily only in Auckland?

It seems to be divorced from reality, as so many political decisions are.

Clearly, the government would rather be seen doing something than doing nothing, regardless of how misguided that ‘something’ might be. We all saw what happened a few years back when government and the banks, ignored the reality that was before them, particularly in the US.

In essence, the government doesn’t need to dictate. It needs to participate if it really wants a solution.

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  1. David Chandler

    Joe, governments are going to have no choice but to participate. The housing market is in failure mode and the traditional levers to improve 'achievable' supply are failing. It is time to focus on making housing 'achievable' as the debate around affordability has lost any sense of viable meaning. The last solution either Australia or New Zealand is to give up and resort to bringing more households into the social housing spectrum. The cost and stickiness of households who cross the self sufficiency threshold of just giving up and becoming dependent on the public purse is not good for them and its not good for the economy. Governments have choices to create a basic supply of housing that enables the housing self sufficiency journey to commence. Singapore is a good model. Governments must shift their focus to solutions that address those caught in the housing 'gap'. I wrote about this in Sourceable recently see: https://sourceable.net/are-governments-abandoning-the-home-ownership-ideal/ While such an intervention would not be attractive to either private developers or the social housing advocates – governments have to come up with some viable non-traditional alternates. In NSW the lack of housing 'achievability' will be a big issue at the next election. Recent announcements that seem to indicate responsiveness (doing something) as discussed in your article are lost on those trying to get ahead. The growing number caught in the housing 'gap' are becoming to big to ignore. These households include key workers, researchers and potential start up entrepreneurs whose energies would be better directed to matters other than stressing out over how to keep a roof over their heads.