Liam Dann: The great New Zealand house-price delusion


Markets where prices never fall are unhealthy and almost always artificially distorted by bad policy.

Share markets rise and fall every day.

Every year or so they fall a lot – more than 10 per cent and we call that a correction.

Once a decade or so they crash – falling more than 20 per cent in a short space of time.

No one likes a crash but the phenomenon is understood and accepted by investors.

The top fund managers and brokers in this country regularly warn that shares are over valued and talk openly the idea that corrections are healthy.

Corrections lessen the risk of more damaging, uncontrolled crashes.

They realign company values to real world profits. They clear out the dead wood.

The forest fire analogy is a popular one because it suggests a natural cycle of growth destruction and renewal.

Smart investors remain constantly alert to the turn of the cycle. They have strategies in place for when it inevitably occurs.

They’ll tell you that a sharp correction or crash is really just an opportunity to go bargain hunting.

Growth still wins.

So, smart or not, sharemarket investors make money over time.

You just have to do the basics right and not panic when prices fall.

That is the first bit of advice you’ll hear from Warren Buffett – one of the smartest investors of all time.

By and large New Zealanders get this now.

Back in 1987 we didn’t. Back then Kiwi investors were unsophisticated.

We thought prices could only rise. We let a market bubble blow-up and when it popped we panicked.

It took years for New Zealand equity markets to recover from the 1987 crash – much longer than the rest of the world.

But it did.And with the help of schemes like KiwiSaver, our attitudes to sharemarket investing has matured.

Compare that with the delusional attitude New Zealanders still have to the housing market.

When it comes to housing, we treat the prospect of any price falls as some kind of social apocalypse.

We (almost) all agree that prices are rising too fast and house prices are over inflated but we can’t seem to accept that they have to fall.

That mass delusion is manifest in the inability of either National or Labour politicians to acknowledge prices should fall.

There is a political divide and plenty of debate about the primary drivers of house price inflation.

But both major parties claim that they aim to make houses more affordable.

Ironically, the formula both parties lean on to achieve that would be considerably more damaging to the economy than a short, sharp correction in prices.

Let’s breakdown what politicians are really saying when they talk about affordability without price falls.

Both are suggesting a long period of market stagnation.

Infometrics economist Brad Olsen crunched some affordability numbers last week using a simple but illustrative metric – a multiple based on the ratio of median household incomes to median house prices.

Let’s just consider his most conservative scenario – a return the affordability we had in 2011, when prices briefly plateaued – a ratio of five times median income.

That multiple is currently approaching seven times median income.

A return to multiple of three – which is the international benchmark of affordability (and the norm in New Zealand before 2001) is probably just too great a leap.

But just to get back to those 2011 levels we’d need prices to fall by 25 per cent or incomes to rise by 34 per cent.

If price rises stopped dead right now it would take at least a decade for wage inflation to balance the equation.

And that kind of decade-long market stagnation would be terrible for the economy.

It would suck the life out of the large property sector that creates jobs – from real estate agents to tradies, landscape architects, interior designers.

A sharp correction on the other hand might cause short-term pain but would quickly create real opportunity for first-home buyers and investors.

I don’t know whether to cut the politicians a break on this or not.

They have to be pragmatic to stay in power.

But they must know this obsession with maintaining house price growth at all costs is flawed.

And it is ultimately their job to lead and to shape public opinion – isn’t it?

A house price fall of 25 per cent would be a shock. There might be some casualties but we’d get through it.

Owner-occupiers should fear rising interest rates more than price falls.

Investors who have been in the market for more than two years would still be ahead and – unless their financial affairs are a poorly structured – they should be able to look through short-term losses.

But it would be better to address affordability with a market that turns through realistic cycles with regular periods of mild contraction providing opportunity for new entrants to the market.

We will not see any real change on house affordability until Kiwis (and our political leaders) acknowledge that markets where prices never fall are unhealthy and artificial.

We need to make that mental shift now.

Not just for first-home buyers but for all those with a vested interest in the long-term health of the property sector.

Sadly I don’t expect we will.

I expect it will take an 1987-style crash to get us there.

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