‘Housing’s haves and have-nots threaten social stability’

Dr Eric Crampton
10 November, 2020

If you really want to spoil your next pleasant weekend urban walk, here’s a suggestion. Pull out your phone, open homes.co.nz and check the estimated prices of every house along the way. Island Bay is reasonably flat, but our Saturday morning stroll through it felt like walking the edge of a precipice.

Along Clyde Street sit tidy 100sqm cottages on 450sqm sections running at $1.1-$1.2 million. New 165sqm townhouses on 92sqm sections near the old Erskine College recently sold for $1.2m. And properties in need of loving attention on smaller sections still valued nearly $900,000.

Over the past twelve months, property prices in Island Bay increased by over 12 percent, according to homes.co.nz. But it isn’t just Island Bay. Brooklyn is up almost 10 percent. Newtown, Kilbirnie and Khandallah are all up by about 12 percent as well.

Wellington simply does not have enough housing. When increases in housing supply do not keep pace with increases in housing demand, prices go up.

It’s a long-standing problem. Nationwide, median house prices have increased by over 40 percent in total over the past five years.

Restrictions on density where people want to live combined with restrictions on suburban growth means too few homes are built. Councils set those restrictions because the urban growth that benefits those in need of housing – and the country as a whole – is costly to the councils left to cover the infrastructure costs.

The restrictions resulted in a construction industry scaled to the levels and types of building that have been allowed by planning processes. Even if councils set up urban plans for a lot more building, it would take a while for the construction industry to scale up.

All of this led to a housing shortage and severe affordability problem over the past decade. Despite net monthly migration figures dropping to trivial levels since April, house price inflation continues.

Reserve Bank policy in response to the global pandemic and recession seems the most likely cause of current housing price inflation. When interest rates are low, the real value of assets that provide a flow of future income increases. Investments that fail an 8 percent hurdle rate can pass a 4 percent hurdle rate.

If housing supply constraints were less rigid, quantitative easing by the Reserve Bank would flow into new construction. Instead, it’s largely bidding up the price of existing houses.

The Bank has sent conflicting signals about what it thinks of the results. Its chief economist noted that declining house prices could be even worse, as families seeing their wealth decrease would be less likely to spend money. But the Reserve Bank governor worried about potential financial stability effects if banks were over-exposed to housing and warned that loan-to-value ratio restrictions could be re-imposed.

Unless the Reserve Bank has stress tests showing that bank balance sheets are becoming risky, we might be sceptical that bank mortgage lending threatens financial stability. But the asset price inflation that follows substantial quantitative easing poses other risks to stability.

It exacerbates the effects of the housing shortage. Saving to buy a first house is harder when house prices appreciate faster than KiwiSaver portfolios.

It benefits homeowners at the expense of those who have not yet been able to afford a house.

And it risks further locking people out of the places where they might be most productive.

The Reserve Bank targets inflation while keeping one eye on unemployment. Avoiding the lower bound of the targeted inflation range means monetary policy will be accommodating in a recession. But hammering the throttle on asset prices will widen inequities between housing’s haves and have-nots. Those who cannot afford a deposit are locked-out.

This seems more a threat to equity and social stability than to financial market stability.

Ultimately, the housing shortage and resulting house prices are a supply-side problem that require supply-side solutions.

But there may be a missing market problem in the meantime.

House prices have been ramping up with lower interest rates, perhaps in expectation that the new Government will not enable sufficiently more construction for some time.

If an investor expects house prices to drop, owners of rental properties can reduce their exposure, but otherwise it’s a hard market to short.

Similarly, those wishing to build up enough funds for a house rely on KiwiSaver portfolios that may bear little relationship to the cost of housing.

What’s missing are markets like the US “Case-Shiller” indices. These track house prices across major US metropolitan markets (Canada also has a version). Traders at the Chicago Mercantile Exchange then buy and sell contracts based on the performance of the index.

Saving to buy a house in San Francisco? Buy futures contracts on the index tracking San Francisco house prices. The value of an investment tracks the cost of housing in a desired location. Live in San Francisco and feel dangerously overexposed to an overvalued market? Short the transaction instead.

These kinds of markets let people buy little bits of exposure to the property market in ways a KiwiSaver portfolio generally does not. The value of an investment may fluctuate in dollar terms, but it will move in parallel with the cost of the cute little cottage next to the waterfront.

None of that helps solve New Zealand’s housing shortage – at least not directly.

But it might provide an indirect benefit. It could help in figuring out if policy changes are likely to enable more housing. Suppose the Government tweaks infrastructure financing – or urban planning, or council incentives or new building – and promises more housing within the next few years. If investors found the plan credible, the price of futures contracts on the housing indices would be an early signal.

Letting potential buyers put a toe into the market by buying futures contracts on house prices in a desired area could help them save for that cottage. And it would make their walks through neighbourhoods where house prices outpace some of the best stock-pickers’ portfolios just a bit less vertigo-inducing.







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