About DPMC

8. Future outlook for prices

• Some easing in real house prices is likely over the next one to two years as the housing market moves past its peak, interest rate increases slow activity and expectations of future gains diminish.
• Most of the increase in prices has been underpinned by fundamental drivers, which for the most part are likely to continue, so house prices are unlikely to fall sharply.
• Price to income measures are likely to remain at elevated levels, even if they ease a little as prices adjust.

Outlook for house prices

The role of longer-term structural factors in contributing to higher prices means that prices are likely to stay at high levels. The strong lift in demand from a surge in net migration, a period of low interest rates and the likelihood that nominal interest rates will remain well below the levels of the early 1990s, together with rising incomes, strong economic growth and increasing availability of credit account for most of the increase in demand for housing. Projections of household formation suggest that demand for housing will remain strong in the future.

Rising investor activity and the likelihood of an element of speculative behaviour as expectations of future house price increases have grown have also contributed to rising demand. New entrants to the market in this group, particularly those financed largely from debt, with low rental yields, are exposed to rising interest rates and may come under some financial pressure as capital gains diminish. This does pose a wider downside risk to the outlook for house prices in the future if substantial numbers of investors try to exit the market.

On the supply side, rising costs of land, materials and labour have all added to price pressures in the housing market. Meanwhile, margins have increased during the boom in construction activity. Falls in margins as activity slows may help decrease the cost of building a house and remove some pressure from house prices.

Short-term factors affecting demand may unwind in the future or have already changed: an example is recent interest rate increases. Likewise, any element of speculative behaviour that has contributed to price rises should also unwind as the housing market comes off its peak. Recent analysis by Westpac suggests that higher interest rates in the past 12 months have reduced the value of houses to investors, suggesting that at current prices, incomes and interest rates, there is an element of overvaluation in house prices.

House price growth has slowed and is likely to continue to ease over the next 12 to18 months as interest rate increases begin to bite and expectations of future house price increases diminish. While expectations have been important, the judgment of the Unit is that longer-term structural factors have been the primary driver of high real prices. As a result, in the absence of an economic shock, adjustment to house prices is likely to be gradual, and it is possible that real prices could fall modestly in the next 1 – 2 years, rather than record a sharp fall. Nevertheless, house price to income ratios are unlikely to return to those that prevailed in 2001. A return to house price to household income ratios of close to their historical average of around 3.5 would either require household disposable income to increase by 80% or house prices to fall by over 40%. In the absence of an economic shock, adjustment to house prices is likely to be gradual.

New Zealand’s historical experience suggests that prices tend to be ‘sticky’ on the downside. A more dramatic fall in prices is only likely to occur if there was a sharp slowdown in economic activity that saw job losses and forced house sales, or a prolonged period of negative net migration, with subsequent falls in the demand for housing.

Figure 26 shows how a period of flat nominal prices could affect price to income ratios in the future. In figure 26, nominal house prices are projected forward, assuming no change in prices over the next five years, while household disposable income is projected forward at annual growth rates of 4%. These are not forecasts of house prices and income but are presented to show how price to income ratios are likely to stay relatively high even if nominal house prices are unchanged for five years.

Outlook for rents

In recent years, rents have increased at a similar rate as incomes. The supply of rental accommodation has increased strongly reflecting increased investor interest in housing, and this has meant that increases in rents have been limited. The current framework for rental accommodation is predominantly based on short, fixed-term arrangements. Issues arising from rising rents are addressed in section 10.4.

The future outlook for rent prices depends on trends in supply and demand. Future demand for rental housing is likely to be underpinned by rising incomes, population growth, and by declining home ownership affordability (addressed in depth in section 10.2). In recent years, the supply of rental properties has been boosted by strong investor activity, in part in response to expected capital gains, as well as by New Zealanders’ preference for property as a form of investment. Rental yields have been low, with capital gains generating most of the return to investment. The likelihood of declining capital gains in the future may discourage new supply of rental properties. With rising demand this would lead to pressure on rents. This was the experience of Sydney when house price growth slowed in 2004. Some increases in rents look likely in the next 1-2 years.