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Average house price inflation to halve.

New Zealand’s average house prices have increased strongly in recent years. Between 2011 and the middle of this year the average house price in Auckland has gone up by 160% while for the rest of the country the rise has been 140%.

There are three key factors above all others which explain house prices rising near 150% while average wages have risen by just 33%. First, because of the 2008 recession and then the Global Financial Crisis (GFC), house construction in New Zealand fell to the weakest levels since the 1960s by 2011.

Second, net migration boomed right after this collapse in house construction courtesy of a net migration surge from 2014 adding an extra 390,000 to the population – a boost of about 8.6%. Our population has grown some 18% since 2012.

Third, interest rates were slashed in 2008 to fight the effects of our recession and then the GFC. When growth in the economy picked up, inflation failed to appear as expected. Reacting to this the Reserve Bank had to cut interest rates further and even before the global pandemic started the official cash rate had fallen to 1.0% from the 2.5% it was cut to for fighting the GFC.

Now we have things moving in the opposite direction.

Firstly, the number of consents issued for new dwellings to be built stands at a record high and continues to grow as all stops are pulled out to try and build as many houses as possible as quickly as possible.

Secondly, net migration has been almost zero over the past year and as the world eventually settles into a new, largely vaccinated, normal, we may see net negative migration flows for a while. We Kiwis are highly mobile internationally, especially across the Tasman. In Australia there are labour shortages across numerous sectors, and it is highly likely that over the next three years a substantial number of New Zealanders will shift to take advantage of higher wages.

Thirdly, interest rates have ended a three-and-a-half-decade period of falling. As they rise a number of potential house buyers will find themselves no longer in a financial position to be able to make a purchase. Some may also find they need to sell.

On all three fronts the case is made for the average pace of house price gains over the next ten years to be substantially less than the gains seen over the past ten. The average annual rise in house prices since 2011 has been about 10% in Auckland and near 9% elsewhere.

Over the next ten years average increases are likely to be around half those rates – roughly 5% and 4.5%. This will make a big difference to the pace with which one accrues wealth through property ownership, especially taking into account the greater costs of running a rental property these days and the loss of ability to deduct interest expenses on existing properties.

Is this altered outlook likely to cause a great wave of money to leave the housing sector? No. Residential property investment is still the only investment vehicle which a bank will eagerly gear one into. It is also accessible to the average person, and interest rates are highly unlikely to get to levels which will make people once again consider simple bank term deposits to be a good way to generate income in one’s retirement.

But when we take into account the shift of the Baby Boomer population cohort towards slowly divesting themselves of their housing assets, a structural shift in average annual house price inflation looks highly likely and for that reason the focus of investors will need to shift towards maximising yield as well as long-term capital gain.

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