Economists warn that house prices are about to see a sharp correction. The NZIER public good team explains why this is happening, and how we can handle it.

For the first time in recent history, New Zealand has been preoccupied by something that isn’t the housing market. With the entire country locked down for four weeks, there have been bigger fish to fry. Now that the lockdown has loosened and the Reserve Bank has lifted loan-to-value (LVR) restrictions, all eyes will be on house prices – will the market be flooded with ex-Airbnb rentals? Will depleted Kiwisavers stop new buyers? Here, we explore how changes in the housing market don’t just affect buyers and sellers; they can affect us all. 

If you haven’t heard, houses in New Zealand are expensive. Really expensive. It’s not just wannabe homeowners making noise about nothing, it’s official; in 2016, the International Monetary Fund found New Zealand has the highest house-price-to-income ratio in the world. To make matters worse, our houses are also not even great quality – one Otago researcher found up to 10% were unfit for living. Recently, the state of our housing market was bad enough for a United Nations official to declare it a threat to human rights. That’s because expensive housing contributes to heaps of problems; overcrowded houses are bad for health, increase family violence, and widen inequality by disproportionately affecting Māori. 

Despite the soaring prices, agreement on the significance of home ownership continues to unify the nation. It’s important for us culturally; alongside a quarter acre, a car, and 2.5 kids, home ownership completes the Kiwi dream. But it’s also important because renting is rubbish. You’ll have heard the rumours about landlords from Hell, who turn a blind eye to mouldy carpets, and make sudden rent increases. While there are rules in place to protect renters, in reality it’s often hard to find alternative housing, leaving renters in a difficult position. But ownership isn’t plain sailing either, with mortgages hard to get and taking longer and longer to pay off. We know New Zealand is special for many reasons, but what is it that makes our houses so pricey? 

Why are our houses so expensive? 

Firstly, when we talk about house prices, it’s helpful to differentiate between house and land prices. Actually, research from Statistics New Zealand and NZIER finds that the house bit – including the building materials and labour – has stayed relatively stable over time. It’s the price of the land you build on that is seriously increasing. It essentially comes down to a standard observation underpinning how prices are determined; demand and supply. Our demand for space to live is increasing (due to normal population growth and migration) but the amount of space available is limited. 

Of course, we’re not literally running out of room. New Zealand has got a fair bit of green space throughout the country (we’re pretty famous for it). But some parts are protected, and the most popular places to live have strict regulations on where and what you can build, as well as real physical limits. Think of the cities with the highest house prices, Wellington and Auckland; Wellington’s most desirable areas can’t expand because of the hills and, obviously, the sea. Auckland is stuck between two harbours and while planners opted for a sprawling approach, the favoured areas are limited in scale. 

Not all regions feel these strains in the same ways, or are equally popular for prospective homeowners. While house price increases were pretty similar across the regions from 2000-2007, from 2008 onwards there is a major geographic divergence. It’s not just the cities with the biggest employment opportunities in high demand; places which are both popular with tourists and have constrained house supply, like Wanaka and Nelson, also have surging house prices. 

Confidence is key 

So basic supply and demand explains part of the house price rise. Of course, our slowly growing population and low-level migration are pretty standard, and often considered ideal for developed countries. Where things get interesting is when people get confident the price trend will continue. This confidence comes from common understanding that house prices are going to carry on going up. We know the population is growing, and the sea and mountains aren’t moving, so we feel sure that house prices will continue to rise. It’s so obvious that house prices are rising, savvy investors spot a smart opportunity, and buy houses safe in the knowledge they can sell them for a decent profit in a few years. This extra demand pushes the prices up, and the price increase attracts the attention of other savvy investors, who start bidding on the same houses, pushing up the prices further. 

This phenomenon of price increases driven by people thinking the prices will carry on increasing is called speculation, and when house prices are driven up by speculation, that’s called a bubble – AKA a problem. You guessed it; bubbles can burst. It might only need a tiny trigger for investors to change their mind and start selling their houses, rapidly prompting others to follow suit. Economists warn about a “sharp correction” in house prices, which means they expect house prices to fall to their “true” value. The problem is, it’s difficult to know what part of house prices are true and what part are speculation, so we don’t know the size of that correction. Imagining what the house market would look like without speculation gets tricky, because alongside speculative buying there’s also been other factors pushing house prices up; low interest rates making mortgages more attractive, and increased migration into the country. The unknown size of a price correction is a source of instability – speculative bubbles always burst, whether it’s houses, stocks, Bitcoin, or even, in 16th century Amsterdam, tulip bulbs.   

A price crash? I like the sound of that… 

If you don’t own a house, a price crash sounds like it could be a good thing. People who just want a place to live could buy up the stock at cut prices – affordable housing for all! The problem is, houses are such a major feature of our economy that even someone with no interest whatsoever in buying one can be affected by a price crash. 

For example, imagine a couple in their 60s. They’ve owned a home for 30 years, and are planning on downsizing soon to help through their retirement. Since house prices have been consistently going up, they can expect to make a sizeable profit when they sell. A price crash would mean a major dent in their savings, and the general response to a less secure financial future is to start spending less (though they might recoup something by accessing a smaller place for less). They might cut back on dinners out, or retail spending. 

And if other people in New Zealand suffer the same loss and respond in this way, that’s bad news for staff in the shops and restaurants, who then also lose confidence in their future earnings, and spend less. Then we’re stuck in cycle where no-one has confidence that their income will be secure in the future. That cycle is called a recession, and once the cycle starts, it can be difficult to stop. 

So, if houses are overpriced, but a price crash is bad, what do we do? 

It’s a question that has had politicians scratching their heads since the 1990s. What we want to achieve is a gradual slowdown in house prices, but any sign of stopping can be enough to make investors pull out, risking a collapse if they all lose confidence at the same time. One way to tackle the problem is to make buying houses for re-sale less attractive. That’s where tax makes a useful policy tool – income from selling a house is taxable, but it’s difficult to enforce. Another way to reduce demand is to make renting more attractive, by introducing longer-term leases and greater freedom to make minor house alterations. There are also options for changing the supply side, by making better use of the land we currently have and freeing up more to use. This is where the debate on housing regulation comes in; limiting building heights and banning small apartments helps keep standards up but also reduces capacity to respond to increasing prices by scaling up supply. 

The housing market presents a complicated problem which affects us all one way or another, regardless of home ownership status. It’s this tangle of interests where some want relaxation of regulations to increase supply, and others want taxes to reduce demand, that means it’s a real challenge to move forward. Any serious policy intervention is going to involve a trade-off, making the decision both economic and political.