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How much will COVID-19 impact house prices?

Housing Market Written by John Bolton, Mar 30 2020

With share markets being routed by close to 30 percent, the question we’re acutely interested in is: will property prices fall, and if so, by how much?

If you’ve followed my blogging over the years, you’ll know that I’ve long predicted this period of debt-fuelled growth coming to an end

Coronavirus looks like the black swan* that’s kicked this change off – and it’s just getting started.

*A black swan event is a major event that wasn’t predicted and seemingly came out of nowhere.

COVID-19 is very different to previous periods of economic turmoil. It’s not like the GFC, which was a financial crisis with poor lending standards – our banks this time around are in very good shape. 

It’s also not like the recession that followed the 1987 share market crash – that was driven by inflation and industry subsidies. 

And it’s not like the Great Depression, when governments practiced austerity, reduced money supply, and literally starved economies. 

Our government and all western governments have thrown everything at this – at current count, NZ could be in for as much as $60 billion by the time we get through. 

The Australian government is already at around $200 billion, and the US government has $2 trillion dollars in the pipeline.

Property prices will be determined by what happens to the economy, and in particular, what happens to business insolvencies and employment. 

House prices fall when there are desperate sellers in a market and a lack of buyers. It’s basic supply and demand.

What will happen to the New Zealand economy?

The initial lockdown is unprecedented, so we have no reference point in history for this. 

My pick is that NZ will do a month at Level 4, followed by up to another month at Level 3, before we move back to Level 2. The property market will start to unfreeze at Level 3, but only in terms of transactions that are currently stalled and unable to settle.

The immediate impact of the lockdown on businesses is huge. The government wage subsidy will help, but the lockdown will still destroy many small business’s balance sheets. 

Many small businesses simply won’t have the financial reserves to continue through this and businesses that were ‘marginal’ beforehand will die.

We won’t really understand the full implications on small businesses until after the lockdown and after the subsidy, when businesses go back to trading (or not). This will impact on unemployment.

My pick is that retailers will be particularly hard hit – they will likely be facing expensive high-street rents, increasing labour costs, reduced consumer wealth, reduced availability of credit, and lower consumer confidence. After a month or two in isolation, there will also be changes in consumer buying behaviour.

Rent is a high cost for retail businesses

We’ve been talking about online shopping for the past decade. It has slowly evolved, but it hasn’t been the industry killer (yet) that many predicted. 

Online shopping has made price comparison easier, so it’s become harder for retailers to move prices and increase margins. Amazon has also finally arrived in Australasia, along with Alibaba.

Some businesses (particularly apparel) have managed to carry incredibly high mark-ups with low manufacturing costs in Asia, and that has allowed them to pay seemingly exorbitant rents. This all relies on high turnover and consumer behaviour.

My view is that the ‘buy-now, pay-later’ industry is the beginning of the end of this debt-fuelled boom. It doesn’t create new money, it simply brings forward purchases with the cost deferred to later.

And what if?

What if youth unemployment goes up? What if a lot of the jobs that disappear (and don’t come back) are low-wage jobs in retail? What happens when retirees are earning a frugal 2% on their savings? What happens when the life savings of baby boomers has dropped by 30 percent? What happens when tourism dies and never comes back to where it was before coronavirus?

My view is that we will see a significant increase in retail and commercial vacancy, and we will see that translate into rents. I think this will be a permanent shift, and many retailers will finally adapt their operating model to online. This will happen faster now as businesses are forced to change.

Other commercial businesses are having to adapt. In lockdown, everyone is now working from home out of necessity, and the idea of ‘flexible work’ is now instantly mainstream.  Many offices had already started moving to smaller, nicer office spaces and hot desking. It is the new normal.

Consumer spending will be impacted by our drop in wealth

No matter what way you look at it, net wealth has been ravaged. Our government will borrow over 40 billion to keep NZ going.

Many of us will borrow on our house to cover cash flow or prop up businesses, and otherwise profitable businesses will become loss-making. 

We are collectively borrowing against our ‘national balance-sheet.’

The share market is down 30 percent, KiwiSaver is down 30 percent and whilst these will come back, don’t expect the equity returns of pre-coronavirus.

The reality is, interest rates are incredibly low, and fund managers are struggling to invest in anything with a good yield.

Much of the share market gain over the past few years has had nothing to do with business fundamentals. It has arguably been speculative, with investors chasing share indices going up and not the fundamentals of the businesses they have been investing in.

Going forward, you are going to see a number of businesses go under, and most businesses will report materially lower earnings. 

Share prices won’t recover no matter what level of stimulus is applied. What we are seeing now is simply volatility and speculation playing out in a bear market. You’ll see commentators talking about ‘value’ buys, but it’s all hype pedalled by overpaid salesmen.

Until we better understand the economic impact of a global pandemic, it’s anyone’s guess as to how far the stock market will fall.

So, what about the property market?

The heightened risk of the share market could have positive and negative impacts on the property market. 

It’s likely that consumers will feel less confident with fund managers, and put their savings into a tangible asset like property. I’m not suggesting that this is the right approach, but it’s understandable. Although yields are low, property will look attractive to investors compared to keeping money in the bank.

A probable negative will be lower confidence from first home buyers. Lower KiwiSaver balances will decrease their deposit, and there will also be apprehension that property prices could fall. 

Landlords in some areas may be exposed to tenants not paying rent, which will tip them into a cash-flow issue.

There may also be a surplus of rentals and Airbnbs in some parts of the country. This could put downward pressure on rents in areas where there are less foreign students, less tourists, and less jobs.

Consumer and business confidence are important

In the immediate short term, first home buyers will be a lot more nervous about going into debt. The prospect of falling house prices, needing two incomes to service the mortgage, and less job security, will all impact on confidence. 

I’ve said plenty of times before that confidence is critical to the housing market, as it sets seller price expectations and brings buyers into the market.

Banks will tighten credit

After the immediate crisis, banks are likely to tighten availability of credit. They will have a spike in loan arrears and loan defaults to manage, and they will tend to be conservative until the full economic adjustment washes through. 

The construction industry is likely to be impacted as banks try to sort out winners and losers.

Banks will also be more cautious about lending. We will rely on non-banks to lend on the fringes, but they will also struggle with funding, at least in the short-term, and will get more expensive.

Longer term, New Zealand has a good economic outlook

If we take a medium-term view, New Zealand has very good economic prospects. 

Food security is becoming an important global issue and the provenance of food will have greater economic value. This is a huge asset for New Zealand.

We will benefit from strong economic growth across Asia – not just China, but younger countries like Vietnam, Thailand, and Indonesia.

As far as COVID-19 is concerned, it looks like China, Singapore, and South Korea are largely through this. 

Friends in China are saying that work is almost back to normal, although social distancing is still in place. Factories are back to almost full production and that will ultimately flow back to New Zealand and Australia, as factories restock and retool. A trade-led recovery will gradually flow through the economy.

Tourism will take longer to recover. Tourists are unlikely to jump on long-haul flights any time soon. However, there is the possibility that selective global travel opens up between COVID-19 free countries. 

What if travel re-opened between NZ and Australia within three to four months? Kiwis spend about $10 billion on travel and Australians are likely around five times that. 

However, that will require our Australian cousins to get COVID-19 under control. Their efforts have been woeful to-date, but they are gradually getting in line. 

What if, within a reasonably short timeframe, travel opened up between NZ, Australia, China, and Singapore? 

Retail, hospitality, and any service businesses that support these industries will also take a long time to recover, and many businesses will die.

Some of the pain in terms of unemployment will be felt by the 200,000 temporary residents on work visas. Business closures will flow through to creditors and landlords, and landlords will carry the ongoing cost of untenanted buildings, especially in areas that rely on tourism.

Will house prices fall?

Firstly, we don’t have an over-supply of houses, which is the issue Europe and parts of the United States had during the GFC.

Once borders open up again, we are likely to have ongoing high migration as a desirable country. Arguably, how we have coped with COVID-19 will be a testament to our good governance and way of life.

Unemployment will increase significantly, but the majority of that will be in relatively unskilled and minimum wage services jobs, held by people who are not property owners.  A good proportion of that may be absorbed by reduced working visas.

Homeowners (and probably landlords) impacted by COVID-19 will have up to a 6-month mortgage repayment holiday. That will mean minimal forced sales over the next six months, and probably for another six months after that. Mortgage repayment holidays will give the property market time to adjust to a post COVID-19 world.

The biggest pain point will come from the closure of businesses and commercial vacancies.  The cash flow challenges of dying businesses could force business owners to sell, and that will put downward pressure on house prices – especially over the next six months, when there are less buyers in market.

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Mortgage rates will stay very low for the foreseeable future, which will support house prices.  Most of the increase in property prices over the past decade was as a direct result of lower interest rates. A large proportion of rental properties will be cash flow neutral, again taking pressure off owners selling into a soft market.

In areas hardest hit by business closures, there will be a more pronounced fall in house prices. These will typically be areas that have relied on tourism to fuel the local economy.  Given that business owners are likely to own discretionary holiday houses – these destinations will be hot with more sellers than buyers. I’m predicting areas like the Coromandel, Bay of Islands, Rotorua, Queenstown, and Wanaka might feel the brunt of it.

Metro locations will be supported by immigration and low interest rates. There are a bunch of Kiwis that have come home, which is an immediate immigration boom, and mortgage rates are now the lowest in modern history.

Up until this year, Auckland has been reasonably frozen with house sales on a per capita basis (hovering around GFC levels). House prices were falling over the past two years, but only slowly and mostly in the upper end of the market. In some instances, house prices were down about 15 percent, although the official number was never much more than 3 percent.

After the GFC in 2008, property prices in Auckland fell by about 10 percent. The mortgage repayment holidays and wage subsidies will stop any immediate issues. Long-term price drops will depend on how quickly we can get New Zealand back to work.

Post-GFC, land developers also took a hit. They couldn’t hold an unproductive asset with high financing costs indefinitely and had to sell into a softer market or go bankrupt. Land prices could definitely drop. Land purchased on builder’s terms could also increase settlement risk for developers. I’ve written about this possibility previously – see here for more details. 

My best guess?

In the post Coronavirus world, vendors will be more negotiable when pressed to sell, and that will reflect in prices. 

However, at some point in the next 18 months, prices will stabilise and we will start to see the underlying forces of low mortgage rates, immigration and a lack of stock start to reassert themselves. 

Will commercial property prices fall?

COVID-19 will change the risk profile for commercial property.

Commercial property collapsed during the great depression when landlords realised that their property wasn’t worth much if wasn’t rented, and there were no investors buying. 

It’s somewhat different these days, with fund managers holding larger properties at reasonably low leverage, so it won’t be apocalyptic. Smaller properties might be more challenged with the added issue of tighter credit conditions and weaker business balance sheets.

Mortgage rates and yields are at historic lows. If that doesn’t change, it will work to hold prices up. There will be an increase in vacancy as businesses go under and an increase in cashflow issues for landlords that might create more selling pressure. 

I expect to see yields (referred to as cap rates) increase where there are not strong tenancies in place, similar to how a bank would traditionally view commercial property. In other words, back to the basics of good credit assessment.

Final thoughts

It feels like a mug’s game to put an estimate on how much house prices could fall.

My view is that they will only soften in Auckland and Wellington. In Auckland, it could feel like much of 2019. 

Areas more impacted by tourism will be harder hit, along with holiday locations. There will likely be more sellers than buyers in these areas over the next 18 months (and beyond the 6-month mortgage deferments offered by banks). That will put more downward pressure on prices in these areas, so expect a bigger fall. I can’t see many people rushing out to buy a holiday house, and there will possibly be some business owners that will need to sell.

Underpinning prices will be the very low interest rates on offer, and that we don’t have an oversupply of housing.

These are my best predictions based on the information I have in front of me today. I’m very optimistic about New Zealand’s prospects this decade, but there’s no avoiding some serious short-term pain.

Watch this space. I certainly will be.

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