It’s hard to disagree with the New Zealand government’s recent assessment that the country’s runaway housing market has moved from mere boom to a bubble that endangers the whole economy. Prices rose a staggering 23% over the past year, putting home ownership way beyond most people not already on the fabled ladder – younger, first-time buyers especially. If it walks like a bubble and talks like a bubble, then it must be a bubble, right?
The only problem is that bubbles might not be what they used to be. House prices are being steadily inflated in many other developed economies such as the US and UK. In Australia, prices rose 2.8% in March, the fastest monthly growth for 33 years. But governments are in no hurry to copy Jacinda Ardern’s canary in the coalmine moment, as the renowned Société Générale economist and market sceptic Albert Edwards has dubbed it, and instruct central banks to make dampening prices part of monetary policy.
Quite the opposite, in fact, with the pandemic crisis seeing interest rates slashed last year to yet more all-time lows. The all-powerful US Federal Reserve sets the tone for other central banks and is telling financial markets that ultra-low interest rates could be with us for years. Along with first-time buyer incentives and building grants, low borrowing costs look like ensuring that property prices will keep rising despite the coronavirus recession.
So while a bubble might be defined as a market where rising prices are not justified by the fundamentals, the era of cheap money ushered in by the global financial crisis and sustained by Covid, has fundamentally changed those fundamentals. There is an expectation that authorities will do anything necessary to keep the party going.
Damien Klassen, head of investments at Nucleus Wealth in Melbourne, believes that the distortion of the property market has further to go because there is more scope for interest rate cuts in western economies.
He points to the eurozone where the base rate is now -1%. In Germany, you can get a 10-year fixed-rate mortgage for 0.3%. Japan, where a stock and property bubble burst 30 years ago, has used massive government stimulus and ultra-low rates to stabilise the economy ever since and mortgage rates are also below 1%. What once might have looked like a bubble might just be the new normal.
“House prices are all about affordability,” Klassen says. “Wages are not rising, so affordability depends on rates. Mortgage rates can easily go lower. Look at Europe.”
Price action suggests it is a powerful example. Towards the end of last year, the investment bank UBS published a report called the Global Real Estate Bubble Index which listed the cities most at risk of a property bubble.
Using factors such as price-to-income ratios and local market distortions (eg, interest rates), it rated Munich and Frankfurt most at risk, with Paris, Amsterdam and Zurich rubbing shoulders with perennials such as Hong Kong and London in the top 10. New York came in 18th, just behind Sydney at 16th. New Zealand was not covered in the survey, although Auckland has often been rated among the least affordable cities in the world.
The UBS index shows the housing boom may have some way to go in countries such as the US and Australia. In the latter, the base rate is 0.1% so the banks can borrow cheaply under the Reserve Bank’s term funding facility and lend that money on to customers at, say, 2%. Although most economists don’t expect more rate cuts, the last few years have shown that the first hint of economic crisis leads to ever-cheaper borrowing costs.
Ben Udy, Australia and New Zealand economist at the consultancy Capital Economics, expected prices to keep rising while rates were so low.
“We don’t think asset classes are overvalued or ripe for bubble bursting,” he says. “Long-term house prices depend on supply relative to demand. Short-term, some people have more money because of the lockdown and that has caused prices to rise.”
Nevertheless, Capital expects prices to start cooling as the pent-up demand built up under Covid lockdowns subsides and grants and incentives are withdrawn. New Zealand’s central bank is now on notice from the government to help curb prices, and property investors face a tougher tax regime to dampen what Ardern calls “speculation”. Udy thinks the RBNZ will hike rates next year. He also thinks Australia’s macroprudential regulator, Apra, will toughen lending standards later this year as credit growth explodes.
However, the wider picture is that the global economy is stuck in a race to the bottom: without a reversal in the decades-long stagnation of wages, interest rates will remain low, and house prices will remain high.
“Australia is stuck in same debt trap as everyone else where we’ve got so much debt we can’t raise rates because it makes it more difficult for people to pay back debt,” says Klassen. “To get more growth we have to cut rates, so people borrow more and the cycle goes on.”
Joe Biden’s gigantic stimulus packages for the US economy could spark a change, he says, if mass New Deal-style work schemes push up earnings and growth comes from real spending power instead of debt.
In the meantime, other ingenious ways could emerge to keep the property juggernaut trucking along, perhaps again following the Japanese example and extending the term of repayments beyond the natural span of a lifetime to 100 years.
“It’s like frogs in boiling water,” says Klassen. “Once mortgages were for 20 years, then 25, now 30. Soon it will be 50. Many people will never pay it back, so owning a home will become like renting – just that it’s renting from the bank.”