New Zealand real estate’s epic run is fast approaching its end, and a correction looms. That was the take in the Reserve Bank of New Zealand‘s (RBNZ) May 2022 Financial Stability Report. The central bank called housing unsustainable and said gradual price declines are desirable. However, they warn a significant correction is possible.
New Zealand Real Estate Prices Are “Unsustainable” and A Correction Is Possible
RBNZ warns home prices are unsustainable and may result in a significant correction. Prices in the country have climbed much faster than low rates and incomes support. RBNZ prefers a soft landing, that would inflict the least amount of pain on the economy. However, exuberance is an unpredictable and emotional state that’s not easy to engineer.
“… a gradual adjustment to a more sustainable level is desirable for the stability of the financial system; a larger correction remains a possibility,” wrote RBNZ in the Financial Stability Report.
The central bank warns homeowners present a risk to the financial system in a correction. New buyers with less equity are “particularly vulnerable to house price declines,” wrote RBNZ. Those with less equity can be in a difficult position if forced to sell.
The drop in home prices can also lead to a drop in housing wealth, leading to less spending. Consumers reducing their spending significantly can trigger a recession. Though one imagines soaring shelter costs also reduces consumption.
New Zealand Home Prices Have Been Falling, But Are Still High
New Zealand home prices have been falling after making an epic run over the past few years. RBNZ estimates home prices fell 4.3% since peaking in November 2021, after rising 48% over the prior two years. The decline is substantial but barely puts a dent in recent gains. CoreLogic data showed similar results earlier this week.
“House prices remain above sustainable levels despite recent declines,” reads the report.
Rising Mortgage Rates And Leverage Reduction Reduced Demand
The decline in home prices has been a combination of factors, including some policy moves. Mortgage costs remain relatively low but are the highest they’ve been in half a decade. Banks raised the mortgage “stress test” rate for borrowers, reducing leverage. The tax deduction of interest from rental income also lowered investor profits.
RBNZ mentions one measure in particular may have had an impact — the tightening of the loan-to-value (LVR) for owner-occupied homes in November. They observed a nearly immediate drop in demand for mortgages.
Rising rates to cool inflation’s multi-decade high is cooling housing demand quickly. Higher financing costs, along with other demand reduction plans, finally slowed bubble growth. While a soft landing is desired, they rarely happen. They also tend to reinforce a bubble mindset, since the speculation results in no consequences.