BOOK EXTRACT: Generation Rent – Does housing affordability really matter?

Copyright © Shamubeel Eaqub and Selena Eaqub. Generation Rent: Rethinking New Zealanders’ priorities is published by BWB Texts (Bridget Williams Books, Wellington). Reprinted with permission

For more New Zealanders than ever, home ownership is out of reach. Incomes have not kept pace with skyrocketing property prices. The authors say this calls into question priorities at the heart of New Zealand’s identity. In this extract they examine the concept of housing affordability, whether prices will remain high and the risks of a downturn

Does housing affordability really matter?
Can rising house prices be a bad thing? Surely they increase New Zealand’s wealth? Well, rising house prices can be a good thing – but too much of a good thing, as we know, can be bad in the long run.

Rising house prices make those who already own houses richer – that is obvious. But at the moment only about two-thirds of all households own the houses they reside in, and even this statistic is deceptive. Because home ownership is concentrated among the richer, older and smaller households, only about half of individual New Zealanders (those aged over fifteen) actually live in a home they own.

In Auckland, only 43% of individuals live in the house they own. Māori, Pacific peoples and recent migrants have very low home-ownership rates, as do young people under forty and people with low incomes. Those not owning their house – 57% of people in Auckland – miss out entirely on the increase in wealth that rising house prices have created. That rise in house prices also reduces their chances of getting on to the property ladder.

In a more structural sense, if house prices rise too fast and out of step with income increases (as they have done in recent decades) housing unaffordability becomes a pressing threat to financial, economic and social stability. There are the obvious risks to economic and financial stability, if rapid house-price rises are followed by a slump. A less frequently discussed, but in fact larger and more insidious problem is that unaffordable housing sows the seeds of wealth inequality between generations and within future generations.

Given the growing reliance by young house- hunters on financial help from their parents, it seems inevitable that home ownership will increasingly become the provenance of the children of those who already own houses. Allowing the influence of hereditary sources of wealth to increase will exacerbate wealth inequality in New Zealand, driving a wedge between the haves and have-nots.

The New Zealand housing system risks becoming a form of reverse welfare, where the rich will unduly benefit from higher house prices. In 2004, the most recent year for which we have data, the wealthiest 1% of households owned 16% of all the country’s wealth; in contrast, the poorest half of the country owned just 5% of the wealth. The growing housing divide will only make this worse. This kind of inequality causes envy and reduces trust in the community, fraying the social fabric that is necessary for any well-functioning society, economy and country.

The trend since the early 1990s has increasingly pushed New Zealand towards a new class system, with house owners – a kind of modern-day landed gentry – at the apex. This is a serious and persistent attack on New Zealand’s identity as an egalitarian society where social and economic success are open to all. Rising housing costs also push poor households further away from work and from attractive places to live, increasing the costs placed on these households and perpetuating a cycle of poverty.

Housing affordability also represents a threat to national prosperity. The often fortuitous returns accumulated by rising house prices risk making New Zealanders complacent and narrow-minded about ways to generate wealth. We need to confront the reality that the productive path to wealth lies not in sitting on property but in hard work and enterprise, across a range of different business settings – work that should generate higher profits and bigger incomes for all.

Will house prices remain high?
House-price falls are possible. New Zealand has a rare history here, in that prices have never really fallen sharply or for a sustained period – we have never had a crash in that sense. But house-price falls have happened in New Zealand, especially in the regions in the wake of the GFC, and especially once prices are adjusted for inflation. In addition, major house-price falls have certainly happened internationally – and we should not be complacent about such a thing happening here.

In Canada, for example, the city of Toronto had a real-estate boom and bust in the 1980s in which prices rose 113% in real terms then fell by 40% in the greater Toronto area and 50% downtown by 1996. Fuelling the boom was rising immigration, strong jobs growth, more women entering the workforce, and the attitudes of a population who saw no likely end to the boom. But it collapsed due to a combination of fixed mortgage rates reaching 12.7%, an early 1990s recession, a spike in unemployment and a drop in immigration.

This cautionary boom and bust tale was recently reported as being circulated among Auckland’s financial networks, with some media and analysts interpreting this as a warning.

In the past 50 years, there are only four years in which nominal (that is, not inflation-adjusted) New Zealand house prices have fallen, generally in exceptional circumstances: the tail end of a long recession in 1992, for instance, or the deep and long recession that lowered prices in 2009. But relative to the cost of living, prices have fallen far more often. This is because New Zealand has been through periods when inflation was high, and the cost of living rose sharply, but house prices did not rise alongside it.

Once inflation is removed from the figures, we can see that in the last half-century, house prices fell in 19 – nearly 40% – of those years. (Care is needed with these figures, as they include an exceptional period in the late 1970s when both the economy and house prices performed poorly, due to oil-price shocks and economic mismanagement.)

More recently, house prices have fallen in many places from their 2007 pre- GFC peak. QVNZ tracks the house prices in some 68 local areas, and its figures show that, as of early 2015, house prices are lower in 62% of the regions in nominal terms than they were in 2007. Once we take into account increases in the cost of living, house prices are lower in 82% of the regions. So even in New Zealand, we have evidence that house prices are not a one-way street – they can fall in many areas, and sometimes severely.

There are similar examples internationally. Compared to their 2007 level, house prices in 2015 are down sharply in Ireland, Spain, the Netherlands, Denmark and the US.6 In each instance, prior to 2007 house prices rose sharply relative to incomes, and lots of houses were built and traded; when the momentum ran out or an external shock hit, house prices fell sharply. The impact of house-price declines has not been even across these countries, but their combined experiences nonetheless provide some insights into the possible implications for New Zealand’s financial and economic stability, should a similar crash occur here.

Financial and economic risks of a downturn
A major fall in house prices can create chaos across an economy, as demonstrated by the GFC. Falling house prices, especially in the US, played a central role in widespread business failures, job losses and a global economic recession. This role was facilitated by the banking and finance sectors. They lent aggressively through the upturn in the housing market and the economy in general, but reduced lending and called back loans when the cycle turned down.

This amplified the economic cycle, over-egging it on the upturn and driving it into the ground in the downturn. As house prices fell, many property developers and their financiers went bust, causing layoffs in construction, real estate, finance and other sectors that supported house building, such as forestry and building materials firms.

There is a familiar pattern in such crises. Initially households become more cautious; they reduce their spending on discretionary and luxury goods, and reduce their borrowing – not just in mortgages, but also credit card use and other consumer finance. They tend to spend only what they earn, rather than borrowing to spend more.

This hits retailers, non-mortgage financiers and those who support these sectors. But as the downturn broadens, job losses mean households spend even less, businesses stop investing and hiring, and a recession ensues. The more debt people had previously taken on, the worse the impact. There is not always a clear sequence of events – the economy is a complex international web of millions of individual decisions. But the end result is inevitably a recession.

A vicious cycle ensues and broadens, as banks become risk-averse, reducing their lending, and tightening their lending criteria not just for house- related borrowing, but also for businesses. The credit drought is worst for small businesses. This change in banks’ lending practices amplifies the impact of the housing downturn on the economy and the financial sector, and leads to a long and deep recession.

Banks, facing lower profits and increasing numbers of defaults in their mortgages (and potentially other lending areas), can in some cases go bust.

The risk of such a scenario is low, but the cost would be high. Even if customer deposits are not lost, confidence can evaporate. This happened in the UK in the run-up to the GFC. In 2007, Northern Rock, the country’s fifth largest mortgage lender, faced a run on its deposits, the first experienced by a British bank since 1866. There were queues of people waiting to withdraw their funds – something the bank could not cope with, as like all banks it had lent many times more funds than it held and simply did not have the money to give out.

In the GFC, nearly 300 US banks with assets of around $US540 billion failed, accounting for around 4% of all bank assets. The situation in the US was worsened by borrowers’ ability to walk away from mortgaged houses. In the US, mortgages are secured against the house in what is known as a non-recourse loan, rather than against the future income of the borrower, as they are in New Zealand. This meant that when a house was worth less than its owner’s mortgage, it made more sense for the owner to walk away from it than keep repaying the mortgage.

Banks received a lot of ‘jingle mail’, the colloquial term for the packages in which mortgage holders sent their house keys to their bank. In New Zealand, by contrast, borrowers remain liable to repay the debt, so in the event of a house-price crash they would have to knuckle down, cut back in other areas, and only default on their mortgage as a last resort.

As housing investment has come to dominate the financial sector, the impact of house-price changes on the economy has become more important. A study that looked at nearly 150 years of data across 17 countries found that households are borrowing more, and mortgages have become a larger share of all lending. In New Zealand mortgages have risen from less than 10% of all bank lending in the 1970s to 25% in the mid-1990s, and over 50% in 2015. This means that financial and economic stability has become increasingly linked to housing booms, which are typically followed by deeper recessions and slower recoveries.

Another recent study has found that, inter- nationally, housing booms have become longer and their subsequent busts are more painful for the economy.10 The same pattern applies in New Zealand, where house-price cycles (the time from the bottom to the top of the market) are getting longer. The typical cycle in New Zealand has gone from around three years in the 1970s to six years in the 2000s boom, and the latest cycle is four years and counting.

This point is especially important because the international evidence suggests that action should be taken within the first six to seven years of a boom.11 We are now in that phase where coordinated action by policy-makers is necessary to avoid the costs of sharply accelerating house prices and the risks of a potential future downturn. If the poor policies that lead to housing bubbles are not fixed, the booms get longer. The longer house-price booms last, the more speculative they become. The more house prices rise, the more people speculate that house prices will rise further and the more they buy houses at even higher prices, typically with high levels of debt. And that just makes the inevitable bust even more painful when it finally arrives.

Copyright © Shamubeel Eaqub and Selena Eaqub. Generation Rent: Rethinking New Zealanders’ priorities is published by BWB Texts (Bridget Williams Books, Wellington). Reprinted with permission