BNZ Weekly Overview. Mission Statement. Staff Shortages ISSN

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1 BNZ Weekly Overview ISSN May 2018 Mission Statement To help Kiwi businesspeople and householders make informed financial decisions by discussing the economy and its implications in a language they can understand. Staff Shortages I was reading the NZIER s latest set of Quarterly Predictions this week and came across something which surprised me, so I went and gathered the data just to be sure. The proportion of the workforce engaged in construction is running at its highest level since records started in the form of the Household Labour Force Survey back in For three years now about 9.5% of everyone in work has been engaged in the construction sector. This is up from a previous peak near 9% just before the GFC. It would be optimistic to predict that this proportion can go even higher in the context of an increasingly tight labour market in New Zealand and seeming trend reduction in the relative productivity of construction sector workers. That is, the ratio of construction employment as a % of all jobs to construction sector output as a % of GDP has been trending up since the 1980s. This is shown in the third graph following this next one which includes construction as a % of GDP. Construction globally is a sector in which productivity growth remains far below improvements in other sectors, mainly because very little of it can be streamlined, standardised, automated etc. Currently many businesses in the sector are finding it hard to make a profit because of hikes in input costs including labour, uncertainties about supply deliveries etc. Yet pressure to hire more to build more continues to grow. The number of consents issued to build a new dwelling rose in seasonally adjusted terms by 10.7% over the three months to April. Page 1

2 A small 3.7% fall in the month of April was easily outweighed by strong rises in February and March. Annual consents now sit just above 32,000 for the first time since 2004 when they peaked just over 33,000. In addition to this volume measure, the value of consents issued for the construction of all other types of buildings in April was 29% ahead of a year ago and full-year growth has been 5.2%. The total adds up to $6.7bn from $4bn five years ago. There are many things to be built but insufficient resources for doing it. If you are getting something built be prepared to pay more if your contractor comes asking for it, perhaps because they are paying more for their inputs and without more money from you they will cancel your job and contract at better prices to someone else. Already we are seeing an increasing number of apartment/townhouse developments having to go off the market for redesign or repricing because costs have jumped so much profits have disappeared. Housing One of the key arguments which proponents of legislation hitting property investors make is that valuable capital will be redirected toward more worthwhile things like business growth. But what they fail to acknowledge when making such a justification is that property investment relies massively upon borrowed money. Property investors write books and lecture people on the simple maths of using someone else s money to fund property purchases a bank s. Banks will lend against the security of a property. But virtually no investor borrows money to invest in shares, not least because banks do not want shares as security against a loan. Experiences from the 1980s show this is a very dangerous practice given that whereas house prices don t usually fall and if they do it is not usually by much, prices of shares in even the best rated blue chip companies can massively fall away in unpredictable circumstances. Nonetheless, opponents of housing as an investment still claim there is over-investment in housing. From the point of view that new entrants to the housing market have to pay more relative to income than previous generations they have a point. But when it comes to measuring overinvestment as over-production they are wrong. In Ireland, Spain, Portugal and the United States ahead of the GFC there was over-investment in housing in that not only did prices soar but so did house output. As we went to pains to point out over New Zealand did not produce excess houses ahead of the GFC. And now we have a situation where the government is trying to direct more capital (investment) into housing construction because of the shortage of state housing generally around many parts of the country, affordable housing in many cases, and housing generally in Auckland. These are three related but different things. The factors accounting for Auckland s housing shortage are numerous and deep-seated and the government has had enough sense not to state any goal of reducing that shortage. Probably noone but the Minister of Housing believes the government will be able to build 100,000 affordable houses over a decade and make a good dent in housing affordability. If the comments of the previous Housing Minister are Page 2

3 anything to go by the current incumbent will express 100% confidence in his ability to achieve the 100,000 goal right up until he is moved aside from his position. At some point, whilst verbally sticking with the 100,000 plan, the government is likely to concentrate its own attention and later the media s attention on the assistance housing goals building state houses and housing the homeless. That is where they have the best chance of making a valuable contribution toward improving the social fabric of our country. It is easy to imagine also that eventually eligibility criteria will be brought in for KiwiBuild homes, restricting purchases to people such as nurses, teachers, and police. By all means from a capital gain forecasting point of view, factor in growth in housing supply over the next few years being greater than growth in the past decade or two. But one would be going a long way out along a thin branch to assume that either Auckland s housing shortage will be addressed or that housing affordability will be much improved especially if you measure affordability as ability to buy a house providing the same level of service as that gained by your parents or grandparents. You will almost certainly get a house with better plumbing and insulation. But you ll get minimal or no section for the kids to play in. You ll probably be in a townhouse or apartment. And/or you will be a long way from your daily worksite. For your guide, builders are being asked by the government to strip out as much as they can from the houses they are being asked to build to contribute toward the affordable goal. What exactly is being stripped out from the new-builds is unclear. But if it is stuff that the young couple can add later through their own labour then that would frankly seem to be a good idea. After all, in the old days plenty of people started with just the basic house plonked on a section scraped of its topsoil and later on they added said soil, a garage, paving, etc. Living in a garage to start with is virtually impossible these days however because of building covenants placed upon sections when sold by a developer. Investor Attitudes For your guide, I have spoken recently at a number of property investor-focussed functions. Attention is firmly on things people expect to slow the market, potentially raise interest rates, and cause other investors to sell. Sentiment is generally downbeat and few see any potential for firm price rises in the near future. Thinking is very much around the cycle having completed its up leg in Auckland up to two years ago, the market sitting flat for some years now with improving affordability, then a new cyclical acceleration in price rises somewhere down the track. People think in terms mainly of a ten year cycle (they used to say seven). That means in the absence of any true market manipulation by either the government or Reserve Bank that it would not seem reasonable to expect any decent acceleration in price rises until perhaps three years from now give or take. Until then skilled long-term investors are taking the opportunity to rationalise their portfolios, including throwing in some low bids at auctions of properties which nervous investors want to dispose of. Some people still think that there will be a bloodletting, that there will be widespread bargains to be had with prices falling away quite a lot. For subdividable sections in Auckland this may happen as lack of builders and development finance means timing for realising value from these large house sites will be a lot longer than the purchasers were thinking. But in a general sense there are two reasons why this period of correction will not be what many potential buyers are hoping for. One of those reasons is not the shortage of properties in Auckland. That shortage is a big component behind the shifting of Auckland s equilibrium prices from where they were in 2009 to where they are now. But a given shortage does not keep having that effect. Instead the two relevant elements are these. First, it is very unlikely that interest rates will rise by much this cycle if they ever rise at all. Around the world inflation refuses to appear and much as government efforts are being made to boost wages growth in New Zealand it is very unlikely that businesses will be able to much recoup higher labour costs with higher prices as we Page 3

4 consumers will simply shop online for something cheaper instead where possible. Second, to get bloodletting you first need the truly uninformed, undercapitalised panicky buyers to have entered the market and that did not happen this cycle. Why? Because at the time when that bottom layer of the investor pyramid was getting itchy feet and thinking about gearing up their grandmothers house to dive in, the Reserve Bank in late-2013 brought in new bank credit controls via the loan to value ratios. That made such buyers hesitate. They blinked and backed off. The RB s timing of the first LVRs was excellent, coming less than two years into the period when Auckland house prices were really rocketing along from early The existence of the LVRs and their strengthening also means such uninformed buyers never started diving in once the regions started moving up in lagged response to Auckland s surge. For your enjoyment here is a graph showing the annual pace of change in Auckland median house prices from The rate of price increase peaks were in 1974, 1982, 1987, 1996, 2003, and The years when strong house price inflation disappeared were 1975, 1983, 1988, 1997, 2008, and other income will make times hard for many investors. Some will sell, fewer will buy. The Reserve Bank also wants to get a debt to income ratio tool in place. Timing on this is unknown and if they did have it they would not be using it in the near future. Given that 39% of all new mortgages by number have DTIs above 5 according to this week s Financial Stability Report (the loan is more than five times the borrower s annual income) a DTI regime would hit many borrowers. According to the RB s June 2017 consultative paper on DTIs, for the five biggest NZ banks some 60% of new investor loans by value had DTIs above 5 versus 35% for all other loans. /media/reservebank/files/publications/policy- development/banks/dti/consultation-paper-dtis- June-2017.pdf?la=en For Auckland 60% of new loans were at a DTI over 5 versus 30% in the rest of the country. But the RB feels these proportions are biased upward, especially for investors, by under-reporting of income and work on obtaining accurate data is continuing. Note that contrary to what I said to a large audience last weekend, both the UK and Ireland Loan to Value regimes exclude buy-to-let lending and the debt total applies to the loan only, not all of the household s debt as the RBNZ is considering. If and when a DTI or LTI regime is introduced it will have the effect of shifting investor purchases toward lower-priced properties thus worsening affordability for first home buyers whilst making relatively cheaper the second stage group of the housing stock. But what people really want to try and get a feel for at the moment is when the next period of firm rises might start. The graph shows previous such periods started in 1971, 1979, 1984, 1994, 2002, and If we take recent history as providing the best guide one s pick would be Good luck. Enjoy the 4-5 year lull from late Two years down, two or three to go. Probably three because the coming ring fencing of investor property losses away from offsetting tax bills from So it seems much more reasonable to expect that the next period of rapid price gains starts in potentially late-2021 rather than late For your guide, as previously mentioned here, I remain of the view that before year-end the Reserve Bank will make another small easing of the LVR rules. Late last year they cut the minimum investor deposit from 40% to 35% purchase price and said 15% of bank lending to non-investor buyers could be where the deposit was less than 20%, an improvement from only 10% of such lending. No easing signal was given Page 4

5 in this week s Financial Stability Report but the next one in November will likely have something (35% to 30% maybe) as long as home lending growth does not accelerate away by then. Here is what the above graph looks like if you adjust house price inflation for consumer price inflation (cost of living change). The patterns are the same, the levels differ. higher wages growth. Ability to service debt is strong. Society wants young people to be able to buy a house. That is good for lending to property buyers. But staff shortages are getting worse and that means builders face growing problems meeting construction deadlines, meeting quality standards passing council inspections, containing costs, and securing timely supplies. The tight labour market affects builders/developers differently from actual buyers and the huge likelihood that the labour market will get much, much tighter says that if credit availability is further restricted it is the dwelling construction side which will be more affected than the demand side. This increases the chances the affordable house price for the government s KiwiBuild programme in Auckland gets pushed up to $700,000 having already been raised from $600,000 to $650,000. And if you think deflating house price changes by the CPI is the right way to do things, don t forget to do it for every other price and returns calculation you do as well returns on equities, term deposits, wages etc. Are You Seeing Something We Are Not? If so, me at tony.alexander@bnz.co.nz with Housing Comment in the Subject line and let me know. If I Were A Borrower What Would I Do? An er this week wondered whether the weakening of the NZD and rise in petrol prices would, by lifting inflation, prompt the Reserve Bank to tighten monetary policy. I replied as follows. Credit Availability Regarding housing credit supply. Putting aside DTIs for now, which of these is more likely to happen in a world where credit availability in the residential property sector has been tightening up for some years. Banks restrict credit to buyers - demand? Banks restrict credit to developers - supply? Look at it from a macroeconomic point of view. The labour market is very strong with potential for The critical point to note here is that the rise in petrol prices is a one off and the Reserve Bank can specifically look through such shocks (especially as this is a very little one) when calculating underlying inflation and setting monetary policy. Their interest at such times is primarily in the extent to which the rise in inflation will feed through into higher inflation expectations and wages then price-setting behaviour. Given the continuing absence of any decent acceleration in wage inflation globally it would be a bold call to expect them to anticipate the slight lift in inflation from 1.1% due to higher petrol prices and a fall in the NZD back to where it was two years ago to generate a surge in wages growth. Also there is a Page 5

6 crucial element to the rise in petrol prices which in effect already does the anti-inflation work of higher interest rates. Higher petrol prices are effectively a tax on Kiwis as the money flows offshore. So restraint on consumer spending growth in other areas is already underway. So I see virtually zero interest rate implications from the currency and oil price movements and as ever await actual rising inflation and evidence that any rise will continue. I think the Reserve Bank is probably of the same opinion and will be unwilling to risk a third experience of raising interest rates post-gfc in anticipation of higher inflation only to have to cut them again. On top of that, the spread of mycoplasma bovis brings a negative hit to the rural sector and economy akin to a drought. Now let s add in the new political turmoil in Italy and resurgence of worries about the ability of the Eurozone to hold together. The Reserve Bank is unlikely to be thinking about bringing forward its current forecasts for when it starts tightening monetary policy which is from early This week the Italian turmoil has seen a substantial rally in the US bond market taking the US ten year government bond yield below 2.8% from 3% last week and 3.1% two weeks ago. This takes upward pressure off NZ fixed lending rates indirectly. But growth in bank credit risks associated with European worries and a new global selloff in bank stocks means actual bank funding costs may not decline overall. Personally I would still be fixing near the two year area. Fixing three years will suit some, but beyond that is quite expensive. The Weekly Overview is written by Tony Alexander, Chief Economist at the Bank of New Zealand. The views expressed are my own and do not purport to represent the views of the BNZ. This edition has been solely moderated by Tony Alexander. To receive the Weekly Overview each Thursday night please sign up at To change your address or unsubscribe please click the link at the bottom of your . Tony.alexander@bnz.co.nz This publication has been provided for general information only. Although every effort has been made to ensure this publication is accurate the contents should not be relied upon or used as a basis for entering into any products described in this publication. To the extent that any information or recommendations in this publication constitute financial advice, they do not take into account any person s particular financial situation or goals. Bank of New Zealand strongly recommends readers seek independent legal/financial advice prior to acting in relation to any of the matters discussed in this publication. Neither Bank of New Zealand nor any person involved in this publication accepts any liability for any loss or damage whatsoever may directly or indirectly result from any advice, opinion, information, representation or omission, whether negligent or otherwise, contained in this publication. Page 6