Property Market Update

One of the things many of us do as investors is think about the changing financial environment we invest in, and try to pick the market trend for the year coming. I think for 2020 it is an easy pick – the market is looking very buoyant and positive for property.

But property is affected by so many variables that it’s often difficult to see the wood for the trees. Supply (dwelling construction rates and zoning changes), infrastructure projects stimulating demand,  population growth (demand from migration patterns, net birth death rates), interest rates, money supply conditions, employment rates and business confidence, taxation trends, government change and regulation, all culminate to stimulate or undermine investor and household appetites to borrow, and purchase housing. 

At a cyclical level, New Zealand peaks every 10 years with Auckland leading the pack on the ‘7’ year. In fact, the last four cyclical peaks were 1987, 1997, 2007 and 2017 (or actually late 2016 to be precise, carrying over similar peak values into 2017). With Auckland and then the main centres peaking first, we should now be seeing them softening and the regions continuing to play catch up. This is because the more populous areas are typically a couple of years ahead of the regions in growth, leading to a ripple effect as the more expensive main centres shunt population to lower cost housing in the regions. With lag in the regions, they should have more upside in them than the main centres, which experienced growth earlier. Indeed, some parts of the regions are further back than others, making them more attractive from an affordability perspective.

For example, Christchurch to the end of 2019 is about 50% up on 2007 average values, compared to Auckland which is 96% up on its 2007 values. This means Christchurch is relatively cheaper, and in my opinion likely to benefit from ripple effect to a greater extent than, say, Dunedin, which is already 80% up. But then you also need to look at what else is going on the areas, like the potential positive effect of a new infrastructure such as the new hospital (in Dunedin) or university campus (Tauranga). 

Cycles
So in 2019 heading into 2020, we should be experiencing a downturn, characterised by falling sales volumes and softening prices in Auckland and main centres. We should have increasing economic concerns and anxiousness amongst investors, if the cycle was on track following prior cycles. We should have interest rates volatile (with bankers repricing risk), declining supply with developers going broke, and investor confidence at a low. After all it’s a ‘9’ year at 2019, only two years into the down market. And in the first six months of 2019, while the main centres were slowing and there was more concern, slower auction clearance rates and volumes, you certainly wouldn't say we were in a significant downturn. More of a soft landing. But then something changed: interest rates dropped.

This time it’s different
The world is awash with cash, printed by insolvent nations and central governments attempting to flood liquidity into the world, and stimulate growth and inflation in asset values. (There is nothing like a bit of inflation to rectify ailing balance sheets.) And this has been going on for a long time globally (over a decade with the US now into a fourth round of quantitative easing ), though it has taken a while to really impact NZ interest rates with supercheap credit.

In the second half of 2019, the cheap cash FINALLY came to New Zealand, with rates dropping into the low to mid 3s. For example, HSBC have been lending last quarter at 3.35% for 1 to 5-year fixed rate agreements, with most other bankers within 35 bps of this rate. And the interest rate yield curves are flat, with most economists predicting things will stay that way for 10 years. 

The impact of higher capital adequacy ratios (requiring main bank lenders to hold 18% instead of 10% tier 1 capital) is a remaining question mark, as banks transition the capital held on their balance sheets. These changes are progressive over seven years commencing July 2020, so the impact should be slow and spread out, not a knee jerk reaction from banks to shunt rates up. But time will tell on this point, with crocodile tears flooding from the big banks at the prospect of having to raise more cash to do the same amount business in NZ. Of course this issue has no impact on non-bank lenders, who compete with the main banks, but don’t have to comply with the Reserve Bank rules. This should give them an advantage, and ultimately curtail the prospect of main banks passing the full cost on to borrowers, as borrowers will simply flock to non-bank lenders if the main banks get too greedy with interest rate rises. 

Boomers chasing yield
Baby boomers are wealthy (compared to their descendants), but are having to change their investing patterns. No longer are they getting yield from fixed interest investments. They have to do something different, and chasing yield in the stock market and property markets is where they (and institutional investors) must head. 

Cash yield from declining interest rates
Consider the effect of a drop in rates from say 5% in 2018 to 3.5% at the end of 2019 on $1.5m borrowed and invested in property, at a net yield (rent less operating expenses) of 5%. The table below compares the two results on the net operating income, after interest cost.