Harry Smith is a portfolio manager in international equities at Fisher Funds.
OPINION: I’ve begun to wonder if New Zealanders have been taking the old adage “safe as houses” a little too literally, believing house prices won’t and don’t fall.
For the last few years many of us have appeared to have taken the gamble that when it comes to house prices the only way is up.
The reality is that property, like all asset classes, can and does fall. And there are some similarities between our housing market now and that of the US in 2007, which fell 27% from peak to trough.
Before the global financial crisis in 2007, 50% of home loans in the US had adjustable-rate mortgages. These mortgages had a low interest rate in the first couple of years, but reset to a significantly higher rate as the Federal Reserve increased interest rates.
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Higher mortgage rates impacted half of all US households, squeezing discretionary income, and spilling over to consumer spending, which accounts for 70% of their gross domestic product (GDP).
Here in New Zealand, our Reserve Bank has been rapidly increasing interest rates in an effort to control inflation, and like we saw in the US, this has the potential to impact homeowners who are used to much lower interest rates.
With nearly 60% of mortgage debt maturing within 1 year, the New Zealand housing market is very interest-rate sensitive, possibly to a higher degree than the US was in 2007.
Current estimates are for the official cash rate to reach 4.25% by the end of the year. Historically the one-year mortgage rate sits roughly 2% above this. It means a household that purchased a $1 million home in 2021 with a 20% deposit and 2.3% mortgage rate will see their yearly cost to service the mortgage increase from $37,000 to $59,000 – a 60% increase.
Consider this increase against the average annual household equivalised disposable income in 2021 of $50,164 and our lack of savings; our back-of-the-envelope maths suggests the increased cost to service mortgages could wipe more than 1.5% off New Zealand’s GDP.
Current economist estimates expect house prices to drop between 15%-20%. These estimates could prove overly optimistic.
If a new homeowner wanted to maintain 2021 mortgage servicing of $37,000 per year with higher interest rates, then this would imply house prices would have to fall 35%. After rising 48% in the two years to December 2021, a 35% drop would take prices back to September 2020.
Now admittedly, a lot of New Zealand homes have little or no debtWe also benefit from having banks with good underwriting standards – no Ninja (no income, no job, no assets) loans that US financial institutions were making pre-financial crisis.
While a lot of this might be unwelcome and even scary news to some, it’s worth remembering that this is just one scenario predicated on higher interest rates. Even if house prices do fall, they will recover in time, and with that recovery there could be other positive outcomes.
Firstly, like Americans, we might learn to extend the maturity of our debt, or at least break it into different buckets to reduce our exposure to macroeconomic trends which are incredibly hard to forecast.
The experience of 2007 dramatically changed how US households structured their debt. Today 90%-95% of mortgagees borrow for 30 years with a fixed mortgage rate throughout that period. So, when the Federal Reserve lifts interest rates 0.75%, as they did recently, it won’t have nearly the effect on consumer consumption as increases in New Zealand’s official cash rate are likely to have.
Secondly, we might take the opportunity to reduce the focus on property in our investment portfolios and instead shift to a more balanced portfolio of cash, bonds, property and shares.
House prices are falling because of higher interest rates, which presents opportunities in term deposits and bonds as an alternative investment. Overseas share markets have already fallen 20-30% presenting attractive entry points.
Lastly, and arguably most importantly, lower valuations should allow those who have been saving hard towards a deposit, to finally buy their first home and that would be welcome news.