Apartment bubble warning follows new Reserve Bank action

Property Institute chief executive Ashley Church warned today of an apartment bubble as the likely consequence of 2 seemingly unrelated responses to Auckland house price inflation.

First came the Reserve Bank’s discussion paper early this year, in which it outlined a range of prudential tools it was considering using to cool house prices. Among these was a suggestion that the bank was investigating loan:income restrictions similar to those recently introduced in England & Ireland. These restrictions would cap the amount that could be borrowed to a percentage of the income of the borrower.

Second, late last week, came news that several major banks were considering dropping the minimum deposit required to buy an apartment to 15% (down from 20%). The banks can do this because of the exemption to the current loan:value clampdown which allows lending beyond 80% of value if the property being bought is new.

Mr Church said the combination of these initiatives would trigger the law of unintended consequences and would almost certainly lead to an apartment bubble – particularly if the Reserve Bank followed the example of England and restricted mortgage loans to 4.5% of income.

“The median Auckland household income is $76,500 – so if we followed the Brits we’d be restricting the average Auckland household to a mortgage of not more than $344,250.That will make apartments look very attractive – particularly if the banks also require a lower deposit to buy these.”

Mr Church outlined a sequence of events he thought was likely to lead to an apartment bubble:

  1. The Reserve Bank restricts mortgage loans to a percentage of household income – effectively making the purchase of freestanding residential homes almost impossible for all but the very wealthy
  2. With median household incomes of just $76,500 – homebuyers flock to the apartment market to find properties which comply with the new rules
  3. The relaxed deposit rules, by the major banks, allow buyers to borrow a little more if the apartment is new – (on average, a little over $400,000 if we adopt the British formula) – and this combination fuels a new wave of apartment building & streamlined marketing programmes designed to entice buyers
  4. Property investors – many of whom have also been caught by the new rules – also start buying apartments in large numbers
  5. The combined effect of this new wave of buyers quickly pushes up the price of apartments – fuelling an apartment bubble
  6. Perversely, the quality of new apartments suffers as developers focus on the low end of the market to appeal to as wide a range of potential buyers, within the Reserve Bank rules, as possible
  7. Meanwhile, the cost of renting freestanding homes in Auckland also increases as demand outstrips supply due to the absence of traditional property investors buying these types of properties
  8. Within 7-10 years Auckland becomes a highly intensified city with large numbers of low quality apartments dotting the landscape and freestanding homes becoming the preserve of the well-off & wealthy renters.

Mr Church said he was aware that a focus on intensification through building more apartments was consistent with the Auckland unitary plan and that some might see this outcome as a good thing – but he noted that this provision was also strongly rejected by a large number of Aucklanders and shouldn’t be forced on the city by the Reserve Bank.

“The drive for intensification is based on a political ideology and is rejected by a large number of Aucklanders. It should only happen if Aucklanders want it.”

Mr Church also conceded that the outcomes might be different if the Reserve Bank imposed a significantly higher loan:income cap, but said a greater focus on apartment buying was still an inevitable outcome of such a cap.

He said the exact sequence of events might differ from the one he had outlined, but the eventual outcome “is very predictable to those who know the market. There’s no rocket science in this – if you close one door and make going through another more attractive, the result is going to be pretty obvious.”

Attribution: Institute release.

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5 Responses to Apartment bubble warning follows new Reserve Bank action

  1. Bob Dey Sunday 14 June 2015 at 6.44pm #

    Ashley Church poses a set of circumstances with a credible outcome. His close is another matter: that the Reserve Bank measures would force intensification which large numbers of Aucklanders don’t want, and they shouldn’t be forced into it.
    It’s a glib conclusion that large numbers don’t want intensification. Until recently, very few had the opportunity to experience it because none was developed. They couldn’t easily reject a housing style which barely existed.
    2 other points arise from my question. One is that, given choice, Aucklanders can choose their preferred housing. The other point is that economic policy could force Aucklanders into a housing style they don’t like.
    But the reason there is any question about housing preferences is because the dominant style, standalone houses, has risen by hundreds of thousands of dollars above recent values in isthmus suburbs, forcing buyers to pay that windfall margin to sellers.
    Simply because of inadequate stock, buyers are shelling out billions of dollars in margins they shouldn’t need to pay.
    A new wave of apartments was already on the way before these changes in rules, and many of them already have a price premium. Little in the current development round is priced at the lower end of the market, which might change if Mr Church’s scenario plays out.
    Mr Church’s seventh point, the impact on traditional investors, illustrates the inflexibility of the tools the Reserve Bank uses. There is an inference from bank & public discussion that all investors are bad when, in my experience, many of them are more level-headed & restrained than other buyers. Ironically, over many years plenty of small investors have paid greater attention to quality than the Government’s housing portfolio owner, the Housing Corp.
    Mr Church’s final point has already arrived – careless development has ensured many apartment buildings have had to be repaired at extreme cost that should have been unnecessary, while houses around the isthmus are far more expensive than they ought to be.
    There are ways out, but inflexible policies aren’t one of them. In a small country we should be capable of nuanced & quick responses to issues. Meanwhile, the responsibility imposed on the unitary plan panel to serve up a zoning model providing better options is growing, and will grow even more as it heads into its final 12 months before making its recommendations.

  2. Andrew Murray Sunday 14 June 2015 at 7.28pm #

    Agree all except one point. The Council resticts two bedrooms to be no smaller than 62m2.

    Developers cant build two bedroom apartments for less than$600,000 and survive in the CBD and fringes.

    Families can’t live in one bedrooms meaning these rules would mean most of New Zealand would never own a family home.

  3. Simon Tuesday 16 June 2015 at 11.25am #

    That will make Auckland another mega unlivable trash city in the world, need to plan to move out soon. Rules are shaping this city in an ugly way. Not very thoughtful development in the 21st century.

  4. Bob Dey Tuesday 16 June 2015 at 1.46pm #

    Hi Simon, would you like to expand with some constructive thoughts – how to do things better?

  5. Simon Wednesday 17 June 2015 at 12.09am #

    Maybe focusing on building a healthy economy and reviving hope for the middle class instead if easy money from overseas. This is not a business this is a country needing workforce with a dream with hope and bright future for the next generations. I came to NZ 3 yrs ago studied and worked hard together with my partner stepped up fast in our careers but the future is not promising. Used to wonder why would anyone want to leave nz to oz. Well it gets more clear to me every day. We can’t convince ourselves to top up this ridiculous rent in low quality houses in Auckland anymore. Buying is just so out of reach. just got eligible for kiwi saver and lost a funny $1000 kickstart makes it all in line. This place is great for rich and beneficiaries at this stage. Hope the ones who are paid to do so do their job and find mindful solutions.

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