Nationwide house prices have now fallen for 10 consecutive months as the effects of rising interest rates and weaker population growth slash both the number of buyers and their ability to pay high prices for property. The 10 consecutive monthly falls in the Real Estate Institute’s index (seasonally adjusted) is just short of the record 11 declines that occurred in 2008. However, the 11.8% drop in this index from the market’s peak has now surpassed the total fall of 11.3% that was recorded between June 2007 and December 2008. But that nationwide fall masks considerable regional differences, which we analyse in this article.

The Auckland and Wellington regions feature heavily among the areas that have recorded the biggest declines since the market’s recent peak, representing 12 of the 14 largest falls (see Chart 1 for the 10 largest falls).

At the other end of the spectrum, the South Island is overrepresented in the areas with the smallest drops, contributing 14 of the 19 smallest declines (see Chart 2 for the 10 smallest declines, including four districts where prices have not yet started to fall).

Intuitively, the largest house price falls occurring in Auckland and Wellington makes sense. The highest median house prices over the last year were in these regions, meaning that buyers are likely to be more sensitive to the effects of higher interest rates on debt-servicing costs. Banks are simply unwilling to lend such large amounts of debt, knowing that borrowers will have less ability to service this debt as mortgage rates climb.

Both Auckland and Wellington also recorded a shrinking population in the year to June 2022. There were three other regions that lost people in 2021/22 as the COVID-19 pandemic continued to affect migration patterns, but the population decline was much more unusual for Auckland and Wellington than for the likes of West Coast or Southland.

Nevertheless, our analysis suggests that, rather than population growth or the level of house prices, the biggest determinant of current house price declines is the magnitude of the house price increase between the market’s previous trough in December 2008 and June 2020. This period of appreciation is also more important than the surge in prices between June 2020 and November 2021 that was fostered by ultra-low interest rates. Although there’s a lot of variation around the trendline shown in Chart 3, a regression confirms the existence of a strong relationship.

How much further might house prices fall? Our most recent forecasts of CoreLogic’s house price index1 saw the rate of decline in prices easing in the final part of 2022, with prices bottoming out in mid-2023. However, these forecasts are looking rather optimistic considering the September quarter consumers price index figures. With consumer price inflation holding up at 7.2%pa, it has forced a rethink on how much higher the official cash rate (OCR) will go before reaching its peak.

We now expect the OCR to be increased by 75 basis points, to 4.25%, in November, with subsequent increases taking it to a peak of 5.25% in May 2023. Ten-year government bond rates have also spiked in late October to a nine-year high of 4.8%. With the whole yield curve moving upwards, banks have pushed through increases of 35-50 basis points across all fixed rates. Our belief that the dip in mortgage rates that occurred in July and August was premature has proven to be true.

With higher wholesale interest rates across the board, we have also lifted our expectation of mortgage rates during 2023. We predict that the cheapest available rates, which will sit in the 1-2 year range, will be close to 7% in the June and September 2023 quarters.

Prospects of mortgage rates close to 7% must start to concern the Reserve Bank. The Bank’s Financial Stability Report in May showed that banks were using an average test servicing rate of just 6.0% in September last year. In other words, anyone who bought at the peak of the market in 2021 could be faced with refixing their very large mortgage at interest rates that will severely stretch their budget (see Chart 4), and the Bank’s latest Financial Stability Report published yesterday estimated that 46% of people who borrowed in 2021 would need to spend at least half their after-tax income on interest payments with mortgage rates at 7%. Mortgagee sale numbers have stayed very low so far thanks to the tight labour market, but there is no guarantee that the incidence of forced sales won’t increase given the persistent of inflation and ongoing upward revisions in interest rate forecasts.

Against this backdrop, we are now predicting that annual house price inflation falls to a record low of -14%pa in early 2023, with a total decline of 19% in house prices between December 2021 and June 2024 (see Chart 5). After adjusting for consumer price inflation, real house prices in mid-2024 will be at their lowest level since December 2019, effectively undoing the massive surge in property values that occurred during 2020/21 in response to ultra-low interest rates.

Finally, it’s worth noting that there is likely to be a lot of regional variation in house price falls in coming quarters. Chart 6 shows the districts with the biggest house price declines in the wake of the Global Financial Crisis. Property prices in smaller districts have the potential to be pushed further away from their “fair” value by short-term trends, such as the coastal property boom of the mid-2000s. This greater price variability over the course of the cycle in smaller districts means that, although Auckland and Wellington are currently leading the house price downturn, larger falls in other parts of the country are likely to emerge in 2023 and 2024.

1 Price falls to date in CoreLogic’s quarterly house price index have been smaller than the falls in REINZ’s index.