Interest.co.nz has today posted an interesting article quoting Westpac Bank economists on the Auckland housing market, where the stratified median house prices hit a record $634,000 in June (see next chart).
From Interest.co.nz:
The rapidly heating Auckland housing market is being driven primarily by buyers’ expectation of capital gains – not a housing shortage, according to Westpac economists…
Westpac chief economist Dominick Stephens said in the bank’s monthly analysis of the housing market, “Home Truths” that it has become “fashionable” to talk about a physical shortage of houses and slow building activity driving prices higher in Auckland.
“But physical housing shortages cannot explain the fact that rents are falling in Auckland,” he said.
“House prices in Auckland are now rising at almost 20% per annum, while rents actually fell 1% in the year to May 2013, according to the Ministry of Business, Innovation and Employment.
“If physical supply was desperately falling short of demand, rents would be rising alongside house prices like they are in Canterbury. Physical supply shortages simply do not fully explain the Auckland housing market.”
Stephens suggested that a better explanation for the characteristics of Auckland’s housing market – these being low turnover, rapid sales, rising prices and falling rents – was widespread expectation of future capital gain.
“Owners are reluctant to sell because they expect better prices in the future, hence low turnover. Buyers are desperate to get in and enjoy capital gains, hence rapid sales and rising prices. Investors are keen to acquire properties despite low rental returns, hence falling rents. Tenants would rather own, again pointing in the direction of falling rents and rising prices”…
Westpac’s Stephens said that in trying to explain why there existed a widespread expectation of capital gain in Auckland, three “candidate explanations” sprang to mind:
- People believe that Auckland’s population and incomes will grow rapidly while insufficient houses will be permitted, creating a future sharp increase in rents that restores balance;
- People believe that today’s low interest rates will last forever, thus allowing future generations to pay more for houses despite low rental yields;
- The expectation is irrational (a bubble).
“If physical shortages are not the main explanation for the behaviour of Auckland’s housing market, then building more houses will not necessarily change the market,” Stephens said.
“I seriously doubt that the supply measures recently enacted by the Government will really change much. Prices are being driven by buyer expectations of future capital gain – we know this because prices have become divorced from rents.
“The key to changing the trajectory of prices is to change buyer expectations.”
As argued many times previously, talking about the supply-side in terms of the physical number of homes versus population, etc, is meaningless. What is most important is the responsiveness of supply – i.e. the ability of the market to build new homes quickly and cheaply in response to increasing demand.
Do the Westpac economists honestly believe that Auckland home prices would have gone bananas if Texas-style planning and “right to built” laws were in place? There would be no expectation of future strong capital growth, since buyers would always know that affordable brand new homes are available and that the construction industry would always rise to meet demand. Accordingly, there would also be little speculative demand, with property investment based primarily on rental yield rather than expected capital growth.
For a variety of reasons, including the metropolitan urban limit (Auckland’s urban growth boundary) and a plethora of Auckland Council regulations and planning rules, new homes cannot be built quickly or cheaply enough to dampen demand. Perceived shortages exist and buyers, rightly or wrongly, expect that prices will continue to rise, creating speculative demand and “panic buying” from first time buyers afraid of missing out.
When combined with demand-side drivers such as easy credit, low interest rates, favourable tax rules (e.g. negative gearing and no CGT), strong inward migration, and foreign purchases, Auckland’s constipated supply system is a bubble waiting to happen.
