Best of the Week

Q+A: Will house prices really slump?

Adrian Orr suggested this week that house prices could fall 10-15 percent, which he said would be just fine. Bernard Hickey looks at whether that's likely, or a good idea.

Comment: Reserve Bank Governor Adrian Orr seemed to commit heresy this week when he agreed house prices here could fall 10 to 15 percent, just as they might in Sydney or Melbourne.

House price inflation has become more than just a topic for barbecue conversation or reality television programming. It's now a religion where the god of tax-free capital gains has become all seeing, all knowing, all powerful and all good. Even talking about big house price falls was like farting in a church.

The assumption of ever-rising house prices, or at least never-falling house prices, has become a sort of base line assumption in public life in New Zealand. Anyone who suggests otherwise is the subject of ridicule or outright hostility. The last active politician to say house prices should fall substantially to make them more affordable, Metiria Turei, is no longer an active politician.

Even Prime Minister Jacinda Ardern would not go there this week when she stuck to the party line that the Government wanted housing to become more affordable for first home buyers, but that somehow that would not mean the values of existing homes would have to fall.

She said the KiwiBuild programme would help build more affordable houses that were smaller, use up less land and be less expensive to build, leaving the suggestion that housing could become cheaper for first home buyers without actually reducing the value of existing houses. She would not address the question of whether house prices would or should come down.

So when the Reserve Bank Governor, who is tasked with forecasting house prices, suggests house prices could fall and by a serious amount, this was worthy of attention. Everyone in the church turned around to see who was making the loud noises and bad smells.

After all, Orr controls the two levers that could cause another surge of house price inflation, or could force prices down: interest rates and loan to value ratio restrictions. A big jump in interest rates and a further tightening of LVR rules would easily do the trick, and vice versa.

But did he actually say prices would fall 10-15 percent?

The short answer is yes, but he also said they could rise by just as much.

TVNZ's Corin Dann rightly asked Orr in an interview for Q+A if a price fall of 10 to 15 percent in Sydney could lead to a similar fall in Auckland.

Orr was blunt in his response, but with caveats.

"You could see a similar fall," he said, adding however that the bank was not forecasting that. The Reserve Bank forecasts house price inflation, as opposed to prices themselves, will slow to two percent in 2019 from five percent this year.

"Likewise, you could see a rise," Orr said.

Orr was pleased though to see inflation slow here and not worried about the effects of a big fall in house prices.

"The wealth, the asset-price side is very, very high, even if house prices did come off from some level, the level of house prices relative to income is still highly elevated, and there is an enormous amount of total New Zealand wealth captured in the equity in the homes they own," he said.

"Now, a house price decline does not mean a housing market crisis. Far from it."

Where's this talk of a big fall in Australia coming from?

Some commentators in Australia have started talking about such big price falls there because Australia's banks are clamping down on easy lending to landlords, partly because their regulators are nervous about the risks to banks, and partly because the banks are nervous about their own reputations.

The Hayne Royal Commission's revelations about reckless lending, about fees charged to dead people and over-charging for managing pension funds has forced many banks to re-examine their portfolios of loans, particularly of interest-only loans to rental property investors.

They have virtually stopped lending interest-only loans to landlords and the Reserve Bank of Australia has estimated A$360 billion worth of these fixed term interest only loans will have to be converted to more expensive capital plus interest loans over the next three years. That's about 21 percent of Australia's total mortgage debt. The RBA estimated this change would add A$7,000 a year to the average mortgage for landlords.

This lending slowdown can been seen in this chart, which measures the 'credit impulse' or lending growth in Australia. It is closely correlated to house price inflation.

But surely that couldn't happen here?

Our big banks are the same banks as in Australia, but they do less interest-only lending and the regulator here, which is the Reserve Bank rather than APRA as in Australia, is not cracking down in the same way. About a quarter of New Zealand's mortgages are interest-only, which is less than the 40 percent in Australia, and around 40 percent of new lending to landlords is interest-only, whereas it was was over 60 percent in Australia.

Our banks are also still issuing interest-only loans to landlords, and aren't forcing them onto more expensive capital and interest loans.

Our Reserve Bank has also been bearing down on highly leveraged and riskier lending for longer than in Australia, which means that the percentage of highly leveraged lending is much lower. The LVR restrictions brought in at the end of 2013 were a blunt instrument that hit first home buyers hardest initially, but they have been refined since then to target landlords an the latest major round was effective at reducing the risks. A little relaxation at the end of last year, as shown in this chart below, helped bolster house price inflation last year and give extra headroom for those worried about going under water.

What about the underlying drivers here?

A big fall is also unlikely because our population is still growing much faster than our ability to build new housing units, and that's before we've dealt with the previous shortage.

Migration remains near record highs despite promises of tighter rules. The Government has also actually loosened some rules for temporary construction and horticultural workers, and has not tightened student visa rules in the ways promised before the election.

The other thing to remember is that if house prices were to to start falling because of some sort of economic downturn and rise in unemployment, then the Reserve Bank would react to cut interest rates.

The bank issued a scenario last week that would see it cut the Official Cash Rate by one more percentage point to 0.75 percent if growth kept slowing. That would take pressure off borrowers, who are already lowly stressed because of low interest rates and the massive capital gains of recent years because of a near doubling of prices in the last decade. Banks would not start kicking people out of their houses at the first sign of trouble, reducing the risk of some sort of house price spiral downwards.

Wouldn't our banks be in trouble?

New Zealand banks also have much more capital than they did ten years ago and a recent Reserve Bank stress test showed they could cope easily with a 40 percent fall in Auckland house prices.

Adrian Orr may have said house prices could fall quite a bit, but the chances of it are very low, and even if it did happen, the chances it would rattle our financial system are even lower.