Submission from the Reserve Bank to the Commerce Committee on the inquiry into housing affordability in New Zealand
This submission includes background material and some policy suggestions which, it is hoped, will be of help to the committee. The Reserve Bank is not seeking to speak to the committee on the submission.
The Reserve Bank is New Zealand's central bank. Its three main functions are:
- operating monetary policy to maintain price stability;
- promoting the maintenance of a sound and efficient financial system;
- meeting the currency needs of the public.
This submission is in three sections.
The first section begins by looking at trends in housing affordability. It then outlines the Reserve Bank's concerns about house prices, which affect not only housing affordability, but have implications for both monetary policy and financial stability.
House prices affect monetary policy through the ‘wealth effect'; as house prices rise, households feel wealthier and tend to spend more, thereby contributing to inflationary pressures. Also, the withdrawal of equity from housing, and other assets, has been high in recent years and this has probably also fuelled consumption.
Regarding financial stability, the Reserve's Bank's main concern is the increase in the household sector's debt, which has been pushed up as house prices have risen, and which is now at a record level relative to household income. The Bank will continue to monitor this situation, assessing whether any possible rise in defaults on housing loans could affect the stability of the financial system. Widespread defaults would also affect the performance of the macro economy, and hence would have implications for monetary policy. Overall, the Reserve Bank is concerned about the possible impact of house prices on macroeconomic stability.
The second section of the submission looks at the drivers of house prices. House prices are seen as being the result of the interplay of demand and supply factors. Factors that have influenced the demand for housing include:
- The move in the early 1990s to a low inflation/low interest rate environment, which meant that households could borrow more since they could now service a higher level of debt.
- Deregulation of the financial sector and increased competition in the mortgage market, which has increased the access to credit for many, if not all, households.
- Population changes, which in the mid 1990s and early 2000s were driven to a large extent by gains from net migration.
- A steady rise in real household income since the early 1990s, and a general fall in the unemployment rate.
- Taxation policy, where the treatment of capital gains on rental properties appears to be relatively favourable when compared to other countries.
- Expectations of continuing house price growth, which has resulted in not only a rise in the number of people buying rental properties but a rise in the number of owner-occupiers ‘trading up'.
The submission takes a look at a few of the factors that have influenced the costs of supplying houses in recent years. These include:
- Land availability
- Planning regulations
- Construction prices.
The third section of the submission looks at whether there are any areas that might warrant policy attention from government. It begins with a discussion of why home ownership has fallen. It seems that increases in household credit have gone largely to households that already owned property and had accumulated some equity in that property. These households have improved their own homes – either through renovations or by ‘trading up' to get a better property – or have bought rental property. The increased demand for housing resulted in higher house prices; housing supply was not high enough, at least in the short term, to prevent this. In this situation, prospective first home buyers were unable to afford a house. The fact that house prices have generally moved up over the last 15 years suggest that there are also some long-term supply constraints on housing.
The Reserve Bank is of the view that government policies should generally focus on increasing the responsiveness of housing supply to changes in demand rather than schemes which increase demand. Policies that do increase demand should be carefully targeted in order to minimise their possible impact on the overall level of house prices.
Looking at supply side issues may require a review of planning practices, with a view to possibly relaxing ‘urban fences' and encouraging medium density redevelopment in existing areas.
Regarding housing demand there are two areas where government may want to consider policy changes:
- Managing migration flows with a view to lessening their impact on house prices.
- Reviewing tax policy, which appears to be more favourably disposed towards returns from rental property than it is in other countries.
Two final points are made:
- Given that the fall in home ownership is unlikely to be turned around quickly, there will be an ongoing role for government in making provision for long-term rental agreements that meet the needs of both tenants and landlords.
- There will an ongoing need for analysis and better data regarding housing.
The Reserve Bank is concerned about the level of house prices. These prices affect not only housing affordability and the economic welfare of households. They also have implications for both monetary policy and financial stability.
Looking first at housing affordability, Figures 1-4 show the major trends. House prices rose through to the mid 1990s, then leveled off as economic growth slowed (Figure 1). However since the end of 2001, prices have risen sharply, with median prices of both houses and sections essentially doubling over the last 6 years.
Figure 1 Median prices for houses and sections, $
Figure 2 Average house price to average
household disposable income
Sources: Quotable Value, RBNZ
Figure 2 shows the average house price as a proportion of average household disposable income and clearly illustrates the difficulties that prospective home owners face. Saving say a 20 percent deposit for a house has become increasingly more difficult for many households since 2001. While the household sector's debt servicing ratio – which is debt servicing as a proportion of disposable income – was reasonably constant up until around 2004, this too has risen sharply in recent times (Figure 3). This reflects both increases in interest rates and higher levels of debt.
In contrast growth in rents has been relatively subdued (Figure 4). Between the end of 2001 and the end of 2006 the rent index of the CPI increased by only 15.5 percent, averaging 2.4 percent growth per annum. Data from tenancy bonds – which cover new rental agreements – show stronger growth than for the CPI; for these, average rents increased by 40 percent from late 2001, averaging about 6 percent growth per annum. Even so, this growth is less than the growth in house prices, which averaged 11 percent per annum over this period.
Figure 3 Household sector's debt servicing
as percent of disposable income
Figure 4 CPI index for rents, base 2006Q2 = 1000
Source: Statistics New Zealand
Rises in house prices, and rents, have implications for monetary policy. However, while rents enter the CPI directly, the impact of house prices on inflation tends to be largely through indirect channels. Sale prices of existing houses are not included in the CPI, although the costs of constructing new houses are. Construction costs tend to rise during housing booms, although not as strongly as house prices.
However, the main impact of house price inflation on the CPI comes from its effect on domestic spending – the ‘wealth effect'. A rise in house prices means that those who already own housing are likely to see a rise in their net worth or wealth. Since owners feel wealthier they tend to spend more. In fact, over recent times, some house owners have been directly accessing this wealth by increasing the mortgages on their property. This is ‘housing equity withdrawal', and is sometimes referred to as active equity withdrawal. Passive equity withdrawal occurs when a house is sold and the seller has a lower mortgage on the property than the buyer; the end result of such a transaction is that equity is withdrawn from the property.
Total housing equity withdrawal has been substantial in recent years; one estimate puts it at $3.6 billion in the year ending March 2006. This is very high, given that total growth in household consumption in this year was $5.5 billion. However, it seems that only a proportion of this equity withdrawal was spent.  Nevertheless, the withdrawal of equity from housing – as well as from farms and businesses – can have a significant impact on the level of consumption. In turn, this can, and does, affect inflation.
Figure 5 shows how the household sector's assets and liabilities have changed over the years. A sharp climb in the value of assets and net worth – which has been driven by house price increases – is clearly evident.
Figure 6 shows contributions to the changes in households' net worth. Such changes can arise from three sources: household saving (which is the difference between household disposable income and household consumption), revaluations of assets and liabilities, and net capital transfers from overseas (mainly migrants' capital). Net capital transfers are relatively minor and are not shown in Figure 6.
Figure 5 Households' assets and liabilities, $billion
Figure 6 Contributions to changes in households' net worth
Sources: Statistics New Zealand, RBNZ
Figure 6 clearly shows that virtually all of the change in net worth has come from revaluations, which are mainly house price changes. In contrast, saving has made a negative contribution to net worth, since households have been dis-saving, rather than saving. One of the ways in which households have been able to spend more than they earn is through equity withdrawal.
In short, borrowing has so far enabled the household sector to both accumulate assets (mainly houses) and to maintain high levels of consumption. This consumption has maintained upward pressure on inflation. The low level of saving, relative to investment, has also contributed to a large current account deficit.
While the Reserve Bank does not use monetary policy to directly target asset prices – it targets only the CPI – it is concerned to see that changes in asset prices do not unduly affect the CPI, pushing it out of the target range. Given the ‘wealth effect' from housing, the Reserve Bank is keen to see that house prices do not continue to grow at the high rates that have been evident over recent years.
The increase in household debt is also of relevance to the Reserve Bank in its role of maintaining financial stability. The rise in household liabilities appears to be relatively mild in Figure 5 especially when compared with the rise in assets. But as Figure 7 shows, household debt has risen from around 56 percent of household disposable income in 1990 to stand at 158 percent of household disposable income now. This rise is due in the main to a rise in mortgage debt.
Figure 7 Household debt as percent of
household disposable income
Sources: RBNZ, Statistics New Zealand
In principle, the increase in the debt servicing burden associated with this rise in debt renders households more vulnerable to an adverse change in economic conditions. Some households could be particularly vulnerable to a shock which made debt servicing difficult – perhaps via a rise in unemployment – and which also resulted in house prices falling. The fall in house prices would reduce households' net worth, and in some cases could result in households having negative equity. Such developments could, in turn, undermine the quality of bank assets; they could also have serious consequences for overall macroeconomic performance.
The Reserve Bank's analysis to date has shown that a high proportion of mortgage debt is held by high income households, who are undoubtedly in the best position to service this debt. However, the Reserve Bank will continue to monitor the situation, assessing whether any possible rise in defaults on housing loans could affect the stability of the financial system.
Even if house prices were to stabilise soon, the household debt to income ratio is likely to continue rising for some time. This is because house prices will still be at high levels and new purchasers – who will tend to be in young cohorts – will still need to take out high loans to buy them. In general these loans will be higher than the loans that were previously held out on the properties.
However, the situation could change in coming years. The proportion of the population aged 65 and over will increase markedly from around 2010. As members of this generation begin to sell their residential properties – trading down their own homes or turning other properties into cash in order to fund their retirement – some downward pressure on house prices is likely to occur.
2. Drivers of house prices
House prices, and hence housing affordability, are driven by the demand and supply for housing stock. The interplay of demand and supply factors results in the prices paid for housing. The demand and supply for housing stock – especially demand – is also affected by the demand and supply of housing finance. In other words, financial market conditions affect the housing market.
Factors influencing the demand for housing
One influence on the demand for housing is obviously monetary policy. When the Reserve Bank lifts the overnight cash rate (OCR) this is usually followed by a rise in mortgage rates, and this in turn can make the purchase of a house less attractive, or even less possible. However, changes in monetary policy tend to produce short term variations in interest rates over the business cycle. There is a range of other factors which have influenced mortgage rates and housing demand over the last 10-15 years. These are discussed below.
The move to a low inflation/low interest rate environment
A factor that has affected household borrowing in many developed countries since the early 1990s is the move to a low inflation environment. As Figure 8 shows CPI inflation in New Zealand fell suddenly in the early 1990s and has remained at low levels since. This fall in inflation generally led to lower interest rates, and again this is illustrated in Figure 8. Mortgage interest rates fell in the early 1990s, reaching levels last seen in the early 1970s.
Figure 8 Average floating interest rate and inflation
Sources: RBNZ, Statistics New Zealand
This fall in interest rates allowed households to borrow more. Banks generally put limits on borrowing by households; they may for example have a rule that the mortgage repayments on a loan should not exceed 30 percent of a household's gross income. Hence if interest rates drop from say 18 to 9 percent while a household's income stays constant, this household is now able to service a loan that is twice as big as the one it could service previously. Overall, the general fall in interest rates in the 1990s, coupled with the effects of financial deregulation (more on this below), resulted in higher demand for mortgage finance and a widespread desire on the part of households to live in a better house. This has resulted in owner-occupiers improving the quality of their own homes, either via renovations, or by ‘trading up' to another property. Lower interest rates also enabled many households to buy second houses or rental properties.
However, one consequence of moving to a low inflation environment has been that the value of a mortgage and the associated repayments do not ‘deflate away' as previously. When inflation was high, nominal wages also tended to grow strongly, and mortgage repayments quickly became a smaller proportion of household income. This no longer happens; mortgage repayments can take up a significant proportion of income for a long time. This is reflected in the decline in home ownership that has occurred since the 1991 census. Some households have no doubt decided that they simply can't afford the ongoing costs of servicing a loan.
Deregulation of the financial sector and increased competition in the mortgage market
Most of the changes to deregulate the financial sector occurred in the mid 1980s. In a series of moves in 1984 controls on interest rates for lending and deposits were removed, as were the guidelines on overall credit growth. In late 1984 overseas borrowing controls were relaxed and in early 1985 the New Zealand dollar was floated. Compulsory ratios, whereby financial institutions had to invest fixed proportions of their total funds in government securities, were also abolished. The result of these changes, and others not mentioned here, was a re-positioning of financial institutions as they each sought to increase their customer base.
The result of these changes became more evident in the early 1990s as the economy bounced back following the 1987-91 downturn. Banks began to lend more to the household sector, possibly in view of the difficulties that they had experienced with their lending to the business sector during the downturn. Investing in housing now looked more attractive. Competition to provide mortgage finance increased. Mortgage brokers began to appear, facilitating transactions between mortgage providers and borrowers.
The banking sector was also able to take advantage of lower interest rates overseas, funneling funds back to the New Zealand mortgage market. This has been particularly evident in recent years, following the crash in US high tech stocks and the sharp easing in US monetary policy. Since then, investment in US bonds by countries like China has tended to keep international interest rates low.
The deregulation of the financial sector can be seen as being an ‘enabling factor' regarding housing demand. The deregulated financial sector has generally been successful in providing finance to a household sector that has been wanting to lift the quality and quantity of its housing in a low inflation environment.
While most of the major regulatory changes were made around 20 years ago, it seems that their effects are still being felt, as both financial institutions and households continue to adapt to operating in the deregulated environment.
Changes in population obviously affect the demand for housing. Figure 9 shows annual population growth and the contribution to this growth from net migration. The difference between the two lines in the chart is the contribution coming from the ‘natural increase' (births and deaths). The rate of growth coming from the natural increase has not varied much from year to year, but has diminished steadily over time. Most of the variation in population growth has been due to net migration. As can be seen net migration was high and had a strong impact on population growth in the three years following 11 September 2001. This certainly affected the short-term demand for housing.
Figure 9 Annual population growth and the
contribution to this from migration
Source: Statistics New Zealand
Changes in household types has also been affecting the demand for housing. Households have generally been getting smaller, with fewer persons per household. In particular there has been an increase in the proportion of ‘couple only' households. These households tend to have higher incomes than other households; it seems that the demand for residential property from these households has been strong.
The move to a low inflation environment, and the deregulation of the financial sector, have been common features of many of the countries that have experienced house price growth.  Back in 2000 the OECD was noting that in many countries movements in house prices had been correlated with the business cycle. New Zealand proved to be no different in this regard. As Figure 10 shows real GDP grew strongly in the mid-1990s and the early 2000s, which were periods when house prices were also showing strong growth. Figure 10 also shows the terms of trade, which is the ratio of export prices to import prices. This has been a significant contributing factor to GDP growth since 2000.
Figure 11 shows growth in real household disposable income. The growth in this measure has not been as high as that for GDP; this is largely because it is an average measure, showing real income per household. Nevertheless, since average real income bottomed out in 1993, it has grown reasonably steadily, averaging 1.3 percent per annum. This rise has produced a strong underpinning for housing demand. Coupled with this, the unemployment rate has declined markedly from its high point of 1991. Even so, this decline has not had the effect of increasing home ownership; it seems that having a job has not been sufficient in itself to enable a person to buy a house.
Figure 10 Real GDP growth & Terms of trade
Sources: Statistics New Zealand
Figure 11 Average household income, $1995/96,
& unemployment rate (%)
Sources: RBNZ, Statistics New Zealand
Capital gains from investments in housing – both owner-occupied housing and rental housing – go largely untaxed in New Zealand. This, together with rises in house prices, has made rental property an attractive investment for many households over the last 15 years or so. As Figure 12 shows, the proportion of privately-owned rental dwellings has increased significantly since 1991. Clearly, increased interest in rental property has been a factor in the rise in housing demand.
Figure 12 Percentage of occupied dwellings rented from private owners
Source: Statistics New Zealand
The capital gain component of the return on rental properties seems to be crucial to rental property owners. IRD returns indicate that a significant proportion of owners are in fact making significant annual losses on these properties. These losses can be deducted from other earnings for tax purposes, which in effect produces a tax credit from the property for the owner. It seems that many rental property owners will only make a profit when the property is sold and the capital gain on the property is realised. Property owners will not pay tax on this capital gain provided that they can show that their intention at the time they bought the property was to earn income from it. It seems that by preparing an appropriate business plan at the time the rental property is bought, many owners are able to avoid paying tax on any capital gain.
The tax treatment of capital gains for owners of rental properties appears relatively favourable when compared to other countries. In many countries capital gains on rental property are taxable. For example, in Australia, realised capital gains on rental properties are taxed, but at half the normal tax rate.
Some changes to the tax system were considered in a Reserve Bank/Treasury report in 2006, which was exploring ways to reduce the cyclicality of house prices and residential investment in New Zealand. These included greater enforcement of existing rules (and potentially a tightening of the rules) regarding the taxation of realised capital gains tax on residential property. Greater enforcement of existing rules is now being actioned; this was announced in the 2007 Budget.
The Reserve Bank/Treasury report also raised the possibility of ring-fencing rental property losses. Ring-fencing would mean that tax losses on a rental property could not be set against income earned from other sources, but could only be retained to be used against any future profits made on the property.
Overall, it appears that tax policy has been a factor behind the rise in the proportion of residential properties being used for investment purposes, which in turn has been a contributing factor to the rise in house demand.
Expectations of continuing house price growth
Once house prices start growing strongly, expectations about future house price growth also lift. So a feedback loop is set up. People buy property thinking that its price will rise further; the ensuing higher demand for property then ensures that prices do in fact rise. The danger is that a bubble develops and prices for houses get out of line with their ‘fundamental values'. However, determining the fundamental value of property is difficult. Recent research offers a range of estimates about how much New Zealand houses are currently overvalued; the estimates range from an overvaluation of around 30 percent to no overvaluation at all.
Expectations of rising house prices have driven not only purchases of rental properties. Many owner-occupiers have probably bought properties, or moved to larger properties, with the expectation that they too would benefit from capital gains. The fact that housing turnover rose sharply in the early 2000s seems to support this.
Also, it seems that overseas buyers have probably taken a greater interest in the New Zealand housing market as prices have risen. It is difficult to get accurate data on the number of properties owned by people living overseas. The data that we have looked at suggests that less than 5 percent of private residential and lifestyle property is owned overseas. The data also suggests that overseas demand has generally strengthened since the early 1990s. In recent years, however, overseas purchases of residential property appear to have eased off, perhaps reflecting the higher value of the New Zealand dollar.
It seems likely though that expectations about property values in New Zealand have been influenced by events overseas. As mentioned earlier, New Zealand has certainly not been alone in seeing strong house price rises during the last decade. Many other developed countries – including the US, UK, and Australia – have seen sharp rises in prices, although in some of these countries, house prices have now levelled off.
Factors influencing the supply of housing
Before looking specifically at factors which influence the supply of houses it is worth taking a long term look at what has actually happened to supply (Figure 13).
Figure 13 Total dwellings, annual percent change
Source: Statistics New Zealand
As can be seen, there was a step down in new supply towards the end of the late 1970s. This was driven initially by a large migration outflow (see Figure 9), which reduced the demand for housing. But in March 1979, a number of significant changes were made to the lending policy of Housing Corporation. The Corporation, formerly State Advances, was a major lender at this time. The changes were designed to encourage better use of the existing housing stock and to discourage urban sprawl. The major change was that loan applicants with a 20 percent deposit were free to choose between new and existing houses. Formerly, loans had been available only for new houses.
This change was clearly not the only reason for the step down in housing supply. As Figure 9 shows, population growth from the late 1970s has generally been lower than it was. Nevertheless, it is worth noting that in earlier times, prior to 1979, the focus of government measures was largely on increasing supply.
Going back to basics, supplying or building a house requires the following components:
- suitable land
- a building design which meets local regulations
- planning consent
- building materials
Given that other government agencies have more knowledge and expertise regarding these areas, comments on only a few of these issues are made here. However, this is not to downplay the role of the supply side in terms of affecting house prices and affordability. As noted above, it seems that a move to a lower inflation/interest rate environment, financial deregulation, and the globalisation of financial markets, have enabled a major expansion in demand for housing to take place. This demand has been widespread, and has generally proved to be unsatisfiable, at least in the short term. A major practical way to satisfy this demand in the long run, and to thereby stabilise house prices, is to increase the supply of housing.
The first chart in this paper, Figure 1, showed section prices, and illustrated the sharp rise since 2001. Rises in section prices are linked to the issue of land availability. A recent study by Motu has noted that land availability in Auckland has been affected by the adoption of metropolitan urban limits, or a boundary within which residential activities can occur. Ownership of land suitable for greenfields development is seen as being concentrated in the hands of a few ‘land bankers'. At the other end of the scale, ownership of sites within the metropolitan area is seen as being fragmented, with developers finding it difficult to purchase a sizeable block for redevelopment. The study notes that there is presently no legal avenue in New Zealand to force amalgamation or sales of sites that would enable more intensive development to occur.
Clearly these issues should receive more attention and analysis. However, a factor that may complicate any progress in this area might be the general rise in land prices in New Zealand. As Figure 14 shows, rural land prices have shown similar price rises to urban sections since 1990. As with house prices, rural land prices may currently be overvalued. However, continuing growth in demand for protein products from emerging countries like China may provide a general underpinning for rural land prices, and hence New Zealand land prices in general.
Figure 14 Indexes for rural land prices and urban
section prices, base 1990Q1=1000
Source: Quotable Value
The Motu study noted the concerns of developers regarding delays in obtaining planning consents. Similar or related comments have been made by analysts in other countries. An NBER study has noted that in the US homebuilders have faced increasing difficult in obtaining regulatory approval for the construction of new homes. Local residents – more educated, more affluent – have had a greater ability to block new projects should they be deemed harmful to their own interest, for example to the value of their home. Zoning has become more restrictive. The result, the study argues, has been higher land prices.
While there will always be a need for government – both central and local – to be aware of community and environmental concerns regarding new housing developments, there will also be a need to balance these concerns against possible impacts on house prices.
Figure 15 shows that since 1991 the price of constructing new housing (blue line) has not risen as much as the price of all houses (red line). However these construction costs do not include section prices. If these are included, the rise in the cost of new housing (dashed black line) has been very similar to the rise in the house price index.
A question arises as to what has been driving construction prices over the period. Have these rises been justifiable? Figure 16 shows the cost of total inputs (purchases and labour) to the construction sector as well as construction prices. As can be seen, a gap opened up between construction prices and input prices in the mid 1990s. However this chart should be regarded as being indicative only. The construction sector undertakes more than residential building – it also erects non-residential buildings and other structures. The series for total inputs covers all of these activities.
Figure 15 House price and construction price index,
base 1991Q1 = 1000
Sources: Quotable Value, Statistics New Zealand
Figure 16 Construction price and input price,
base 1991Q1 = 1000
Sources: Statistics New Zealand, RBNZ
The profits of construction firms are also dependent on the level of activity, as well as the difference between unit costs of inputs and outputs. In turn, the level of activity is dependent on how many dwelling are built – Figure 13 gives a rough idea of this – and the size of those dwellings.
Figure 17 shows average floorspace of new dwellings. The figures cover apartments as well as houses. Average floorspace has increased by 45 percent since 1991. This is consistent with the view that over this period many households were aiming to ‘move up the ladder' to a better house. The end result has been that a higher proportion of the new houses being added to the existing stock are high quality homes.
Figure 18 shows a proxy measure of profit for the construction sector. The chart shows that profitability increased markedly from 1992 through to 1997, which is broadly in line with the change in price differentials shown in Figure 16. It should be remembered though that the period from 1987 to 1992 was a difficult one, especially for the building sector; the sharemarket crash in 1987 ended a period of very high commercial building and signaled the onset of what was to be a severe recession. Hence, profits may have been extraordinarily low in this period.
Figure 17 Average floorspace for dwelling consents,
Source: Statistics New Zealand
Figure 18 Construction sector profit (operating
surplus as % of output)
Source: Statistics New Zealand
Overall, construction prices seem to have largely reflected market conditions, where this market includes both residential and non-residential activity. Capacity utilisation in the building industry has been very high over recent years, indicating that the sector has been stretched in trying to meet demand. This is despite employment in sector also being at very high levels.
An easing in building demand is likely to be followed by an easing in the growth of construction prices. It is less clear though whether there will be a re-orientation away from building high quality houses to more affordable houses.
3. Are there any areas that warrant policy attention?
The housing picture that emerges for New Zealand over the last 15 years or so is slightly different than that for most other developed countries. It is different in that home ownership rates have declined. In contrast other countries have seen rises in home ownership rates, and some have put this down to the ‘democratisation of credit'.
The starting points were different however, in that in 1991 New Zealand had a high level of home ownership, compared to other countries. It might be argued that there has been some sort of convergence in home ownership rates around the world, with New Zealand converging from above, and most other countries converging from below. This argument would be of no comfort to prospective home owners.
What has driven the decline in home ownership rates in New Zealand? It seems that the move to the low inflation/low interest rate environment, financial deregulation, and low international interest rates has resulted in increased access to credit for many New Zealand households. But these households have largely been those that already owned property, and had accumulated some equity in their property. Home owners have had the opportunity to exchange their house for a better one, lifting the amount that they had on a mortgage as they did so. Some home owners have taken the option of buying a rental property, using their own house as collateral. Many of the people taking this course would have been counting on house prices to keep rising, thereby producing a significant capital gain. This would seem to them to be rational behaviour, given that few, if any, New Zealanders can recall a time when nominal house prices have declined for a sustained period.
This burgeoning demand for housing resulted in house prices moving up. Housing supply was not high enough, at least in the short term, to prevent this.
Coupled with this, large migration inflows – in the mid 1990s and the early 2000s – increased housing demand further and provided more upward pressure on house prices. This is perhaps the area where New Zealand differs from most other countries – our net migration inflows, at the top of an economic cycle, tend to be large, relative to our population size.
In this situation, prospective first time buyers simply got left behind. Rising house prices generally meant that a higher deposit was required. And in the low inflation environment, mortgage payments as proportion of income would decline only slowly. And in recent years, mortgage payments would have moved up, as monetary policy started to bite.
A major puzzle is why house prices relative to income haven't adjusted down again after a strong migration period has ended. This may reflect the new environment for credit. But it also points to there being some long-term supply constraints on housing.
The Reserve Bank is of the view that government policies should focus on increasing the responsiveness of housing supply to changes in demand rather than schemes which increase demand. Hence the Reserve Bank is very supportive of the work being undertaken by the Ministry of Housing and the Department of Building and Housing which focuses on supply side issues.
Government has already initiated a number of schemes that will affect the demand for housing. These include the Welcome Home loan scheme, and the proposed home equity scheme, which is currently being trialled. Kiwi Saver too can be expected to have some impact on housing demand, once savers begin to receive the first home deposit subsidy. These schemes are generally targeted at specific population groups. It is important, in the Reserve Bank's view, that such schemes continue to be carefully targeted. The aim should be to minimise the impact of such schemes on the overall level of housing demand and house prices. This will avoid such schemes being self-defeating.
Unfortunately issues relating to housing supply are not likely to be solved easily and quickly. A review of planning practices may be required, with a view to possibly relaxing ‘urban fences' and encouraging medium density redevelopment in existing urban areas. Nevertheless, the best approach for restraining house price rises in the long term, making housing more affordable for both owners and renters, will be to ensure that, as far as possible, supply is ample and responsive.
There are two areas on the demand side where government might want to consider policy changes:
- Managing migration inflows: To date policy has tended to produce
pro-cyclical results, with migration levels being increased in economic upturns
in order to relieve skill shortages. This approach may need to be tempered in
future in the light of migration's apparent sustained impact on the level
of house prices. Improving the responsiveness of housing supply would obviously
lessen the need to do this.
- Tax arrangements for rental property: As noted earlier, New Zealand tax policy appears to be favourably disposed towards rental property, compared to other countries. The Reserve Bank welcomes the initiatives announced in the 2007 Budget to provide stricter enforcement of existing tax rules for rental property. However, it may be appropriate to consider further tax measures such as the ring-fencing of operating losses on investment properties. Care would be needed in implementing a ring-fencing policy in order to minimise any short term impacts on rents. Consideration might also be given as to whether taxation policies could be more in line with those in Australia, where realised capital gains on rental properties are taxed, but at half the normal tax rate.
Finally, two general issues are noted:
- Making provision for long-term rental agreements: The Reserve Bank
is forecasting that house prices will level off within the next two years,
although as the Bank has been warning for some time now, there is a risk that
nominal prices will actually decline. Assuming that house prices do stabilise,
buying a house will still be difficult for a significant proportion of the
population. In this situation it is likely that the home ownership rate will
continue to decline, and an increasing proportion of the population will be in
rented properties. In view of this, there may be an increasing need to provide
for long-term rental agreements that clearly set out the rights of both tenants
and landlords. Long term leases that allowed the tenant to modify the dwelling
to some degree would provide the tenant with some of the benefits normally
associated with owning a dwelling. Such arrangements could potentially divert
some of the pressure that is currently on the owner-occupied market. As allowed
for in government's current housing strategy, there will be a need to keep
assessing whether the legislative/regulatory framework covering tenancy
agreements is adequately allowing for the changing needs of tenants and
- The ongoing need for analysis and better data regarding housing: It seems likely that issue of housing affordability will not be solved quickly. There will be a continuing need to analyse and monitor the housing market. There are some areas where the quality of data could be improved. There is for example a need for better measures of the housing stock, which would capture changes in both the quantity and quality of the stock. At the moment it is difficult to assess the extent to which changes in house prices are reflecting changes in the quality and quantity of land and buildings as well as underlying movements in prices. Another area where there is a need for better data is in the measurement of rental yields; this would require data where the rental earnings from a property can be linked to the value of a property.
 The sharp decline in the CPI rent index in the first quarter of 2001 reflects a movement away from market rate rents in state housing to income-based rents.
 See Smith, Mark (2006) What do we know about equity withdrawal by households in New Zealand?, paper prepared for Reserve Bank workshop on ‘Housing, saving, and the household balance sheet', 14 November. Available from www.rbnz.govt.nz.
 Statistics New Zealand's figures on household saving, which were revised recently, are still classified as being ‘experimental'. While these figures may overstate the level of dis-saving, recent work at the Reserve Bank confirms that level of dis-saving is indeed likely to be large. See Hodgetts, Bernard, Phil Briggs and Mark Smith (2006) Trends in household savings, wealth and debt, paper prepared for Reserve Bank workshop on ‘Housing, saving, and the household balance sheet'. Available from www.rbnz.govt.nz.
 The aim is to keep CPI inflation within 1-3 percent over the medium term.
 See Financial Stability Report, Reserve Bank of New Zealand, May 2006, pp13-14. Available from www.rbnz.govt.nz.
 See Ellis, Luci (2006) Housing and housing finance: the view from Australia and beyond, paper prepared for Reserve Bank workshop on ‘Housing, saving, and the household balance sheet'. Available from www.rbnz.govt.nz.
 See Debelle, Guy (2004) Macroeconomic implications of rising household debt, BIS working Paper 153, pp15-16, for notes on financial deregulation measures taken in a range of countries.
 OECD (2000) Economic Outlook 68.
 See Ellis, Luci (2006) Housing and housing finance: the view from Australia and beyond, paper prepared for Reserve Bank workshop on ‘Housing, saving, and the household balance sheet', pp9-11. Available from www.rbnz.govt.nz.
 See RBNZ and Treasury (2006) Supplementary Stabilisation Instruments: initial report to Governor, RBNZ, and Secretary to the Treasury. Available from www.rbnz.govt.nz.
 For a brief summary of this research see Financial Stability Report, May 2007, Reserve Bank of New Zealand, pp11-12.
 This data was obtained from Quotable Value, the IRD, and private businesses.
 Grimes, Arthur, Andrew Aitken, Ian Mitchell and Vicky Smith (2006) Housing supply in the Auckland region 2000-2005, prepared by Motu, published by the Centre for Housing Research, Aotearoa New Zealand.
 Glaeser, Edward L, Joseph Gyourko, Raven E Saks (2005) Why have housing prices gone up?, National Bureau of Economic Research, Cambridge, MA.
 The construction price index used here represents unit costs (in effect, costs per square metre); it does not account for changes in the size or quality of houses.
 This proxy measure is derived from national account figures and is gross operating surplus as a percentage of gross output. Gross operating surplus does not account for interest payments, interest receipts, or depreciation.
 Housing New Zealand Corporation (2005) New Zealand Housing Strategy, p42. Available from wwww.hnzc.govt.nz.