A different truth about house prices

I love property. Early last year I wrote that I thought we were going into the last great property boom based on ultra-low interest rates and the increasing importance of having a home in the post COVID world.

I predicted an average house price of $1 million in New Zealand by 2030. At the time that seemed loopy as economists were talking about price falls. Even I thought there would be a short-term correction that never eventuated.

I arrive at $1 million based on affordability, which is a function of incomes and costs but mostly interest rates. There is an indisputable truth that homebuyers or even renters cannot afford to pay more than 45% of their after-tax income on accommodation costs.

Borrowers are stretching themselves to the max

In a world with plenty of housing supply, house prices might be around 35% of after-tax income. In our world, with limited supply, buyers pay up to the maximum they can afford. Increasing demand and limited supply has accelerated getting to the new equilibrium. But how much homebuyers can borrow is not unlimited. If we’re not at the top quite yet, we are within a cat’s whisker. No-doubt we will see some ongoing price increases through to early 2022 but that will run out of steam.

Interest rates have bottomed out

It is very easy to forget that since the late 1980s the world has been in a downward interest rate cycle that has lasted 30 years. Just about anyone invested in property has never been in a different part of this mega-cycle. That’s why we can all sit here believing that house prices double every seven or so years, because from our limited time on this planet they always have.

I am still hearing people say house prices will double again over the next seven years. Seriously, where is the science?

If most Kiwis are leveraged up to the max and first homebuyers are buying at six times their income, where will that come from? The only thing left to keep pushing up house prices is income growth.

Not only are borrowers maxed out on their borrowing potential, but we have the loss of tax deductibility for landlords, an increase in housing supply and low population growth, increasing tax rates and increasing interest rates.

Monetary policy and targeting inflation dropped interest rates and pumped asset prices up globally. It created increasingly extreme inequality. Then COVID hit, requiring a massive intervention from the government. With that came stimulus from the government’s need to borrow. With Delta and future strains of the virus, it is not going away quickly, and we will need to find a way to live with it. That is going to require a massive investment in our health system given our acute shortage of ICU beds.

These trends take time to unfold

The one I’m watching closely is retirees. We will have a growing proportion of retirees who have never owned a home. How will they be able to afford rent in retirement on New Zealand Superannuation? Nobody can answer that question and if it requires increasing accommodation supplements, who will ultimately pay for that?

Love it or hate it we are entering a cycle of more government/fiscal intervention. There will be higher taxes or less services for those that can afford it, and likely higher inflation and interest rates. My view is that interest rates will not go up by much and the increase will happen more slowly than predicted, but nonetheless they will go up.

I still love property but if this is indeed the end of a 30-year cycle, it is going to take more wisdom and hard work to outperform an increasingly flat property market. There is no longer a rising tide that will lift all boats. You’ll need to be smarter than that and you’ll need to think about your wealth management more holistically.

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