After house prices rose by around 30% during 2021, the tide may be turning. Economists are now predicting that prices will fall by between 4% and 7%, starting this year. There are some signs that the market is cooling, such as more listings and slower growth in December and January. The OECD predicts a correction is a major risk factor for our economy.
Could these be the first harbingers of a serious house price crash this year?
What’s causing downward pressure on house prices?
There are four main reasons that house price growth is slowing, and may plateau or turn negative:
- Rising interest rates: this reduces how much buyers can afford to spend and increases the costs for existing borrowers.
- More difficulty borrowing: it’s tougher than ever to get a mortgage from a bank with new regulations and some banks trialling debt-to-income ratios.
- A construction boom: more supply of homes means scarcity isn’t driving up prices.
- Migration outflows: Kiwis leaving to chase higher wages overseas, coupled with slowing immigration
Counterbalancing factors
There are several factors that are likely to prevent any major crash in prices:
- Lenders calculate a buffer for borrowers: most loans are tested at 3% to 3.5% above the current interest rate, so forced sales are unlikely.
- Construction costs are rising fast: when houses are expensive to build, the value of existing properties rises.
- Jobs are plentiful: people with good jobs can keep paying their mortgages.
- The Government doesn’t want a crash: a serious crash in house prices would have an enormous knock-on effect for the entire economy. It’s likely the Government would try to counteract a price collapse.
Taken together, all these factors suggest prices could be flat or fall slightly, but it’s unlikely that we’ll see a crash.
Historic house price movements
Over time, house prices tend to increase. However, they can drop suddenly. Many of you will remember prices dropping by 10% during the GFC in 2008. That hit hard, particularly because interest rates rose at the same time, the economy was in recession and many jobs were lost.
A far larger crash occurred in the 1970s, after the oil shock of 1973 and following a period of booming values. Between 1974 and 1980, house prices fell by around 40% in real (inflation adjusted) terms. If you bought a house in 1970, by 1980 it was worth pretty much what you paid for it – contrary to the usual belief that house prices ‘double every 10 years’.
But both these price drops were followed by periods of recovery and growth. A 7% drop in prices this year would still only take prices back to the levels we saw in the third quarter of 2021.
Ultimately, nobody knows what will happen
House price forecasts are rarely accurate – during the first lockdown of 2020, commentators predicted price drops of around 15%, only for the market to go on a rampage. Last year the Reserve Bank admitted its forecasts have been consistently wrong for 10 years and economist Tony Alexander says the OECD “do not have a good record with regard to picking house price movements in New Zealand – that would be the polite way of describing their forecasting ability.”
The long-term outlook for property remains positive as part of balanced portfolio of investments. Here at Zagga, just as at the main banks, we calculate borrowers’ ability to service their loan and repay the debt at the end of the loan term. Given our underlying security for loans is a first mortgage over property, we also consider the loan-to-value ratio (LVR) when assessing a loan and that information is made available to our investors. Over the 2021 year, our average LVR was 53%, providing comfort that funds could be repaid from the security property if worse came to worst.
Nobody has a crystal ball labelled ‘house prices’. Our philosophy is to take a long-term approach to our investments and to minimise risk by carefully vetting each deal. If you have any questions about how a market downturn could impact your investment, do get in touch and we’ll be happy to talk them through our strategies with you.