Blame it on the boomers

The affordability of housing is currently ahot topic.   But even with house prices so high, over 102,000 properties changedhands last year – implying that housing is still affordable for some.   Simpleeconomics tells us that prices would not keep rising if they weren’t beingdriven by demand.

Why has the boom kept going for so long?  Migration is no longer providing the same impetus that it did a few years ago.  Population growth halved between mid-2003 and June 2005 and has changed littlesince then.   But the annual build rate remains above historical averages and,if anything, suggests we should be seeing an oversupply of housing starting todevelop.

Persistently good economic growth between2001 and 2005 has fuelled increases in incomes and virtually eliminatedunemployment.   High levels of job security have made people confident abouttaking on more debt to purchase property.   To some extent, this appetite fordebt has been facilitated by relatively attractive interest rates.   NewZealanders are willing to borrow at 8%pa, and foreigners have been more thanhappy to lend us money at rates well in excess of what they can secure back inEurope or Japan.

Zoning restrictions have been a factorunderpinning land prices, but this is not a trend that has suddenly developedover the last five years.   Back in 1960, an average section was worth around25% of an average house with land.   That figure has steadily risen to 53%.   Inother words, if you’re thinking of buying a property, you’re probably payingmore for the land than the structure on top of it.

The surge in house prices has not beenunique to New Zealand, with similar phenomena occurring in the UK, Australia, and the US, to name a few.   When investing in stocks fell out of favour in 2001, foreignerswere quick to take advantage of New Zealand’s cheap prime coastal property –especially with the exchange rate closer to US40c than US70c.   And by 2004, asthe housing market across the Tasman cooled, yields on rental property inprovincial towns such as Wanganui were attractive for Australian investors discouragedby the miniscule returns on offer in Sydney and Melbourne.

Baby boomers across the Western world arenow saving as fast as possible for retirement, which helps explain the globalnature of the house price boom.   New Zealanders’ love affair with owning investmentproperty is well documented, and the tax treatment of rental property(accelerated depreciation rates, LAQCs, and the lack of any capital gains tax)has ensured it remains one of the most popular savings vehicles.

It also explains why momentum in thehousing market has kept on rolling – even though economic growth has slowed andinterest rates have risen, saving for retirement will continue en masse for thenext 5-10 years.

With rental yields in New Zealand now at historically low levels, and housing affordability measures at their worst fordecades, it is implausible that house price inflation will continue at therates seen over the last five years.   But with the largest swathe of babyboomers not reaching retirement age until around 2015, a sudden reversal inprices is not on the cards either.   Most property investors are likely tomaintain their holdings for another decade before cashing up, and there arebound to be other purchasers on the fringe of the market hoping the gains ofthe last few years are repeated.

The government’s angst about housingaffordability is a response to a relatively short-term problem, and riskscausing a repeat of the 1970s housing crash.   When all the baby boomers lefthome early that decade, there were not enough houses to accommodate them all.   Subsequenthigh levels of state house building combined with an economic downturn to leavethe real estate market grossly oversupplied.   As a result, house prices, ininflation-adjusted terms, collapsed.

For those readers worried about acorrection in house prices in ten years’ time as everybody tries to cash up atonce, the news is not all bad.   By 2015, the baby boomers’ kids will be intheir early 30s and looking to settle down.   As long as your investmentproperty would appeal to someone as a first home, you should be able to find abuyer out there.

Putting aside policy-related risks, asoft landing for house prices still looks to be on the cards.   While currentdemand for residential property is not due to population growth (the mostfundamental of drivers), neither is it simply a speculative bubble.   NewZealanders have simply responded to the incentive structures in place whenchoosing how to save for their retirement.

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