House prices and affordability

Abstract

The decade following the global financial crisis (GFC) has witnessed rampant house price appreciation in many cities of the developed world. The metropolitan centres of New Zealand showcase this phenomenon with house price appreciation persistently outpacing income growth. In Auckland, the ratio of prevailing median house prices to median household income rose from 6.4 in 2010 to 10.0 in 2016 (Demographia, 2011, 2017), before declining to 8.6 by 2019 as house prices flat-lined while household incomes increased (Demographia, 2020). However, a strong resurgence in house prices during 2020 means that this ratio has resumed its upward trajectory, with an increase of approximately 16% set against an increase in average household income of only 4.4% for the year through to June 2019 (Statistics New Zealand, 2020). Increases over the last decade of a similar or even larger magnitude have occurred in the cities of Tauranga, Hamilton, Napier, Wellington and Dunedin. A study by the authors (Greenaway-McGrevy & Phillips, 2016) analysed data for the main metropolitan centres over 2005–2016, finding strong evidence of repeated episodes of house price exuberance coupled with clear indications of spill-over effects among New Zealand cities. In response to these developments in the New Zealand housing market, an array of policy tools has been marshalled by the government and central bank designed to curb house price inflation. The measures have acted on both housing supply and demand but broadly have met with very limited success, as evidenced by the raw data in Figures 1 and 2. Empirical results from recursive econometric tests for speculative exuberance in theAuckland andWellingtonmarkets are shown in Figure 3. These recursive tests use the methods of Phillips, Shi, and Yu (2015a, 2015b) for detection and real-time dating of asset price bubbles, and indicate the presence of real estate bubble episodes in bothAuckland andWellington housingmarkets over the two periods 2004–2006 and 2015–2016.Moreover, the latest data for Auckland and Wellington suggest a renewal of explosive behaviour in these two real estate markets in the final quarter of 2020, confirming widespread anecdotal and media evidence in late 2020 of intensive demand pressure and resulting FOMO1 in real estate activity in New Zealand. In response to these recurrent developments over the last two decades, central government has recent sought to restrain housing demand by reducing foreign investment (through the Overseas Investment Bill) and by restricting investor speculation (through the Taxation (Bright Lines Test for Residential Land) Bill).2 In addition, macro-prudential policies by the Reserve Bank of New Zealand have sought to restrict access to credit through maximum load-to-value ratios (LVRs) that serve to cool down housing demand (Armstrong, Skilling, & Yao, 2019). These policies contributed to stabilizing house price appreciation for a few years after 2016, as evidenced in Figure 1. But these cooling measures have not led to noticeable reductions in house prices or improvements in affordability as measured by median price-to-income ratios. The latest data for 2020 indicate a renewal of rampant house price inflation that is contributing further to unaffordability.