Interest Outlook for October

This spring sales season is shaping up as a crucial one for New Zealand's real estate market, with some are saying a turning point is approaching, or at least that headwinds are gathering on the horizon.

Sales volumes surged through the winter into the warmer months as listings rose and demand from investors remained buoyant, particularly from Auckland investors looking for properties in the surrounding cities to the north and south.

But the test heading into the summer and the subsequent big sales month of February and March is whether the strong prices and volumes achieved through the first half of 2015 can be sustained well into 2016 as Reserve Bank and Government moves to try to cool the Auckland market are introduced.

The three driving forces behind Auckland's 25% rise in house prices over the year to August remain firmly in place, and there are signs that Auckland's inflation is beginning to spill over to neighbouring cities.

Firstly, net migration hit a record high of 60,300 in the 12 months to August, including 27,900 into Auckland. Given Auckland's population per dwelling ratio of around 3, that means migration soaked up all 9,300 new houses consented over the last year. That also means the current shortage of around 25,000 houses in Auckland has not been reduced and is likely to have worsened because of natural population growth of around 15,000 per year.

Most expect net migration to slow down in the year ahead as Australia's economy improves, which in theory would reduce the number of New Zealanders returning home from Australia and increase the usual flow of young New Zealanders leaving for Australia. But economists and the Reserve Bank have been predicting a reversal of the migration surge for over a year, without much success. Australia's economy, if anything, seems to be weakening.

Secondly, the supply of new houses, offices and warehouses being built in Auckland remains insufficient to eat into the existing shortages. The Auckland Unitary Plan, which would allow more affordable and smaller apartments and townhouses to be built nearer the CBD, is unlikely to be confirmed until mid-2016 at the earliest. The Government is even having to change the law governing the Independent Hearings Panel for the Plan so it can meet more often and with a smaller quorum to deal with a swathe of objections and challenges.

Thirdly, interest rates are continuing to fall as investors crunch their numbers heading into the spring and summer. The Reserve Bank has cut the Official Cash Rate three times or by 75 basis points to 2.75% since June and most expect it to cut one more time in either late October or early December. This would completely unwind the central bank's 100 basis point of hikes in mid-2014. Some even predict further cuts to 2.0% early in 2016 if the global economy continues to slow, El Nino hits farm exports and inflation remains surprisingly weak.

One and two year mortgage rates have fallen more than 100 basis points to record lows near 4.3% over the last year and further cuts by the Reserve Bank in December and early 2016 would generate a mortgage rate with a 3 in front of it.

But there are a few headwinds that have some wondering if the rapid pace of house price inflation in Auckland could ease back through late 2015 and early 2016.

Firstly, the Reserve Bank is determined to dampen the enthusiasm of rental property investors in Auckland. It is pushing ahead with its limit on mortgages with a Loan to Value Ratio (LVR) of over 70%. Only 5% of new mortgages to landlords in Auckland will be allowed to have an LVR of over 70% from November 1.

But there is a silver lining in this cloud. The Reserve Bank has eased its first version of LVR restrictions for areas outside of Auckland so that 15% of new mortgages to both owner-occupiers and investors can have an LVR above 80%, which is a higher speed limit than the 10% in place since October 2013.

Secondly, the Government's new two year 'bright line' test for capital gains will kick in from October 1, as will tougher requirements for non-residents to report their home tax details when buying properties here. This means that from October 1 the IRD will assume that any investor who sells within two years was doing so with the intention of making capital gains, which would then be taxed at their marginal income tax rate.

Opinions are divided on whether these measures announced in the Budget will have much impact, although there are early reports that the measures to force more disclosure from non-resident investors has dampened demand.

The biggest Government intervention to affect the New Zealand market may actually come from further afield. China's Government has re-imposed capital controls to make it harder for Chinese investors to get their money out and into other property markets after more than US$150 billion was pulled out in August. Sydney property watchers have reported a slowing of demand from Chinese investors by mid-September because of the Chinese Government moves.

The final and broader headwind may come from the New Zealand economy itself. Unemployment is forecast to edge up over 6% and economic growth is seen slowing to 2% by early 2016 from over 3% in early 2015 because of lower dairy incomes and a plateauing of the Christchurch rebuild.

The bottom line:

Auckland house price inflation an annual rate of 25% in August and nationwide inflation was over 10%, with activity accelerating in markets such as Tauranga and Hamilton where Auckland investors are more active.

Most economists now expect the Reserve Bank to cut the Official Cash Rate to 2.5% by the end of the year as inflation remains well below the bank's 2% target. Fixed mortgage rates could fall below 4% in early 2016 if the central bank is forced to cut the OCR to 2%, as some expect.

The Reserve Bank's restriction on 70% LVR lending to landlords applies from November 1, while the Government's two year 'bright line' test for taxing capital gains applies from October 1.

Reference: Bernard Hickey


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