The best is some way off

The worst may be over but don't expect a boom just yet. Khoon Goh gives his predictions for the year ahead

The New Zealand economy is on the road to recovery. While growth is unlikely to be spectacular, at least it is growing as opposed to contracting. On the face of it, this should be positive for the housing market. But not everything will line up in its favour over 2010. In this month column, I outline my four predictions for the year ahead.

Prediction one:
Interest rates are heading higher. Floating mortgage rates hit 40 year lows last year and it looks set to stay that way over the first half of this year at least. Thereafter, it will be heading higher, as the Reserve Bank starts to take the Official Cash Rate (OCR) back towards neutral levels. I see the floating rate heading past 7% by the end of this year. Fixed mortgage rates will not rise by as much, mainly because they have already risen last year in anticipation of higher future tightening by the Reserve Bank and also as a result of new regulatory requirements that increase the cost of borrowing for financial institutions.
The days of an inverted yield curve are long gone. The mortgage curve will stay upward sloping, with the two-year fixed rate heading close to 8% and the five-year rate moving past 9%. This means for borrowers wanting certainty of repayments, they will have to pay a premium for it. Those wanting the cheapest possible mortgage rate will have to live with greater volatility in their repayments by going floating or fixing for much shorter durations. On the positive side, this also means that the Reserve Bank will not need to take interest rates as high.

Prediction two:
The housing demand-supply equation will swing around, due to a drop-off in the former and an increase in the latter. On the demand side, there is no doubt that strong net migration inflows last year provided a good level of funda¬mental support to the housing market. But most of the net migration gains were due to a sharp drop-off in the number of New Zealanders: emigrating, especially to Australia, rather than a large influx of new immigrants.
With the Australian economy growing much stronger than New Zealand's and employment prospects there picking up already, I expect departures to Australia to steadily rise as the year progresses. Overall net migration will still stay positive, but closer to 10,000 annualised rather than the current rate of over 20,000. On the supply side, I expect building consents to pick up from the current depressed level of around 1,200 a month towards 2,000 a month.

Prediction three:
Regulatory and tax changes impacting on the housing market will be introduced. At the time of writing, the recommendations of the Tax Working Group and the details of the government's Budget Policy Statement have not been released yet. But there have been enough noises coming out of policy circles to know that changes are coming.
Capital gains tax has been ruled out, but I see changes coming for LAQCs and trusts, which may include ring-fencing of tax losses and changes to depreciation rules. A land tax cannot be ruled out, though this is politically a hard sell at present. Stricter prudential regulation governing banks is also likely to be introduced, which will change the appetite to lend towards residential investment property.

Prediction four:
Housing price gains to ease but rents to rise. The strong rebound seen in house prices since hitting a low in early 2009 look premature in my view. A shortage of listings has been behind the price rise. But as interest rates rise and net migration gains ease, at a time when housing supply starts to pick up and we have changes occurring on the tax and regulatory front, we will see house prices stall and track sideways for most of the year. There is no getting away from the fact that house price valuations still look stretched and we have not had a decent house price cor¬rection following the 2002-2007 house price boom. Prices cannot continue to defy gravity forever.
A bright spot will be rents, which have been static for the past two years. With prospects of capital gains limited and tax changes set to alter the invest¬ment equation for property investors, yield and cash flow will become more important considerations. But there is only so much that rents can rise, given that overall wage growth will remain sluggish this year. This means the onus is on house prices to do more of the adjustment in order to get the investment criteria to stack up.

In summary, I am not expecting the start of a new housing market boom. I still think we are half-way through the correction that started in late 2007, with the rebound seen last year giving way this year. The worst may be over, but the best is still some way off.

Khoon Goh is a senior economist at ANZ Bank

Article from NZ Property Investor Magazine January 2010