Recent housing policy will help balance society’s genuine housing needs for shelter, but it will do little to address the investment demand for housing. Michael Rehm looks at some long-overdue solutions.

Comment: Warren Buffett quipped “you don’t find out who’s been swimming naked until the tide goes out”.

During the Covid-19 pandemic the tide went out on New Zealand’s housing markets and exposed droves of skinny-dipping speculators. Lockdown-fatigued homebuyers were pumped full of cheap credit and frolicked naked in the surf. Nationwide house prices increased by 45 percent from the dawn of the pandemic to December 2021.

That month the tide turned, and a financial tsunami struck in the form of amendments to the Credit Contracts and Consumer Finance Act (CCCFA) and rising interest rates. With house prices in full reverse, market analysts are reading their tea leaves for explanations.

The Covid-19 experience punctured most theories on what drives house prices while providing an illustrative natural experiment on how bank credit manipulates housing markets. Despite this, many analysts remain fixated on land supply as the key housing market failure as outlined in the Government’s recent ‘Assessment of the Housing System’ report. Sky high land prices, however, are a symptom, not a cause.

A residential vacant section on its own has very little utility or use value until you place a house on it. When a land developer bids on raw block land, their calculus starts with the value of the houses that will occupy the paddocks in several years’ time. The price paid for the land reflects its residual value after the infrastructure, construction and other development costs are deducted from the forecast house sales prices. Interestingly the housing market’s bank puppeteers are timid when it comes to funding land, often limiting credit supply to 50 percent loan-to-value.

However, once a completed dwelling graces the land, banks open their arms and with the stroke of a few keys conjure up new money from the ether. This new money supply is what enables house prices to defy gravity and fundamentals such as incomes. Unfortunately for those with substantial mortgage debt, when the flow of credit wanes, gravity kicks back in, house prices fall and negative equity looms.

In the same report, the authors refer to United States housing markets where land supply tends to be less restricted and abundant. Aside from more laissez-faire land use regulations, there is another key difference between US housing markets and our own. Kiwis are fanatics when it comes to property and we’ve taken the financialisation of housing to a whole new dimension. New Zealand investors tend to purchase between one-third and one-half of all transacted dwellings. However, Forbes reported this February that US investors snapped up a record share of home purchases – nearly 10 percent.

Unlike first home buyers who must commit to years of diligent savings to raise an adequate deposit, investors can simply recycle their accumulated equity into further investment property purchases. Leveraging unearned capital gains to create new money that is pumped into the housing market has dislocated house prices from fundamentals, not overzealous urban planners restricting land supply. As my recently published research found, such purchases are speculative in nature and target capital gains. Of course, investors are now panicking as capital gains are no longer on the horizon and they are facing tax bills rather than rebates thanks to last year’s interest deductibility rule changes.

While rents are tightly coupled to incomes, house prices are not. Profit-seeking banks leverage against borrowers’ future income and their willingness to lend has changed over time. Masked by interest rate movements, banks have saddled homebuyers with debts that are increasingly out of proportion to their incomes. Despite two rounds of consultations, the Reserve Bank has yet to devise or implement a debt-to-income lending limit. Mortgage debt needs to be tethered to borrower incomes and housing speculation must be stomped out.

Recent policy, namely the national policy statement on urban development and townhouses bill, are supply-side solutions. That will help balance society’s genuine housing needs for shelter and roots in a community, but it will do little to address the investment demand for housing. Demand-side solutions like debt-to-income limits and anti-speculation measures like the Income Tax Act’s intention test put to full force are long overdue.

Dr Michael Rehm is a senior lecturer in property at the University of Auckland Business School

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