July 24, 2023 by Dymphna

Why house prices can’t actually fall

This is the key reason why a house price collapse is an impossibility, we have a shortage of housing. Yes, it’s about to get a whole lot worse.

Last week I shared some analysis from independent Kiwi economist Tony Alexander, arguing that the crash in kiwi house prices is over.

I shared it because the parallels with the Aussie market are striking.

And then over the weekend I found another one where he argues that there is never going to be a sustained improvement in affordability in New Zealand. Prices might ebb and flow with the cycle, but they’re never going back to what they were.

Basically, higher construction costs have been locked in by the pandemic. Building standards are increasing. New builds have more features than historically. Land supply is scarce and costs are inflated. And the population is growing quickly.

This means that it’s practically impossible for house prices to fall on a sustained basis.

And again, this is interesting because you could make exactly the same arguments about the Australia market:

Will housing affordability ever strongly improve in New Zealand?

No. Construction costs have not sat unchanged while prices for existing dwellings have risen on average 7% a year for the past three decades.

… The pandemic has created supply chain problems which although easing seem to have locked in higher costs for many construction inputs.

Houses are increasingly being required to meet higher, and therefore costlier, standards for many things. Insulation, earthquake standards, health and safety rules, council inspections, etc.

Councils charge more fees than in the past. People also want their new houses built to higher specs than in earlier decades. They want toilets to be on the inside and that there is more than one for instance.

There is a fixed quantity of land available within any given distance from every city’s centre. Our population in 1973 was 3 million. Twenty years later in 1993 it had grown 18% to 3.5 million.

Now, 30 years beyond in 2023 it has grown another 46% to 5.2 million. The average annual growth rate for the past three decades as the ratio of average house prices to income has risen from three to near eight has lifted from 0.8% to 1.3%.

More people, same quantity of land = land prices much higher.

Even opening up swathes of land on the fringes won’t change this dynamic much.

Mortgage interest rates trended down from the early-1990s until two years ago. The ability to service a mortgage of any given size therefore improved and that improvement led to more people looking to buy and prices being bid upward.

Lower financing costs have been baked into higher house prices.

There are other reasons. But they add up to the ratio of house prices to incomes permanently shifting upward.

Yep. It’s the exact same story here. Builds are more expensive, the population is growing strongly, and they’re just not making any more land.

And when you look at the chart of house prices to income, it tells a pretty similar story.

People still want to tell the story that house prices are going back to 1980s levels. They’re not. It won’t happen.

It can’t happen.