Article: Property Investment
Property Decline, Half Way Through - Economist with Frank Newman
A recent article in The Economist magazine had some sobering (alarming) comments about global property prices, and specifically mentioned New Zealand as one of those at risk of collapse. Here are some extracts from their article called House of Horrors. (The full article can be viewed online at http://www.economist.com/node/21540231.)
The article makes the point that the debt fuelled property boom that ended in 2007 was one of the largest in history. “Never before had house prices risen so fast, for so long, in so many countries.” They go on to say, but “the bust has been much less widespread than the boom.” Some have been hit very badly (Ireland down 45% since 2007, the United States down 28%, Spain -15%, Denmark -14%, Japan -10%) but others have continued to boom (Hong Kong +77%, Singapore +34%, China and Canada +22%, Australia +18%, Sweden +15%). In their words, “In some countries, such as Australia, Canada and Sweden, prices wobbled but then surged to new highs. As a result, many property markets are still looking uncomfortably overvalued.”
According to QV the average house price in New Zealand is down 4.4% from its peak in 2007. They are down about 15% after adjusting for inflation.
To assess risk of housing price declines, the Economist use two measures. “The first is the price-to-income ratio, a gauge of affordability. The second is the price-to-rent ratio, which is a bit like the price-to-earnings ratio used to value companies. Just as the value of a share should reflect future profits that a company is expected to earn, house prices should reflect the expected benefits from home ownership: namely the rents earned by property investors (or those saved by owner-occupiers). If both of these measures are well above their long-term average…. this could signal that property is overvalued.”
Using these measures they conclude house prices are overvalued by at least 25% in Australia, Belgium, Canada, France, New Zealand, Britain, the Netherlands, Spain and Sweden.
They go on to say, “Some economists reject our measures of overvaluation, arguing that lower interest rates justify higher prices because buyers can take out bigger mortgages. There is some truth in this, but interest rates will not always be so low. The recent jump in bond yields in some euro-area countries has raised mortgage rates for new borrowers.”
They are right about the effect a rise in interest rates could have on our economy. Heavily indebted homeowners and investors who are already finding things tough would hit the wall. Against this through there is some room for the Reserve Bank to manage interest rates and try to keep a lid on rises but it alone does not control the cost of money because we are heavily reliant on overseas capital (their savings) because we as a nation have so little accumulated savings to draw upon.
They also make the point that, “Prices do not necessarily need to drop sharply to return to fair value. Adjustment could come through higher rents and wages. With low inflation, however, it could take a decade or more before price ratios return to their long-run average in some countries.”
In my view this is the most likely scenario for New Zealand, assuming no further financial calamities (like the collapse of Euroland). The Economist also point out, “Another concern is that Australia, Britain, Canada, the Netherlands, New Zealand, Spain and Sweden all have even higher household-debt burdens in relation to income than America did at the peak of its bubble. Overvalued prices and large debts leave households vulnerable to a rise in unemployment or higher mortgage rates. A credit crunch or recession could cause house prices to tumble in many more countries.”
The Economist’s assessment was rejected by real estate agents and some, but not all, economists. One view was that house prices were being influenced by a growing urban population and an increasing housing shortage.
I am not convinced that too much value can be placed in The Economist view that house prices are 25% overvalued, given what it actually costs to develop land and build, due to restrictive controls over land usage thanks to green lobby groups and excessive regulatory costs by local councils passing on the cost of their inefficiencies and imposing additional revenue streams in the form of development impact fees. But their comments do reinforce the view that the adjustment is likely to take some time to work through, and there are global risks that could push our economy into recession.
Frank Newman is the author of numerous books on investment matters and the creator of the NZ Investment Game which may be ordered at http://www.investmentgame.co.nz. He is a director of the accounting firm Smart Business Centre. He may be contacted at .(JavaScript must be enabled to view this email address).
